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# UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

# FORM 20-F

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

OR

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

For
the fiscal year ended December 31, 2005

OR

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

OR

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

Date of event requiring this shell company report __________

For the transition period from ___________ to _____________

Commission file number
001-14184

|B.O.S.
BETTER ONLINE SOLUTIONS LTD.(Exact name of Registrant as
specified in its charter)
|-----------------------------------------------------------------------------------------

ISRAEL
(Jurisdiction
of incorporation or organization)

Beit Rabin, 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

Securities
registered or to be
registered pursuant to Section 12(g) of the Act: Ordinary Shares, nominal value NIS
4.00 per share

Securities for which there is a reporting
obligation pursuant to Section 15(d) of the Act: NONE

Indicate the number of outstanding
shares of each of the issuers classes of capital or common stock as of the close of
the period covered by the annual report: 6,589,385 Ordinary Shares, nominal value NIS
4.00 per share, as of December 31, 2005



---

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Indicate by check mark if the registrant is a
well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes  o No x

If this report is an annual or transition  report,  indicate by  check-mark if the  registrant is not required to file
reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

Yes o No x

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

Yes x No o

Indicate by check mark whether the
registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.
See definition of accelerated filer and large accelerated filer in Rule 12b-2
of the Exchange Act. (Check one):

Large accelerated filer o Accelerated filer  o          Non-accelerated filer x

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

Item  17 o Item 18 x

If this is an annual  report,  indicate by check mark whether the  registrant  is a shell  company (as defined in Rule
12b-2 of the Exchange Act).

Yes  o         No x

ii

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# TABLE OF CONTENTS

|                                                                                      |   
|------------------------------------------------------------------------------------- | --
|
|
|
|
|PART I                                                                                | 1 
|ITEM 1: IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS                         | 1 
|ITEM 2: OFFER STATISTICS AND EXPECTED TIMETABLE                                       | 1 
|ITEM 3: KEY INFORMATION REGARDING B.O.S                                               | 1 
|ITEM 4: INFORMATION ON THE COMPANY                                                    | 16
|ITEM 4A: UNRESOLVED STAFF COMMENTS                                                    | 31
|ITEM 5: OPERATING AND FINANCIAL REVIEW AND PROSPECTS                                  | 31
|ITEM 6: DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES                                    | 47
|ITEM 7: MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS                             | 57
|ITEM 8: FINANCIAL INFORMATION                                                         | 59
|ITEM 9: THE OFFER AND LISTING                                                         | 61
|ITEM 10: ADDITIONAL INFORMATION                                                       | 62
|ITEM 11: QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK                    | 77
|ITEM 12: DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES                       | 78
|PART II                                                                               | 79
|ITEM 13: DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES                              | 79
|ITEM 14: MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS | 79
|ITEM 15: CONTROLS AND PROCEDURES                                                      | 79
|ITEM 16: [RESERVED]                                                                   | 79
|ITEM 16A: AUDIT COMMITTEE FINANCIAL EXPERT                                            | 79
|ITEM 16B: CODE OF ETHICS                                                              | 79
|ITEM 16C: PRINCIPAL ACCOUNTANT FEES AND SERVICES                                      | 80
|ITEM 16D: EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES                  | 80
|ITEM 16E: PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS      | 80
|PART III                                                                              | 81
|ITEM 17: FINANCIAL STATEMENTS                                                         | 81
|ITEM 18: FINANCIAL STATEMENTS                                                         | 81
|ITEM 19: EXHIBITS                                                                     | 81
|SIGNATURES                                                                            | 84

iii

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# PART I

# Item 1: Identity of
Directors, Senior Management and Advisors

Not required.

# Item 2: Offer Statistics
and Expected Timetable

Not required.

# 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, our or the Company refer to B.O.S. Better Online
Solutions Ltd. and its subsidiaries.

|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, 2005, 2004 and 2003, and the consolidated balance sheet data
as of December 31, 2005 and 2004, 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, 2002 and 2001, and the consolidated balance sheet data as of December 31,
2003, 2002 and 2001, 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, 2003, 2004 and 2005 were audited
by Kost, Forer Gabbay & Kasierer, an independent registered public accounting firm and
a member of Ernst & Young Global. 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.

1

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

Year
Ended December 31:

|                                | 2005 | 2004 | 2003 | 2002   | 2001
|------------------------------- | ---- | ---- | ---- | ------ | ----
|
|
|
|
|Revenues                        |      |      |      | 27,053 |     
|Cost of revenues                |      |      |      | 20,025 |     
|                                |      |      |      |        |     
|Gross profit                    |      |      |      | 7,028  |     
|Operating expenses:             |      |     
|Research and development, net   |      |      |      | 2,312  |     
|Selling and marketing           |      |      |      | 3,563  |     
|General and administrative      |      |      |      | 3,267  |     
|Restructuring costs             |      |      |      | -      |     
|                                |      |      |      |        |     
|Total operating expenses        |      |      |      | 9,142  |     
|                                |      |      |      |        |     
|Operating loss:                 |      |      |      | (2,114 | )   
|Financial income (expense), net |      |      |      | (448   | )   
|Other income (expenses)         |      |      |      | 1,134  |     
|                                |      |      |      |        |     
|Loss before equity in losses of |      |     
|an affiliated company           |      |      |      | (1,428 | )   
|Taxes on income                 |      |      |      | (204   | )   
|Equity in losses of an          |      |     
|affiliated company              |      |      |      | (1,750 | )   
|Minority interest in earnings   |      |     
|of a subsidiary                 |      |      |      | (223   | )   
|                                |      |      |      |        |     
|Loss from continuing operations |      |      |      | (3,605 | )   
|Net earning (loss) related to   |      |     
|discontinued operations         |      |      |      | -      |     
|                                |      |      |      |        |     
|Net loss                        |      |      |      | (3,605 | )   
|                                |      |      |      |        |     
|Basic and diluted net loss      |      |     
|per share from continuing       |      |     
|operations                      |      |      | $    | (0.64  | )   
|                                |      |      |      |        |     
|Basic and diluted net           |      |     
|earning (loss) per share        |      |     
|related to discontinued         |      |     
|operations                      |      |      | $    | 0.00   |     
|                                |      |      |      |        |     
|Basic and diluted net loss per  |      |     
|share                           |      |      | $    | (0.64  | )   
|                                |      |      |      |        |     
|Weighted average number of      |      |     
|shares used in computing basic  |      |     
|and diluted net earning (loss)  |      |     
|per share                       |      |      |      | 5,616  |     
|                                |      |      |      |        |     

2

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Year ended December 31,

|Balance Sheet Highlighted
Data: | 2005 | 2004 | 2003 | 2002   | 2001
|------------------------------- | ---- | ---- | ---- | ------ | ----
|
|
|
|
|Cash and Cash Equivalents       |      |      |      | 2,346  |     
|                                |      |     
|Working Capital (*)             |      |      |      | 4,200  |     
|                                |      |     
|Total Assets                    |      |      |      | 22,646 |     
|                                |      |     
|Short-term banks loan and       |      |     
|current maturities of           |      |     
|long-term bank loans and        |      |     
|convertible note                |      |      |      | 2,625  |     
|                                |      |     
|Long-term liabilities           |      |      |      | 2,550  |     
|                                |      |     
|Minority interest in a          |      |     
|subsidiary                      |      |      |      | -      |     
|                                |      |     
|Share Capital                   |      |      |      | 6,432  |     
|Additional paid in Capital      |      |      |      | 47,588 |     
|Shareholders' equity            |      |      |      | 11,266 |     
|                                |      |     
|(*)Working capital comprises    |      |     
|of:                             |      |     
|                                |      |     
|Current assets                  |      |      |      | 12,793 |     
|Less: current liabilities       |      |      |      | 8,593  |     
|                                |      |      |      |        |     
|                                |      |     
|                                |      |      |      | 4,200  |     
|                                |      |      |      |        |     

|3B. | Capitalization
and Indebtedness
|--- | -------------------------------

Not applicable

|3C. | Reasons
for the Offer and Use of proceeds
|--- | -----------------------------------------

Not applicable

|3D. | Risk
Factors
|--- | ------------

The following factors, in addition to
other information contained or incorporated by reference in this Form 20-F, should be
considered carefully.

This report on Form 20-F contains
forward-looking statements that are intended to be, and are hereby identified as, forward
looking statements for the purposes of the safe harbor provisions of the Private
Securities Reform Act of 1995. These statements address, among other things: our strategy;
the anticipated development of our products; our anticipated use of proceeds; our
projected capital expenditures and liquidity; our development of additional revenue
sources; our development and expansion of relationships; the market acceptance of our
products; and our technological advancement. Actual results could differ materially from
those anticipated in these forward-looking statements as a result of various factors,
including all the risks discussed below and elsewhere in this report.

3

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We urge you to consider that
statements which use the terms believe, do not believe,
expect, plan, intend, estimate,
anticipate, projections, forecast and similar
expressions are intended to identify forward-looking statements. These statements reflect
our current views with respect to future events and are based on assumptions and are
subject to risks and uncertainties. Except as required by applicable law, including the
federal securities laws of the United States, we do not intend to update or revise any
forward-looking statements, whether as a result of new information, future events or
otherwise.

Market data and forecasts used in
this report have been obtained from independent industry sources. We have not
independently verified the data obtained from these sources and we cannot assure you of
the accuracy or completeness of the data. Forecasts and other forward-looking information
obtained from these sources are subject to the same qualifications and additional
uncertainties accompanying any estimates of future market size.

Risks relating to our business:

We have had a history of
losses and our future levels of sales and ability to achieve profitability are  unpredictable.

We have incurred net losses of $3.6
million in 2005, $2.1 million in 2004 and $21,000 in 2003. As of December 31, 2005, we had
an accumulated deficit of $42.7 million. Only in the fourth quarter of 2005 did we manage
to breakeven, and there can be no assurance that this trend will continue. According to
our unaudited financial reports for the first quarter of year 2006, operating loss was
$43,000 and we ended the quarter with a net profit of $137,000, this mainly due to the
fact that we recorded a capital gain of $350,000. Our ability to maintain and improve
future levels of sales and profitability depends on many factors.

These factors include:

| |  | the
continued demand for our existing products;
| | - | -----------------------------------------------

| |  | our
ability to develop and sell new products to meet customer needs;
| | - | --------------------------------------------------------------------

| |  | management's
ability to control costs and successfully implement our business strategy; and
| | - | -------------------------------------------------------------------------------------------

| |  | our
ability to manufacture and deliver products in a timely manner.
| | - | -------------------------------------------------------------------

There can be no assurance that we
will experience any growth in sales or achieve profitability in the future or that the
levels of historic sales or profitability experienced during previous years will continue
in the future or that our net losses will not increase in the future.

Fluctuations in our
operating results could result in lowered prices, and we may be unable to maintain our gross
 profit margins.

Our sales and profitability may vary
in any given year, and from quarter to quarter. In order to increase sales and enter into
new markets with new products we may find it necessary to decrease prices in order to be
competitive. Additionally, the gross profit margin of our subsidiary, Odem, whose sales
accounted for 75% of our total sales in 2005, tends to fluctuate. We may not be able to
maintain current gross profit margins in the future, which would have a material adverse
effect on our business.

We have limited capital
resources and we may encounter difficulties raising capital.

Continued expansion requires additional
resources and especially working capital. If our efforts to raise capital do not succeed,
our efforts to increase our business and to compete in the marketplace may be seriously
jeopardized, which would have a materially adverse effect on our business.

4

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A significant part of the
revenues of our wholly-owned subsidiary, Odem Electronic Technologies 1992 Ltd.
(Odem), is from one major customer. Our business relationship with such
customer involves the following risks:

| |  | An
interruption in our business relationship with such customer would materially
adversely impactour financial results.
| | - | -----------------------------------------------------------------------------------------------------------------------

Sales to this customer accounted for
14% of our revenues in year 2005. An interruption in our business relationship with such
customer would result in a significant reduction in our revenues and in a write-off
of inventory, and would have an adverse effect on our business and results of
operations.

| |  | Significant
appreciation in the cost price of electronic components under a long term salesagreement
with a fixed sales price with this customer, may materially adversely impact ourfinancial
results.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

In September 2004, Odem entered into
a long term sales agreement with the aforementioned customer for the supply of electronic
components. The agreement provides for a fixed sales price of the components during the
term of the agreement thru December 2008. Absent the flexibility to increase our prices as
a result of increased costs of the components, significant increased costs may adversely
impact our financial results.

| |  | The
relationship with this customer requires us to hold large inventory, in order to meet its
shortlead time and delivery requirements. If we are unable to sell
this inventory on a timelybasis, we could incur charges for excess
and obsolete inventory which would materiallyadversely affect our
results of operations.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Under the agreement with Odems
aforementioned major customer, we are obligated to hold inventory of products necessary
for three months of the customers production. This requires us to incur the costs of
purchasing inventory without having an outstanding purchase order for the products. If we
are unable to sell products that are purchased to hold in inventory, we may incur write
offs and write downs as a result of slow moving items, technological obsolescence, excess
inventories, discontinued products and products with market prices lower than cost. Such
write-offs and write-downs could adversely affect our operating results and financial
condition.

We may be unable to maintain
and continue developing marketing and distribution arrangements and expand our reach into
oversea markets. Additionally, we have limited experience in selling in the Far East,
which could have a materially adverse impact on our results of operation.

In 2005, nearly half of our revenues
were generated from sales outside Israel. If we are not able to maintain our existing
distribution channels and expand to new international markets, our operating results may
be materially adversely affected. Additionally, in 2005, our sales to the Far East
accounted for 22% of our total sales. We have limited sales and marketing experience in
the Far East. Furthermore, in October 2005 Odems major supplier to the Far East
territory, opened headquarters in China. If we are unable to continue to achieve the same
Far East sale levels as were achieved in 2005, our business condition and results of
operation may be materially adversely affected.

5

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We recently sold our
Communication segment to IP Gear Ltd., a subsidiary of Qualmax Inc., in exchange for shares
of Qualmax Inc. Common Stock. If Qualmax is not successful in its business, we may
lose the value of our investment.

On December 31, 2005 we closed a
transaction for the sale of our Communications segment to IP Gear Ltd., a wholly owned
subsidiary of Qualmax Inc. (the Qualmax Transaction). The consideration was
comprised mostly of common stock of Qualmax Inc. Qualmax Inc. has a limited operating
history on which to judge whether or not this company will be successful. If Qualmax is
not successful in its business, we may lose the value of our investment, and be required
to record an impairment of the investment, which could materially affect our results of
operation. Additionally, we are entitled to earn out shares in 2006 based upon revenues
that IP Gear will generate from the sold segment, however there is no assurance that the
revenues shall be such that will grant us such earn out shares. For additional information
on the Qualmax Transaction see Item 4B.

We have limited order backlog.
If revenue levels for any quarter fall below our expectations, our result of operation
will be adversely affected.

We have a limited order backlog,
which makes revenues in any quarter substantially dependent on orders received and
delivered in that quarter. We base our decisions regarding our operating expenses on
anticipated revenue trends, and our expenses level are relatively fixed, or require some
time for adjustment. Hence, revenue levels below our expectations will adversely affect
our results of operation.

In 2004 we completed the
acquisition of a controlling stake in Odem. In September 2005, we acquired another 23.9%
of Odems shares and in November 2005, we increased our holdings in Odem to 100%. The
integration of this acquisition may interrupt the activities of the combined companies and
could have an adverse effect on our business, results of operations, financial condition
or prospects.

Our acquisition of Odem involved the
integration of a company that had previously operated independently. The difficulties of
combining Odems operations with our other operations included, and continue to be,
but are not limited to: the necessity of coordinating geographically separate
organizations and integrating personnel with diverse business backgrounds, potential
difficulties in retaining employees and the associated adverse effects on relationships
with existing partners. The integration may interrupt the activities of the combined
companies businesses and may result in the loss of key personnel. This could have an
adverse effect on our business, results of operations, financial condition or prospects.

The sales of our Connectivity
products in the US depend on one master distributor. In the event that we cease working
with the master distributor, we may experience an interruption in sales until an
alternative source of distribution can be found, which may have a material adverse effect
on our business.

We market Connectivity products in
the USA through one master distributor. In 2005, our sales of Connectivity products in the
US market accounted for 9% of our total sales and approximately 23% of our gross profit.
In the event that we cease working with the master distributor, we may experience an
interruption in sales until an alternative source of distribution can be found, which may
have a material adverse effect on our business.

We are engaged in a
highly competitive industry, and if we are unable to keep up with or ahead of the technology
our sales could be adversely affected.

We offer our Connectivity solutions
to the IBM midrange computer communications market. IBM sells competing products to our
own, and can exercise significant customer influence and technology control in the IBM
host connectivity market. We may experience increased competition in the future from IBM
or other competitors, which may adversely affect our ability to successfully market our
products and services.

We also compete against various
companies that offer computer communications products based on other technologies that in
certain circumstances can be competitive in price and performance to our products. There
can be no assurance that these or other technologies will not capture a significant part
of the existing or potential IBM midrange computer communications market.

6

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The market for our products is also
characterized by significant price competition. We may therefore face increasing pricing
pressures. There can be no assurance that competitors will not develop features or
functions similar to those of our products, or that we will be able to maintain a cost
advantage or that new companies will not enter these markets.

Some of our current and potential
competitors have longer operating histories, greater name recognition, access to larger
customer bases and significantly greater financial, technical and marketing resources than
ours. As a result, they may be able to adapt more quickly to new or emerging technologies
and changes in customer requirements or to devote greater resources to the promotion and
sale of their products, than us.

In late 2002 we decided
to wind up the business of our subsidiary, Pacific Information Systems, Inc. (PacInfo),
due to its severe financial situation.

The wind up process was accompanied
by settlements with a majority but not all of PacInfos creditors. An action by any
of such remaining creditors would result in additional costs to the Company.

Furthermore, certain actions
involving PacInfo, if occurred before the end of 2003, may have triggered a tax event for
PacInfo former owners (the Sellers). In such event, we may be obligated, under
the purchase agreement, to grant the Sellers a loan on a full recourse basis for certain
tax payments the Sellers may be liable for, currently estimated at approximately $2
million. The purchase agreement provides that the Company is to receive a security
interest in shares of the Company that the Sellers hold 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 we are required to loan
such sum to the Sellers, we may also be required to reimburse the Sellers for certain
interest on taxes that they may owe. It is possible that the windup of PacInfo during 2002
and 2003 may have triggered such a tax event for the Sellers, which would result in our
obligation to loan the Sellers such amount and to reimburse them for interest expenses
incidental to the tax event. Such a loan and reimbursement may have a material adverse
effect on our business condition and results of operations.

If actual market
conditions prove less favorable than those projected by management, additional inventory write-downs
may be required.

Inventories may be written down for
estimated obsolescence based upon assumptions about future demand and market conditions
and such write-downs could adversely affect our business condition and results of
operations. As of December 31, 2005, inventory is presented net of $100,000 general
provision for technological obsolescence and slow moving items.

Our acquisitions, to
date, have not always proved successful.

Over the past years we have pursued
the acquisition of businesses, products and technologies that are complementary to ours.
However, our acquisitions have not always proven, in the aftermath, to be successful. In
June 1998, we acquired PacInfo, which was based in Portland, Oregon, and in 2001 PacInfo
acquired Dean Technologies LLC (Dean Tech), which was based in Grapevine,
Texas. Both businesses have since ceased operations. In September 2004, we acquired the
majority of the assets of Quasar Communications Systems Ltd., which we sold, as part of
the sale of the Communication Solutions segment in 2005, as the segment did not fare well.

7

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Acquisitions involve a number of
risks, including the difficulty of assimilating geographically diverse operations and
personnel of the acquired businesses or activities and of maintaining uniform standards,
controls, procedures and policies. There can be no assurance that we will not encounter
these and other problems in connection with any future acquisitions we may undertake.
There can be no assurance that we will ultimately be effective in executing additional
acquisitions. Any failure to effectively execute and integrate future acquisitions could
have an adverse effect on our business, operating results or financial condition.

We depend on certain key
products for the bulk of our sales and if sales of these products decline, it would have a material adverse effect on us.

Our IBM midrange related products
contributed 30% of our gross profit in year 2005. If sales of our IBM midrange products
were to decline significantly for any reason, or the profit margins on such products were
to decrease significantly for any reason (including in response to competitive pressures),
our financial results would be adversely affected. 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).

To reduce the risk of such a decline
or decrease due to competitive pressures or technical obsolescence, we are continually
seeking to reduce costs, upgrade and expand the features of our IBM related products,
expand the applications for which the products can be used and increase marketing efforts
to generate new sales.

Although we are developing and
introducing new remote date access communication products and increasing our marketing
efforts, there can be no assurance that the planned enhancements or the new developments
will be commercially successful, or that we will be able to increase sales of our IBM
midrange products.

If we are unsuccessful in
developing and introducing new products, we may be unable to expand our business.

The market for some of our products
is characterized by rapidly changing technology and evolving industry standards. The
introduction of products embodying new technology and the emergence of new industry
standards can render existing products obsolete and unmarketable and can exert price
pressure on existing products.

Our ability to anticipate changes in
technology and industry standards and successfully develop and introduce new and enhanced
products as well as additional applications for existing products, in each case on a
timely basis, will be critical in our ability to grow and remain competitive. Although
these products are related to, and even incorporate our existing products, there can be no
assurance that we will be able to successfully develop and market any such new products.
If we are unable to develop products that are competitive in technology and price and
responsive to customer needs, for technological or other reasons, our business will be
materially adversely affected.

We depend on key
personnel and need to be able to retain them and our other employees.

Our success depends, to a significant
extent, on the continued active participation of our executive officers, other members of
management and key technical and sales and marketing personnel. In addition, there is
significant competition for employees with technical expertise in our industry. Our
success will depend, in part on:

| |  | our
ability to retain the employees who have assisted in the development of our products;
| | - | -----------------------------------------------------------------------------------------

| |  | our
ability to attract and retain additional  qualified personnel to provide  technological
depth and          support to enhance existing products and develop new products; and
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | our
 ability to attract  and retain  highly  skilled  computer  operating,  marketing  and
 financial          personnel.
| | - | -------------------------------------------------------------------------------------------------------------------------

8

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---

We cannot make assurances that we
will be successful in attracting, integrating, motivating and retaining key personnel. If
we are unable to retain our key personnel and attract additional qualified personnel as
and when needed, our business may be adversely affected.

We may be unable to
successfully defend ourselves against claims brought against us.

We are defendants in a number of
lawsuits filed against us, and from time to time may receive written demands for payments
from prospective plaintiffs, in the normal course of our business (for details regarding
currently pending material claims or demands, see Item 8). Legal proceedings can be
expensive, lengthy and disruptive to normal business operations, and can require extensive
management attention and resources regardless of their merit. Moreover, we cannot predict
the result of all proceedings and there can be no assurance that we will be successful in
defending ourselves against them. An unfavorable resolution of a lawsuit or proceeding
could materially adversely affect our business, results of operations and financial
condition.

We depend on third
parties licenses for the development of our products.

Third party developers or owners of
technologies may not be willing to enter into, or renew, license agreements with us
regarding technologies that we may wish to incorporate in our products, either on
acceptable terms or at all. If we cannot obtain licenses to these technologies, we may be
at a disadvantage compared with our competitors who are able to license these
technologies. In addition, when we do obtain licenses to third party technologies that we
did not develop, we may have little or no ability to determine in advance whether the
technology infringes the intellectual property rights of others. Our suppliers and
licensors may not be required or may not be able to indemnify us in the event that a claim
of infringement is asserted against us, or they may be required to indemnify us only up to
a maximum amount, above which we would be responsible for any further costs or damages.
Additionally, from time to time there may arise disputes with respect to royalties owed to
third parties from which we obtained licenses.

Indemnification of
Directors and Officers

The Company has agreements with its
directors and senior officers which provide, subject to Israeli law, for the Company to
indemnify these directors and senior officers for (a) monetary liability imposed upon them
in favor of a third party by a judgment, including a settlement or an arbitral award
confirmed by the court, as a result of an act or omission of such person in his capacity
as a director or officer of the Company, (b) reasonable litigation expenses, including
advocates professional fees, incurred by them pursuant to an investigation or a
proceeding commenced against them by a competent authority and that was terminated without
an indictment and without having a monetary charge imposed on them in exchange for a
criminal procedure (as such terms are defined in the Companies Law), or that was
terminated without an indictment but with a monetary charge imposed on them in exchange
for a criminal procedure in a crime that does not require proof of criminal intent, as a
result of an act or omission of such person in his capacity as a director or officer of
the Company, and (c) reasonable litigation expenses, including attorneys fees,
incurred by such a director or officer or imposed on him by a court, in a proceeding
brought against him by or on behalf of the Company or by a third party, or in a criminal
action in which he was acquitted, or in a criminal action which does not require criminal
intent in which he was convicted, in each case relating to acts or omissions of such
person in his capacity as a director or officer of the Company. Such indemnification may
materially adversely affect our financial condition.

9

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We may be unable to
effectively manage our growth and expansion, and as a result, our business results may be adversely affected.

Our goal is to grow significantly
over the next few years. The management of our growth, if any, will require the continued
expansion of our operational and financial control systems, as well as a significant
increase in our manufacturing, testing, quality control, delivery and service
capabilities. These factors could place a significant strain on our resources.

Our inability to meet our
manufacturing and delivery commitments in a timely manner (as a result of unexpected
increases in orders, for example) could result in losses of sales, our exposure to
contractual penalties, costs or expenses, as well as damage to our reputation in the
marketplace.

Our inability to manage growth
effectively could have a material adverse effect on our business, financial condition and
results of operations.

The measures we take in
order to protect our intellectual property may not be effective or sufficient.

Our success is dependent upon our
proprietary rights and technology. We currently rely on a combination of trade secret,
copyright and trademark law, together with non-disclosure and invention assignment
agreements, to establish and protect the proprietary rights and technology used in our
products. Much of our proprietary information is not patentable. We generally enter into
confidentiality agreements with our employees, consultants, customers and potential
customers and limit the access to and the distribution of our proprietary information.
Despite these precautions, it may be possible for a third party to copy or otherwise
obtain and use our technology without authorization, or to develop similar technology
independently. We do not believe that our products and proprietary rights infringe upon
the proprietary rights of others. However, there can be no assurance that any other party
will not argue otherwise. The cost of responding and adequately protecting ourselves
against any such assertion may be material, whether or not the assertion is valid.
Further, the laws of certain countries in which we sell our products do not protect our
intellectual property rights to the same extent as do the laws of the United States.
Substantial unauthorized use of our products could have a material adverse effect on our
business. We cannot make assurances that our means of protecting our proprietary rights
will be adequate or that our competitors will not independently develop similar
technology. Additionally, there are risks that arise from the use of intranet networks and
the Internet. Although we utilize firewalls and protection software, we cannot be sure
that our proprietary information is secured against penetration. Such penetration, if
occurs, could have an adverse effect on our business.

We rely on certain key
suppliers for the supply of components in our products.

We purchase certain components and
subassemblies used in our existing products from a single supplier or a limited number of
suppliers. In the event that any of our suppliers or subcontractors becomes unable to
fulfill our requirements in a timely manner, we may experience an interruption in
production until an alternative source of supply can be obtained.

One of Odems major suppliers
accounted for 25% of our purchases in the year 2005. An interruption in our business
relationship with such supplier would have an adverse effect on our business and
results of operations.

New industry standards,
the modification of our products to meet additional existing standards or the addition of
features to our products may delay the introduction of our products or increase our costs.

The industry standards that apply to
our Connectivity segment products are continually evolving. In addition, since our
products are integrated into networks consisting of elements manufactured by various
companies, they must comply with a number of industry standards and practices established
by various international bodies and industry forums. Should new standards gain broad
acceptance, we will be required to adopt those standards in our products. We may also
decide to modify our products to meet additional existing standards or add features to our
products. It may take us a significant amount of time to develop and design products
incorporating these new standards. A prolonged disruption in supply may force us to
redesign and retest our products.

10

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There can be no assurance
that we will not be classified as a passive foreign investment company (a
PFIC).

Based upon our current and projected
income, assets and activities, we do not believe that at this time BOS is a passive
foreign investment company (a PFIC) for US federal income tax purposes, but
there can be no assurance that we wont be classified as such in the future. Such
classification may have grave tax consequences for US shareholders. One method of avoiding
such tax consequences is by making a qualified electing fund election for the
first taxable year in which the Company is a PFIC. However, such an election is
conditioned upon our furnishing US shareholders annually with certain tax information. We
do not presently prepare or provide such information, and such information may not be
available to US shareholders if we are subsequently determined to be a PFIC.

We may be required to pay
stamp taxes on documents executed by us on or after June 2003.

The Israeli Stamp Tax on Documents
Law, 1961, or the Stamp Tax Law, provides that certain documents signed by
Israeli companies are subject to a stamp tax, generally at a rate of between 0.4% and 1%
of the value of the subject matter of the applicable document. As a result of an amendment
to the Stamp Tax Law that came into effect in June 2003, the Israeli tax authorities
have commenced enforcement of the provisions of the Stamp Tax Law.

Consequently, we may be liable to pay
stamp taxes on some or all of the documents we have signed since June 2003, which
could have a material adverse effect on our results of operations.

Recently promulgated regulations
provide for the cancellation of the stamp tax with respect to documents signed from
January 1, 2006 onwards.

We have significant sales
worldwide and could encounter problems if conditions change in the places where we market our products.

We have sold and intend to continue
to sell our products in markets through distributors in North America, Europe and Asia.

A number of risks are inherent in
engaging in international transactions, including 

| |  | international
sales and operations being limited or disrupted by longer sales and payment cycles,
| | - | -------------------------------------------------------------------------------------------------

| |  | possible
problems in collecting receivables,
| | - | --------------------------------------------

| |  | imposition
of governmental controls, or export license requirements ,
| | - | ---------------------------------------------------------------------

| |  | political
and economic instability in foreign countries,
| | - | --------------------------------------------------------

| |  | trade
restrictions or changes in tariffs being imposed, and
| | - | -----------------------------------------------------------

| |  | laws
and legal issues concerning foreign countries.
| | - | ---------------------------------------------------

If we should encounter such
difficulties in conducting our international operations, it may adversely affect our
business condition and results of operations.

The slow down in
technology markets and technology-focused corporations in prior years has had an adverse impact
on us and the value of our shares.

Our Company, like other technology
companies, has been significantly impacted by the current market slowdown in the
technology industry in prior years. There can be no assurance that the technology market
will fully recover or that our operating results will not continue to suffer as a
consequence.

11

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Inflation and foreign
currency fluctuations significantly impact on our business results.

The vast majority of our sales are
made in US Dollars and most of our expenses are in US Dollars and New Israel Shekels
(NIS). The Dollar cost of our operations in Israel is influenced by the extent
to which any increase in the rate of inflation in Israel over the rate of inflation in the
United States is offset by the devaluation of the NIS in relation to the Dollar. Our
Dollar costs in Israel will increase if inflation in Israel exceeds the devaluation of the
NIS against the Dollar or if the timing of such devaluations lags behind inflation rate
increases in Israel.

If we are forced to repay
our secured convertible note in cash, we may not have enough cash to fund our operations
and may not be able to obtain additional financing.

Our secured convertible term note
issued in September 2005, contains certain provisions and restrictions, which if violated,
could result in the full principal amount together with interest and other amounts
becoming immediately due and payable in cash. If such an event occurred and if the holder
of such note demanded repayment, we might not have the cash resources to repay such
indebtedness when due. The note is repayable in monthly installments commencing January 1,
2006, with principal payments which start at $15,000 and increase to $55,200. Subject to
certain conditions, the monthly principal and interest payment on the note may be paid in
cash or ordinary shares. If we are required to pay the note in cash rather than ordinary
shares, it would reduce the amount of cash available to fund operations. Also, in
connection with the issuance of the note, we agreed to certain restrictions upon incurring
additional indebtedness such as in case of certain mergers and acquisitions. The existence
of debt service obligations and the terms and anti-dilution provisions of the note may
limit our ability to obtain additional financing on favorable terms, or at all.

If the investor in our convertible
note financing converts or exercises its warrants, or if we elect to pay principal and/or
interest on the note with our ordinary shares, our existing shareholders will be diluted.
In addition, sales of substantial amounts of our ordinary shares could cause the market
price to go down.

To the extent that the note is
converted and/or the warrants that were issued with the note are exercised, a
significantly greater number of our ordinary shares will be outstanding and the interests
of our existing shareholders will be diluted. If these additional shares are sold into the
market, it could decrease the market price of our ordinary shares and encourage short
sales although the purchaser of the note has agreed to not engage in short sales of our
ordinary shares. Short sales and other hedging transactions could place further downward
pressure on the price of our ordinary shares. We cannot predict whether or how many of our
ordinary shares will become issuable as a result of these provisions. Risks related to our
location in Israel:

Political, economic, and
security conditions in Israel affect our operations and may limit our ability to produce
and sell our products or provide our services.

We are incorporated under the laws of
the State of Israel, where we also maintain our headquarters and our principal
manufacturing, research and development facilities. Political, economic, security and
military conditions in Israel directly influence us. We could be adversely affected by any
major hostilities involving Israel, the interruption or curtailment of trade between
Israel and its trading partners or a significant downturn in the economic or financial
condition of Israel. The future of the peace process with the Palestinians is
uncertain and has deteriorated due to Palestinian violence. Furthermore, the threat of a
large-scale attack by Palestinians on Israeli civilians and key infrastructure remains a
constant fear. The past few years of renewed terrorist attacks by the Palestinians has
severely affected the Israeli economy in many ways. In January 2006, Hamas, an Islamic
movement responsible for many attacks against Israelis, won the majority of the seats in
the Parliament of the Palestinian Authority. The election of a majority of Hamas-supported
candidates is expected to be a major obstacle to relations between Israel and the
Palestinian Authority, as well as to the stability in the Middle East as a whole. In
addition, several countries still restrict business with Israel and with companies doing
business in Israel. We could be adversely affected by adverse developments in the
peace process or by restrictive laws or policies directed towards Israel or
Israeli businesses.

12

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Generally, all nonexempt male adult
citizens and permanent residents of Israel, including some of the our officers and
employees, are obligated to perform military reserve duty annually, and are subject to
being called to active duty at any time under emergency circumstances. While we have
operated effectively under these requirements since its incorporation, we cannot predict
the full impact of such conditions on us in the future, particularly if emergency
circumstances occur. If many of our employees are called for active duty, our business may
be adversely affected.

Additionally, in recent years Israel
has been going through a period of recession in economic activity, resulting in low growth
rates and growing unemployment. Our operations could be adversely affected if the economic
conditions in Israel continue to deteriorate. Also, due to significant economic reforms
proposed by the Israeli government, there have been several general strikes and work
stoppages in 2003 and 2004, affecting all banks, airports and ports. These strikes have
had an adverse effect on the Israeli economy and on business. Following the passing of
laws to implement economic measures, the Israeli trade unions have threatened further
strikes or work stoppages, and these may have an adverse effect on the Israeli economy and
our business.

Furthermore, Israel is a party to
certain trade agreements with other countries, and material changes to these agreements
could have an adverse effect on our business.

If the Israeli Government
programs that we benefit from are reduced or terminated, our costs and taxes may  increase.

Under the Israeli Law for
Encouragement of Capital Investments, 1959, facilities that meet certain conditions can
apply for Approved Enterprise status (or be a Benefited
Enterprise, if qualified, without prior application and approval). This status
confers certain benefits including tax benefits. The existing facilities of our wholly
owned subsidiary, BOScom, have been designated as Approved Enterprises. If we attain
taxable income in Israel, these tax benefits will help reduce BOScoms tax burden.

In order to maintain our eligibility
for the grants and tax benefits BOScom receives, BOScom must continue to satisfy certain
conditions, including making certain investments in fixed assets and operations and
achieving certain levels of exports. If BOScom fails to satisfy such conditions in the
future, BOScom could be required to refund tax benefits which may have been received, with
interest and linkage differences to the Israeli Consumer Price Index.

The Israeli Government authorities
have indicated that the government may reduce or eliminate these benefits in the future. A
termination or reduction of certain programs and tax benefits (particularly benefits
available to BOScom as a result of the Approved Enterprise status of the BOScoms
facilities and programs) would have a material adverse effect on the Companys
business, operating results and financial condition.

The anti-takeover effects
of Israeli laws may delay or deter a change of control of the Company.

Under the Israeli Companies Law, a
merger is generally required to be approved by the shareholders and Board of Directors of
each of the merging companies. Shareholder approval isnt required if the company
that will not survive is controlled by the surviving company. Additionally, the law
provides some exceptions to the shareholder approval requirement in the surviving company.
Shares held by a party to the merger and certain of its affiliates are not counted towards
the required approval. If the share capital of the company that will not be the surviving
company is divided into different classes of shares, the approval of each class is also
required. A merger may not be approved if the surviving company will not be able to
satisfy its obligations. At the request of a creditor, a court may block a merger on this
ground. In addition, a merger can be completed only after all approvals have been
submitted to the Israeli Registrar of Companies, provided that 30 days have elapsed since
shareholder approval was received and 50 days have passed from the time that a proposal
for approval of the merger was filed with the Registrar.

13

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The Israeli Companies Law provides
that an acquisition of shares in a public company must be made by means of a tender offer,
if as a result of the acquisition, the purchaser would become a holder of 25% or more of
the voting power at general meetings, and no other shareholder owns a 25% stake in the
Company. Similarly, the Israeli Companies Law provides that an acquisition of shares in a
public company must be made by means of a tender offer if, as a result of the acquisition,
the purchaser would become a holder of 45% or more of the voting power at general
meetings, unless someone else already holds 45% of the voting power. An acquisition from a
25% or 45% holder, which turns the purchaser into a 25% or 45% holder respectively, does
not require a tender offer. An exception to the tender offer requirement may also apply
when the additional voting power is obtained by means of a private placement approved by
the general meeting of shareholders. These rules also do not apply if the acquisition is
made by way of a merger.

The Israeli Companies Law also
provides specific rules and procedures for the acquisition of shares held by minority
shareholders, if the majority shareholder shall hold more than 90% of the outstanding
shares.

These laws may have the effect of
delaying or deterring a change in control of the Company, thereby limiting the opportunity
for shareholders to receive a premium for their shares and possible affecting the price
that some investors are willing to pay for the Companys securities.

All of our directors and
officers are non-U.S. residents and enforceability of civil liabilities against them is
uncertain.

All of our directors and officers
reside outside of the United States. Service of process upon them may be difficult to
effect within the United States. Furthermore, because the majority of our assets are
located in Israel, any judgment obtained in the United States against us or any of our
directors and officers may not be collectible within the United States.

Risks related to our ordinary shares:

Our share price has been
and may continue to be volatile, which could result in substantial losses for individual shareholders.

The market price of our ordinary
shares has been and may continue to be highly volatile and subject to wide fluctuations.
Since January 2005 through May 2006, the daily closing price of our ordinary shares has
ranged from $2.15 to $3.74 per share. We believe that these fluctuations have been in
response to a number of factors including the following, some of which are beyond our
control:

| |  | actual
or anticipated variations in our quarterly operating results;
| | - | --------------------------------------------------------------------

| |  | announcements
 of technological  innovations or new products or services or new pricing  practices by
         us or our competitors;
| | - | -------------------------------------------------------------------------------------------------------------------------------------

| |  | increased
market share penetration by our competitors;
| | - | ------------------------------------------------------

| |  | announcements
by us or our competitors of significant  acquisitions,  strategic  partnerships,  joint
         ventures or capital commitments;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------

| |  | additions
or departures of key personnel; and
| | - | ---------------------------------------------

| |  | sales
of additional ordinary shares.
| | - | ------------------------------------

14

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In addition, the stock market in
general, and stocks of technology companies in particular, have from time to time
experienced extreme price and volume fluctuations. This volatility is often unrelated or
disproportionate to the operating performance of these companies. These broad market
fluctuations may adversely affect the market price of our ordinary shares, regardless of
our actual operating performance.

The Companys shares
may be delisted from the Nasdaq National Market for failure to meet Nasdaqs  requirements.

In late 2002 and early 2003 the
Company received notice from the Nasdaq Stock Market that its ordinary shares were subject
to delisting from the Nasdaq National Market for failure to meet Nasdaqs minimum bid
price and shareholders equity requirements ($10 million) for continued listing on
the National Market. As a result of the hearing requested by the Company and supplemental
information presented by the Company to the Nasdaq Listing Qualifications Panel by the
Company, the Panel determined to continue the listing of the Companys securities on
the Nasdaq National Market pursuant to a detailed exception to the Nasdaq National Market
Rules, and the Company successfully met all the conditions set forth in the exception.

On August 30, 2004, we received
notice from the Nasdaq Stock Market that our ordinary shares are subject to delisting from
the Nasdaq National Market for failure to meet Nasdaqs minimum market value of
publicly held shares requirement ($5 million) for continued listing on the National
Market. On November 4, 2004, we were notified by Nasdaq that we have regained compliance
with this requirement.

On January 25, 2005, we received
notice from the Nasdaq Stock Market that we were not in compliance with the minimum $10
million shareholders equity requirement for continued listing on the National
Market. Following that notice, on January 28, 2005, we received an additional notice
indicating that based on further review of our financial statements as they appeared in
our filing on Form 6-K dated January 10, 2005, it was determined that the
shareholders equity was $10,601,000 on a pro forma basis as of September 30, 2004.
Therefore we were in compliance with the stockholders equity requirement for
continued listing on the National Market and the matter had been closed.

On June 2, 2005, the Company again
received notice from the Nasdaq Stock Market indicating that based on the results for the
period ended March 31, 2005, the shareholders equity was $9,425,000, and accordingly
not in compliance with the minimum $10,000,000 shareholders equity requirement for
continued listing on the National Market. The Company was requested to provide by June 17,
2005, its specific plan to achieve and sustain compliance with the listing requirements.
The Company subsequently submitted a proposed plan of compliance to Nasdaq based upon
completing a previously announced private placement offering of its ordinary shares. On
July 11, 2005, the Company was advised by the Nasdaq Staff that contingent upon completion
of the private placement by August 11, 2005, the Staff believed that the Company had
provided a definitive plan evidencing its ability to achieve and sustain compliance with
the listing requirements. The private placement took place in June 2005, and consequently
the Company regained compliance with Nasdaqs minimum $10,000,000 shareholders
equity requirement for continued listing on the National Market. However, the Company has
been advised by Nasdaq Staff that the Staff will continue to monitor its ongoing
compliance with the stockholders equity requirement and, if at the time of the
Companys next periodic report, the Company does not evidence compliance, it may be
subject to delisting.

There can be no assurance that we
will be able to meet and continue to meet these or other Nasdaq requirements to maintain
our Nasdaq National Market listing, in which case we will have the right to apply for a
transfer of our ordinary shares to the Nasdaq Small Cap Market.

15

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# 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. We design,
integrate and test our products in our facilities in two locations in Israel. Our
headquarters and manufacturing facilities are located at Teradyon Industrial Zone, Misgav
20179 Israel, telephone number 972-4-990-7555. The facilities of our subsidiary, Odem are
located in Rishon Letzion, Israel.

We currently manage our operations
through our subsidiaries:

a)  BOScom that is engaged in the provision of Connectivity Solutions; and

b)  Odem that is engaged in
the supply of Electronic Components and solutions.

Our Connectivity Solutions
segment focuses on providing emulation solutions for the popular IBM iSeries, enabling
customers to extend its capabilities and life cycle. Our server and associated modules
empower the iSeries, providing a scaleable solution for transparent expansion and growth.
Until July 2005, the Connectivity Solutions segment also included the PrintBOS, an Output
Management solution, which provides design, print, distribution and archiving management
solutions and enables customers to cut costs, enhance brand and marketing clout, and
direct output to multiple distribution channels. The PrintBOS was sold in July 2005 (see
Item 4B).

Our Electronic Components segmentprovides solutions in RFID (radio frequency identification devices), semiconductors,
electronic components, CCD (charge  coupled device), imaging, networking, telecom
and automation. Odem is a major solution provider and distributor of electronic components
and advance technologies in the Israeli market.

The Companys Communication
Solutions segment was sold in the fourth quarter of 2005.

We constantly seek growth
opportunities by developing new marketing channels for our products in North America,
Europe and emerging markets in Eastern Europe, Asia-Pacific and South America. We intend
to continue to raise funds in order to expand operations and capitalize on merger and
acquisition growth opportunities.

On November 18, 2004, we purchased
63.8% of Odems issued and outstanding shares from Odems existing shareholders,
for $2,740,000, comprised of cash in the amount of $1,971,000 and $769,000 by the issuance
of 290,532 of the Companys ordinary shares (subject to lock-up periods
of 2 to 4 years). We purchased an additional 23.9% and 12.3% from the minority
shareholders on September 29, 2005 and November 1, 2005, respectively, and thus Odem
became our wholly-owned subsidiary. In consideration for the 12.3% of Odems shares
purchased in November 2005 the Company paid $554,000 in cash and for the 23.9% of
Odems shares purchased in September 2005 the Company (i) issued 232,603 of the
Companys ordinary shares (subject to lock up periods of 2 to 4 years)
and paid $716,000 in cash.

In addition, we have an interest in
two affiliated companies:

(a)
          Surf Communications Solutions Ltd. (Surf), a developer and global
          supplier of universal access and network convergence software solutions to the
          wireline and wireless telecommunications and data communications industries. In
          November 2001, the Company invested $1,000,000 as part of a private placement in
          Surf. At the same time, the Company converted its convertible loan in the amount
          of $1,042,000 (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 and conversion of
          the loan, the Company held 17% of Surf. Accordingly, the investment was
          accounted based on the cost accounting method.

16

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In March 2003, the Company purchased
from Catalyst Investments L.P. (Catalyst) most of the Surf shares held by
Catalyst (191,548 of Catalysts Preferred C shares in Surf, and a pro rata share of
the Surf Preferred C warrants held by Catalyst), in consideration of $1,755,000 by the
issuance of ordinary shares of the Company (representing 19.9% of its then outstanding
shares pre-issuance, as a result of which Catalyst held 16.6% of the outstanding Company
shares, after the issuance). As a result of the transaction with Catalyst, the
Companys holdings in Surf gave it the ability to exercise significant influence over
Surf and therefore the Companys investment in Surf was accounted for based on the
equity accounting method.

The Company had an option to purchase
the remaining Catalyst Preferred C shares in Surf by January 31, 2006, and until such
purchase, had voting rights in these Surf shares, in addition to being entitled to profits
resulting from the sale of these shares to a third party. The Company later assigned these
voting rights to Mr. Yair Shamir, who was a director of the Company. The Company did not
exercise its option by January 31, 2006 and it expired.

In September 2005, Surf completed a
private placement that is considered an event of change in circumstances that has a
significant adverse effect on the fair value of the investment. Therefore, the Company
evaluated its investment in Surf and determined that it amounts to $722,000 as of December
31, 2005 based on managements analysis (supported by an independent third-party
valuation). As a result, the Company recorded an impairment of $1,385,000, which has been
included in the equity in losses of an affiliated company in the statement of operations
for the year December 31, 2005.

Moreover, following the private
placement in Surf, the Companys voting rights have been diluted to 8.7% of the total
voting rights in Surf. As a result, the Company ceased to have the ability to exercise
significant influence over Surf and, accordingly, the adjusted carrying amount of the
investment of $722,000 is accounted for based on the cost accounting method.

(b)
          Qualmax Inc. (Pink Sheets: QMXI.PK), a US corporation, which is a developer and
          supplier of VoIP technology products and services (Qualmax). As of
          December 31, 2005, BOS held an approximate 16% interest in Qualmax, as part of
          the consideration received upon the sale of the Communication segment. As a
          result of the conversion into shares of the loan BOS extended to IP Gear, a
          subsidiary of Qualmax, in May 2006, BOS holdings in Qualmax increased to
          17%. On June 8, 2006, Qualmax agreed to issue to BOS an additional 250,000
          shares, on account of earn-out shares, however, these shares have not yet been
          issued (see Item 4B).

BOScom Ltd.s subsidiaries are:
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 all BOScoms subsidiaries
was ceased (only the US subsidiary still exists) and the sales and marketing in Europe and
the United States have since been conducted through master distributors. In February 2006,
BOS filed an application with the Companies House requesting the strike off and
dissolution of Better On-Line Solutions Ltd., the U.K. subsidiary.

Discontinued operation 
computer networking:

On June 1, 1998, we acquired 100% of
the share capital of PacInfo, a U.S. corporation which resold, installed and provided
computer networking products to various business entities. In 2001, PacInfo acquired 100%
of Dean Tech Technologies Associates, L.L.C. (Dean Tech). Dean Tech was an IBM Advanced
Business Partner providing complete IT solutions utilizing IBMs industry-leading
eServer pSeries and xSeries lines of servers, as well as IBM Total Storage Solutions. 100%
of our computer networking revenues were derived from sales to US customers. In the fourth
quarter of 2002, Pacinfos operation was wound up due to a change in the
Companys strategy as a result of Pacinfos severe financial situation. Dean
Tech has also ceased all operations.

17

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Our U.S. subsidiaries are Lynk USA,
Inc., and its subsidiary PacInfo, Inc. Both are non-operational and commencing the
beginning of year 2003 we market our products in the U.S. through one Master Distributor.

|4B. | Business
Overview
|--- | -----------------

# Industry Background

The Company manages its business in
two reportable segments, which consist of Connectivity Solutions and the supply of
Electronic Components Solutions. A third segment, Communication Solutions, existed until
it was sold in the fourth quarter of 2005.

# (a) Connectivity
Solutions

In the 1960s and 1970s, the business
computing environment was typically organized with the mainframe in the data center and
minicomputers at the division or department level. The host mainframe and minicomputers
were accessed by dumb terminals at the user level. These host systems featured
high performance and throughput and often ran custom-designed, critical applications such
as organization-wide payroll, general ledger, inventory management and order processing
programs. Because of the importance of the mainframe and minicomputers as central
repositories of corporate data and critical applications, significant corporate resources
were, and continue to be, dedicated to maintaining this installed hardware and software
base. Although these host systems are capable of supporting enterprise-wide information
system networks, their applications are generally characterized by limited availability,
complex command sequences and character-based user interfaces.

With the introduction and
proliferation of the personal computers in the 1980s, a substantial amount of corporate
computing power was added to the workers desktop, a change facilitated by the
availability of increasingly powerful personal productivity applications such as
spreadsheets and word processors. Personal computers began replacing dumb terminals and,
as the business computing environment became increasingly heterogeneous, organizations
found themselves with significant investments in multiple, but often incompatible, systems
each performing different functions within an organization.

Despite the functionality of personal
computers, users still needed access to certain data and applications residing on host
systems. Terminal emulation hardware and software was developed to provide host
connectivity by allowing personal computers to emulate the dumb terminals they had
replaced. Often, however, these terminal emulation products were complicated, difficult to
use and allowed only a single connection to a single host. In addition, terminal emulation
products made little or no provision for the integration of host data and applications
with personal computers data and applications such as spreadsheets. Therefore, the full
capabilities of the personal computers were not available to the user when the personal
computer was used as a terminal.

In the mid-1980s, the desire of
personal computer users to share files and peripheral devices, and to communicate with
other users, led to the widespread implementation of Local Area Networks. Local Area
Networks significantly expanded an organizations ability to more efficiently connect
increased numbers of its personal computer users to host environments through a
gateway dedicated to LAN-to-host communication services. The personal computer
software enabling this LAN-to-host connectivity continued to use terminal emulation
technology.

18

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The emergence of the
Internet/intranets in the 1990s has encouraged the development of numerous new products
and services that enable and facilitate access and connectivity of host computers with
computer networks. New IBM midrange products have expanded capabilities of the iSeries in
the area of electronic commerce.

Continued widespread use of Twinax
cable infrastructure has created a need to develop solutions that can provide these users
with such features as e-mail, networking, Internet, and mobile-devices.

An industry trend noticed in the late
1990s was a move to a Thin Client environment. Larger enterprises use this
method as a means to reduce cost of ownership by employing Microsoft Windows NT/2000
Terminal Servers, which enable central configuration and user management. Terminals
(thin clients) are deployed to users throughout the network to provide the
requisite connectivity to host applications. We moved into this arena in early 2003 with a
progressive release program culminating in a full suite of Thin Clients and Ethernet
terminals. In the first quarter of 2005, we stopped our activities in the Thin Client
sector and assigned our rights with suppliers to our master distributor in the U.S., as
the profit margin for these products was small, its influence on our revenues marginal,
and the risk significant.

# (b) Electronic Components

Components are the basic building
blocks of all electronic products and in the twenty-first century the end use of
electronic products spans virtually all sectors of the economy. There are three major end
uses for electronics components (a) information technology (IT); (b) industry; and (c)
transportation and consumer goods.

The twentieth century global
revolution in electronics contributed to both the automation of repetitive tasks and the
more efficient performance of other tasks. This revolution began in the late 1940s,
followed by advances in integrated circuit technology in the late 1950s. Since 1960,
continuous improvements in the production of components and subsystems have allowed prices
to decline sharply, while market size increased dramatically.

There are two major groups of
components: a large family of active components and a small group of passive components.
Active electronic components are semiconductor products that supplanted the previous
generation of vacuum tube devices. Passive components can interrupt, resist, or otherwise
influence current flow, but cannot control it. Passive components are capacitors,
resistors, connectors, filters and inductors. In general, the passives are
used to enhance or supplement the performance of ICs. The demand for electronic components
is a derived demand. The vast majority of both active and passive components are installed
in original equipment manufacturer (OEM) products: consumer electronics, motor
vehicles, telecom equipment, factory automation systems, military hardware, and other
goods.

Since electronic components are so
widely installed, their market is affected by all major macroeconomic variables, such as
capital spending, disposable income and government budgets.

# (c) Communication
Solutions (Sold in 2005)

In 1995 the first Client VoIP
solution was introduced to the market by VocalTec, an Israeli company that demonstrated
telephone calls over the internet. Since then, in an accelerated mode, the VoIP (Voice
over Internet Protocol) and IP Telephony (Internet Protocol Telephony) have become a
market with a turnover of billions of dollars.

Large companies like Cisco, as well
as telephony players such as Lucent, Nortel, Siemens, Alcatel, Avaya and others are
selling VoIP solutions and embedding such technologies into their product lines.

19

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As broadband connectivity grows in
popularity for all organizations, major savings on calls are a potential reason for
migrating traditional calls to VoIP. Service availability and quality of service (QOS) are
two key issues that enterprises need to address in the Internet architecture to
availability and quality. The incremental cost savings for Internet telephony will depend
on the mix between on-net and off-net calls. Global enterprises with extensive private
voice networks will realize greater savings on global destinations by avoiding
international tariffs.

As the accelerated growth and
penetration of the cellular communication, there is an increase demand to extend the PBX
functionality and connecting branch offices with the mobile community via cellular
gateways in order to reduce communication costs among different operators.

In September 2004, the Company
purchased most of the assets (and liabilities) of Quasar Communication Systems Ltd., an
Israeli company engaged in the business of developing, manufacturing and selling cellular
communication gateways for an aggregate consideration of $539,000 by the issuance of
285,000 of the Companys ordinary shares. The assets and some of the liabilities of
Quasar were transferred into Quasar Telecom (2004) Ltd. (Quasar Telecom), a
wholly owned subsidiary of the Company (previously named Boslynk Ltd.). The acquisition
enabled the Company to continue developing the Communication segment, while offering to
the Companys clients an extended product line enabling savings in telecommunication
expenses for enterprise.

On October 26, 2005, the Company
entered into a definitive agreement for the sale of its Communication assets, and the
transaction closed on December 31, 2005. The Company sold its Communications related
property and equipment, goodwill, technology, trade name, existing distribution channels
and related contingent liability to the Office of the Chief Scientist to IP Gear Ltd.
(IP Gear), a wholly owned Israeli subsidiary of Qualmax Inc. (Pink Sheets:
QMXI.PK), an IT solutions provider focused on deployment of best-of breed VoIP, virtual
private networks, turnkey network design, wireless connectivity and web. The consideration
paid to the Company in the transaction was approximately 3.2 million Qualmax shares of
common stock constituting approximately 16% of Qualmaxs total issued and outstanding
Common Stock as of December 31, 2005, and $800,000 in royalties to be paid at a rate of 4%
from future revenues IP Gear will generate from the disposed segment
(Royalties) with the entire $800,000 due no later than 90 days from the third
anniversary of the closing of the transaction. Additional shares may be issued to the
Company at the end of four consecutive fiscal quarters following the closing of the
transaction, contingent upon IP Gear generating by then a certain level of revenues from
the disposed segment (Earn Out Shares). The maximum number of Earn Out Shares
that may further be issued to the Company is approximately 1 million, constituting
approximately 5% of Qualmaxs outstanding shares as of June 15, 2006. On June 8,
2006, Qualmax agreed to issue to BOS, on account of the abovementioned commitment, 250,000
Earn Out Shares.

The Company received certain
piggy-back registration rights with respect to the Qualmax shares. The Company does not
have a representative on the Board of Directors of Qualmax.

In addition, the Company and IP Gear
entered into an Outsourcing Agreement, pursuant to which the Company will provide IP Gear
with certain operating services relating to the sold Communications Segment. In accordance
with the Agreement, the first three months of services were provided for no charge and IP
Gear is to pay for these services starting from April 2006. IP Gear can elect to pay for
the services rendered in April thru June 2006 by issuance to the Company of Qualmax shares
valued at a predetermined price of $1.43 per share. The Company undertook to provide these
services at least until December 31, 2006 (12 months from closing).

The Company also granted a bridge
loan to IP Gear in the amount of $1,000,000. The term of the loan is three years and it
bears interest equal to the Prime rate plus 2.5%, up to a maximum of 12%. In the first 18
months, IP Gear shall pay only the interest accrued on the loan and monthly principal and
interest payments shall commence thereafter. The loan granted to IP Gear is secured by a
first priority floating charge, which may be subordinated to a charge in favor of Bank of
America, NA in the event such charge is recorded. In addition repayment is guaranteed by
Qualmax Inc.

20

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The loan agreement provides that if
the disposed segment would incur in the first quarter of 2006, losses that exceed
$250,000, the principal amount to be repaid under the loan shall be reduced by the excess
losses. In such event, Qualmax shall issue to the Company additional shares of Common
Stock against such reduction, valued at a predetermined price of $1.43 per share. Pursuant
to this provision, in May 2006, Qualmax issued to the Company 244,755 shares, and the
principal amount of the loan was reduced to $650,000.

In addition, the loan shall be
immediately repaid in the event Qualmax raises by way of equity financing (or a series of
equity financings) an aggregate amount equal to at least $4,500,000.

The Companys holdings as of
June 15, 2006, equal approximately 17% of Qualmaxs issued and outstanding Common
Stock (excluding the abovementioned Earn Out Shares which have not yet been issued).

Qualmax also issued to the Company a
five-year warrant for the purchase of up to 107,143 shares, constituting less than 1% of
its outstanding shares in Qualmax, at the exercise price of $2.80 per share
(Warrants). The Company received certain piggy-back registration rights with
respect to the shares underlying the warrant.

# Description of
Business Product Lines

# (a) Connectivity
Solutions

The Connectivity Solution product line
focuses on Connectivity solutions for the popular IBM iSeries server, enabling customers
to vastly extend its capabilities and life cycle. Its BOSâNOVA products family
empower the iSeries, providing a scaleable solution for transparent expansion and growth.

Connectivity products are based on
TCP/IP to Twinax controllers, as well as iSeries full and rich TCP/IP emulation, that help
extend the life cycle of the organizations iSeries. All products are unmatched in
their emulation capabilities, compatibility and transparency

Realizing the changing role of this
IBM midrange environment in todays workplace, our mission is to provide our users
with technologically advanced and cost-effective solutions for connectivity between them
and personal computers, mobile devices and local area networks, whether local or remote.
We sell and support our products worldwide through distributors, and value-added
resellers.

Our proprietary products are sold to
users of IBM iSeries, which are predominantly medium to large sized corporations that use
large data banks in their businesses and require the ability to integrate and manipulate
the data into graphics and popular personal computer programs. The target market for our
products is composed of the owners of iSeries servers and the growing number of users who
connect to these computers through the Internet, intranets, mobile devices and various
other connectivity products.

Our main product line is comprised
primarily of TCP/IP to Twinax controllers that allows Legacy Twinax equipment to work
locally or remotely via TCP/IP line to the iSeries server. In addition we have a line of
emulation software, to simulate a personal computer environment having the same
functionality to which the users are accustomed (i.e. Windows or similar graphical
interfaces), while using a midrange computer. The emulation solutions are offered at two
levels  at the user interface level and at the computer connectivity level. At the
user interface level, our emulation technology allows customers to utilize popular Windows
functions and graphics. At the connectivity level, our connectivity technology provides
personal computers with the ability to act as terminals for IBM midrange computers either
through gateway, Internet or direct connection.

21

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We are using our expertise in the
midrange computer environment to develop Internet/intranet solution products that will
enable and enhance connectivity between IBM iSeries computers, personal computers and
mobile devices via the Internet and intranets.

In 2005, 14% of our sales were
attributable to sales of Connectivity solutions and services.

Below is a description by category of
our development activity in the Connectivity product line:

# (a1) Software based
solutions

In December 1997, we announced our
BOSaNOVA transmission control protocol / internet protocol product, a connectivity tool
for organizations with either local or remote TCP/IP networks (intranet or extranet) of
personal computers using Windows 9x/Me or NT/2000/XP operating systems connected to the
iSeries. Development resources in 1999 were directed toward making TCP/IP connectivity
available for Twinax users. The e-Twinax technology has now been implemented in products
such as the BOSaNOVA Plus, BOSaNOVA TCP/IP, and e-Twin@x Controller, which made its debut
in the middle of 1999, and has been rapidly established as the remote computer controller
of choice.

Our products under this category
include:

| |  | BOSaNOVA
TCP/IP
| | - | ---------------

| | A
robust client application that provides Windows9x/Me/NT/2000/XP users on a TCP/IP network
with essential iSeries connectivity. The product includes BOSs rich 5250 emulation,
LPD printing capabilities, file transfer and a remote command facility.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | BOSaNOVA
Secure
| | - | ---------------

| | A
BOSaNOVA Secure is an all-in-one solution for totally secure iSeries emulation delivering
security from the workstation through the TCP/IP net to the organization level. Secured
TN5250 emulation is a solution for the Desktop on the TCP/IP net, which implements SSL
and SSO (Single Sign ON) with Kerberos. This security emulation provides a comprehensive
net security solution, including data on the net. While current customers can implement
the SSL protocol and SSO (Single Sign ON) by adding BOSaNOVA Secure to BOSaNOVA TCP/IP,
new customers are offered BOSaNOVA Secure.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | BOSaNOVA
Web
| | - | ------------

| | In
December 1997, we introduced BOSaNOVA Web, a Java-based application that provides iSeries
web-emulation, allowing organizations to upgrade their iSeries to enable full web
benefits. BOSaNOVA Web slashes communication costs, ensures a friendly, transparent work
environment, installs rapidly and easily without a client install and delivers a fast ROI.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Loaded
on a central server and managed by a network supervisor, BOSaNOVA Web allows normal user
changes to occur hassle-free. Whether moving users to new workstations, upgrading
software, pushing out new applications, or enhancing security, users simply log on to
receive the correct workstation parameters for their jobs.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
server and users are managed easily and economically via the browser. The Network
Supervisor can change or modify parameters from any enterprise computer whether internal
or external. There is no need to use the servers computer for changes or upgrades.
It is all done seamlessly via the web and from a remote workstation.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| | Application
upgrades and parameter changes are automatically delivered to end-users as soon as they
log on via the browser to the web server integrated into BOSaNOVA Web.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | BOSaNOVA
Web eliminates the need for both additional push software and expensive
technical support at the desktop. Additionally, the client/server architecture means
current cache capabilities can be used, thus enabling upgrades in real-time.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
client/server architecture allows all internal and external iSeries users to benefit from
the network. Users access the iSeries through the BOSaNOVA web server which incorporates
a web server. The server encodes all transmitted information, complying with SSL
standards, amplified by user verification via a client certificate.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | BOSs
Printer Client technology is embedded in BOSaNOVA Web to enable to print via the web.
| | -------------------------------------------------------------------------------------------

| |  | BOSaNOVA
Mobile
| | - | ---------------

| | In
March 2006, we announced the new BOSaNOVA Mobile product, which combines the convenience
of mobile and PDA instruments with the ability, stability and power of a BOSaNOVA
platform. The system converts mobile instruments such as mobile terminals and cellular
telephones to mobile work stations while using the familiar emulation of the fixed work
stations.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | BOSaNOVA
Mobile is based on a server architecture, enabling central management of work stations,
without the need to make local definitions for every mobile instrument in the network. It
enables dynamic and remote identifications of users, configurations of mobile work
stations, automatic installation and updating of software in the cellular instrument and
the mobile terminal. In addition, the system provides a solution to the problem of
instability in the network, enables maintaining and retrieving information up to the
point when the mobile instrument was cut off.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | BOSaNOVA
Mobile enables end users to perform their work from any place, while using the familiar
emulation of work stations in mobile terminals and cellular instruments. The mobile
instruments maintain a work environment recognized from end stations. In addition, the
Screen Designer module, which is part of the BOSaNOVA Mobile enterprise server, enables
end users to redesign their working screens so they will fit to the size of the mobile
screen without changing the application itself.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
creation of the BOSaNOVA Mobile is part of the process to expand the basket of solutions
of the BOSaNOVA products family to additional fields, while maintaining the capability of
central management and control tools, also when using advanced instruments. BOSaNOVA
Mobile also enables all organizations to shorten the work process, to make the work of
agents in the field much more efficient and to keep them all up-to-date in real-time.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | BOSaNOVA
Spooler
| | - | ----------------

| | In
April 2006, we released the new BOSaNOVA Spooler product.
| | ------------------------------------------------------------

| | BOSâNOVA
Spooler is built as a client-server system, and is designed for users that connect to the
organization via the Internet in a complete Web environment. A print job routing
mechanism is built into this system, based upon dynamic parameters which identify the
user and his workstation. The BOSaNOVA Spooler has a mechanism that converts the
workstations exiting system definitions to the new Web-enabled system parameters.
Names of the telnet printer devices in the new system, and their local definitions, are
built by an automatic conversion process that is initiated when the workstation activates
the client station for the first time. With the help of this system, the connection
process becomes easy and fast.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| | The
printer client software included in BOSaNOVA Spooler is based on the leading printing
software of BOSâNOVA family of products. It includes complete support for iSeries
print output, and a complete and easy configuration, including configuration of the
smallest details of the local printer.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
centralized configuration of the BOSâNOVA Spooler server contributed to the fast
implementation process at the workstations. The BOSâNOVA Spooler is fully adapted
to meet most of the organizations security needs and support the following features:
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Encryption
| | - | ----------

| |  | VPN
| | - | ---

| |  | Protocols
conversion between external and internal networks
| | - | -----------------------------------------------------------

| |  | Client
certificates
| | - | -------------------

| |  | Load
balancing
| | - | --------------

# (a2) Hardware and
software based solution

The e-Twin@x Controller, which made
its debut in 1999, supplies a secure, encrypted TN5250e connection to the iSeries over the
Internet or WAN, and provides local or remote Twinax networks with access to LAN
resources. The e-Twin@x Controller allows enterprises to leverage their Twinax investments
(in equipment and cabling) while providing the benefits of a TCP/IP connection. Dramatic
improvements in performance, uptime and cost-efficiency are the result. A new model, the
e-TwinStar, was released in 2002. It features native support for CAT5 cabling, in the form
of built-in RJ45 sockets, saving customers with this environment the cost of an active
star hub.

Our products under this category
include:

| |  | e-Twin@x
Controller
| | - | -------------------

| | This
product provides IP over Twinax connection to local and remote Series, adding the
benefits of a Local Area Network to existing Twinax infrastructure. This product
eliminates the difficulty of maintaining System Network Architecture and Anynet
protocols, replacing them with fast, state-of-the-art Transmission Control Protocol /
Internet Protocol (TCP/IP).
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Native
Plus
| | - | -----------

| | An
IBM-compatible Twinax card with 5250 Stealth Technology. This product does not
require a memory segment of the personal computer or its valuable resources in order to
facilitate interaction with the hardware.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | BOSaNOVA
Plus
| | - | -------------

| | An
enhanced version of the Native Plus that includes a Twinax adapter card with feature-rich
5250 display/printer emulation software for either DOS, 16- or 32-bit Windows and
32-session APPC display/printer emulation software.  This product is based on
an IBM compatible Twinax card with 5250 Stealth Technology.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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(a3)
Software Utilities

Until July 2005 the Connectivity
Solutions segment had an additional product line  the PrintBOS Output Management
product, which was introduced in late 1998 as an innovative Enterprise Output Management
solution answering a growing demand for central printing and output management solutions
in medium and large IT organizations. PrintBOS is implemented as the central solution for
layout design, printing, faxing, e-mailing, archiving, barcode printing, cheque printing
and secured printing in banks, insurance companies and medium and large corporations.
PrintBOS is also a recognized complementary solution for SAP layout design and printing
and integrates SAP output with other enterprise software outputs. PrintBOS was designed
for a wide range of operating systems, including mainframe and UNIX. PrintBOS customers
use it for a variety of documents  from forms, reports, barcodes and labels to faxes
and cheques. PrintBOS transparently intercepts these print jobs and applies the correct
graphic formatting to create the customers preferred output. Time and labor-saving,
PrintBOS allows employees to focus on more added-value tasks than output jobs.

On July 18, 2005, BOScom signed an
asset purchase agreement with Consist Technologies Ltd. and Consist International Inc.
(collectively, Consist), for the sale of its PrintBOS product line in
consideration of $500,000 and a contingent payment in each of the next three years equal
to 6-10% of future revenues exceeding $1,000,000 per year, generated by Consist from the
PrintBOS product line. The Company has accounted for a gain of $273,000 in 2005. As of
December 31, 2005, the Company has received $375,000 and the remaining $125,000 has been
placed in escrow, pending repayment of royalties to the Office of the Chief Scientist
(OCS) on sales of PrintBOS products.

# (b) Electronic Components

Our subsidiary, Odem, is engaged in
providing electronic components, data systems, image processing products, and Radio
Frequency Identification Devices (RFID) and solutions.

Electronic Components

Odem imports electronic components
and distributes them to the local defense and civilian electronic industries. It
represents suppliers of components in four categories:

1)
          Active Components  semiconductors, transistors, detectors, diodes,
          integrated circuits, hybrid modems, cellular components, communication ICs,
          memories, displays, and LEDS;

2)
          Passive Components  capacitors, thermistors, varistos, oscillators,
          crystals, resistors, C-DC converters, and power supplies;

3)
          Electro-mechanical Components  relays, connectors, circuit breakers,
          filters, transformers, plugs, thermostats, switches, etc.

4)
          Discontinued Semiconductors- made by Intel, Fairchild, Harris, Microchip,
          National, Quality SMC, Texas Instruments, Vantis, Motorola, and more.

Data systems

Odem provides full access solutions
for IT and telecommunications (LAN/WAN) applications, selling communication servers,
multi-protocol print servers, server adapters, USB products, switches, fiber optics
equipment, ADSL and XDSL routers, modems, VoIP equipment, ATM devices, and more.

Image Processing Products

Odem markets image processing
products, charge-coupled-device (CCD) and CMOS imaging technologies. The products and
technologies Odem markets in this field, such as CCD & CMOS sensors, line and area
scan and camera interface items, are used in applications of management and quality
control in production lines for products such as semiconductors, PCBs, and textiles.

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Radio Frequency
Identification Devices (RFID) solutions

RFID is the use of radio frequencies
to read information from a small device known as a tag that can be sensed at a distance by
radio frequencies. The tag can be any small device such as pendants, beads, nails, labels,
microwires and fibers. According to IDTechEX research (a knowledge based company
specializing in RFID smart labels, that provides independent marketing, technical and
business advice and services on this subject), in 2006, it is expected that the volume of
RFID tags that will be sold will be almost three times more than the volume sold during
the past 60 years since their invention, with the increase primarily driven by the use of
RFID for tagging vehicles and cases. Additionally, it is forecasted by IDTechEX research
that the future years shall bring another new development  the tagging of high
volume items  notably consumer goods, drugs, and postal package  at the
request of retailers, military forces and postal authorities.

In
2004,  Odem  started to  provide  products  and  solutions  in the field of RFID and  successfully
implemented  an RFID  solution  in the  Maccabia  sports  event  and in a dairy  farm  (identification  of
cattle),  both in Israel.  Recently,  Odem entered into an agreement for the supply of RFID tags for waste
disposal  systems,  in  Europe,  and is  expected  to begin  supplying  the tags in  early  2007.  Odem is
investing in developing  new RFID  solutions and  constantly  searching for new  marketable  solutions and
applications, as well as actively searching for acquisition opportunities, in this growing field.

In 2005, 75% of our sales were
attributable to sales of the Electronic Components Solutions segment.

# (c) Communication
Solutions (Sold in 2005)

Our Communication products included
multi-path, intelligent routing VoIP gateways, GSM gateways and other cellular gateways.
Designed for the corporate market, these devices enable major reduction of inter-office,
long-distance and cellular-to-line communication costs using VPN, cellular-to-cellular
networks or the public Internet to carry telephone calls.

Additionally, they extend PBX
functionality to enterprise branch offices. Supporting standard protocols, the gateways
are built on robust platforms to allow modular incorporation of value-added applications.

Designed for the enterprise market
and OEMs, our Claro VoIP solutions were the preferred choice for sites requiring just a
few connections through mid-market sites with hundreds of connections. Our VoIP products
were distinguished by their seamless integration. For end users, this means absolutely no
change in their familiar work environment, eliminating a learning curve. For enterprises,
it translates into a more affordable, attractive investment, as VoIP products fit in with
existing equipment, and demand no changes or additions, delivering significant, measurable
economies of cost.

The Cellular Gateways Solutions of
Quasar Telecom became an integral part of the Communication segment with their acquisition
in 2004 (see Item 4A). Quasar Telecoms proven cellular technology created gateways
between the corporate PBX and cellular network to enable cost savings of communication
cost.

In
2005, 11% of our sales were attributable to sales of Communication products and services.
As aforementioned, the assets of the Communication Solutions segment were sold to
Qualmaxs subsidiary, IPGear Ltd. in the fourth quarter of 2005 (see item 4B(c)).

# Marketing,
Distribution and Sales

We market our products primarily to
medium and large sized corporations through a combination of direct sales, indirect
distribution and original equipment manufacturers.

In the United States, we market our
Connectivity products through one master distributor located in Phoenix, Arizona, which
coordinates the midrange connectivity-related marketing efforts of dozens of distributors
and resellers, and also offers technical support and after-sales service. Odem (Electronic
Components solutions) markets its products and services in the United States through a
wholly owned company, Ruby-Tech, Inc., located in Sherbourn, Massachusetts.

26

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In Europe, we market our Connectivity
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.

We further rely on peripheral product
distributors who offer our products along with other products for the IBM midrange market.
We also rely on value added resellers who offer system sales and installation, which
include a variety of our products. In addition, we heavily depend upon our own marketing
resources operating from Israel.

Our Connectivity products largest
customer is our master distributor located in Phoenix, Arizona, and Odems largest
customer is located in Israel.

We generally do not have any
significant backlog because orders are usually shipped when received.

Our Companys sales do not
fluctuate seasonally, with the exception that third quarter sales are affected (set back)
by vacations in Europe and the holidays in Israel, and December and January sales are
affected (set back) by the Christmas season.

The following table sets forth our
revenues (in thousands of US$) from the continuing operations, by major geographic area,
for the periods indicated below:

|                  | 2005 | % | 2004 | %      | 2003 | %
|----------------- | ---- | - | ---- | ------ | ---- | -
|
|
|
|
|United States     |      |   |      | 3,615  |      |  
|
|Europe            |      |   |      | 2,887  |      |  
|
|Far East          |      |   |      | 6,083  |      |  
|
|Israel and others |      |   |      | 14,468 |      |  
|                  |      |   |      |        |      |  
|Total Revenues    |      |   |      | 27,053 |      |  
|                  |      |   |      |        |      |  

See Note 19b to the Consolidated
Financial Statements.

# Manufacturing

The products of our subsidiary
BOScom, are designed, integrated and tested at our facilities in Israel. The manufacturing
is done by Israeli subcontractors using components and subassemblies supplied by vendors
to our specifications. Certain components and subassemblies used by us in our existing
products are purchased from a single supplier or a limited number of suppliers. Most of
the imported components are purchased in Israel from local representatives of the
manufacturers. Some of them have exclusive representative rights in Israel. In the event
that these suppliers are unable to meet our requirements in a timely manner, we may
experience an interruption in production until an alternative source of supply can be
obtained. We generally maintain an inventory of components and subassemblies which we
believe is sufficient to limit the potential for such an interruption. Our current
manufacturing facilities have sufficient capacity to exceed current demand. The prices of
raw materials used in our industry are volatile and availability of electronic components
may vary due to changing demand in the market.

Odem distributes products that are
manufactured by third party suppliers.

27

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---

# Intellectual Property

We currently rely on a combination of
trade secrets, copyright and trademark law, together with non-disclosure agreements and
technical measures, to establish and protect proprietary rights in our products.

We believe that the improvement of
existing products, reliance upon trade secrets and proprietary know-how and the
development of new products are generally as important as patent protection in
establishing and maintaining a competitive advantage. We believe that the value of our
products is dependent upon our proprietary software and hardware remaining trade
secrets or subject to copyright protection.

Generally, we enter into
non-disclosure and invention assignment agreements with our employees and subcontractors.
However, there can be no assurance that our proprietary technology will remain a trade
secret, or that others will not develop a similar technology or use such technology in
products competitive with those offered by us.

While our competitive position may be
affected by our inability to protect our proprietary information, we believe that because
of the rapid pace of technological change in the industry, factors such as the technical
expertise and the knowledge and innovative skill of our management and technical
personnel, name recognition, the timeliness and quality of support services provided by us
and our ability to rapidly develop, produce, enhance and market software products may be
more significant in maintaining our competitive position.

As the number of software products in
the industry increases and the functionality of these products further overlaps, we
believe that software programs will increasingly become subject to infringement claims.
The cost of responding to any such assertion may be material, whether or not the assertion
is valid.

On May 10, 2006 the Company received
a written demand from IDEAL Software GmbH, a German corporation, in which it claims that
the Company owes it for unpaid license fees (see Item 8).

# Competition

Connectivity Solutions:

The connectivity market is subject to
rapidly changing technology and evolving standards incorporated into personal computers,
networks and host computers. BOScoms products compete with products that have
already been on the market for a number of years and are manufactured by competitors, most
of which have substantially greater financial, marketing and technological resources and
name recognition than ours.

Our competitors include IBM, Perle,
Advanced Business Link, IGEL, CLI PowerTerm, NLynx, NetManage, Attachmate, and Seagull,
Adobe, Optio and Formscape.

Electronic Components
Solutions:

The common practice in the industry
is that suppliers and manufacturers usually grant a non-exclusive representation right in
a specific territory. As long as sales reach a reasonable level and the relationship
between the parties is good, the supplier will usually not grant another representation in
the agreed territory.

Although most of Odems
representation agreements are not on an exclusive basis, in most cases it does not have a
local competitor who distributes components from the same source. However, there may be
competition in case of similar components made by other manufacturers. In October 2005,
Odems major supplier to the Far East market opened headquarters in China, that
increased the competition in the Far East territory.

28

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The number of instances in which
territorial-based distributing agreements are challenged by large foreign distributors,
who receive a special discount on large volume purchases from the suppliers and compete
with the local distributor by selling directly to its customers, is increasing. Still,
despite inferiority in pricing, local distributors have some advantages over such
competition by providing close and continuous technical support, large inventory, a wide
spectrum of products and short reaction time.

Odem currently represents about 35
overseas suppliers, of which approximately 20 are electronic components suppliers, 8 are
suppliers of IT equipment, 2 are suppliers of market image-processing products and 5 are
suppliers of RFID tags.

The electronic market is
characterized by multiple agents and distributors. Five local electronic component
competitors  Telsys Ltd., Nisco Projects Ltd., STG Ltd., Semicom Ltd. and Rapac
Electronics Ltd., are publicly traded on the Tel Aviv stock exchange. Other large and
influential competitors which are active in the electronic components market are
Eastronics Ltd.,STG International Ltd., Chayon Computers Ltd., RDT Ltd. and Abnet
Communications Ltd. There is an increase in the number of distributors that are owned by
international companies.

# Strategy

The
Companys  strategy  is to  enable  organizations  to  increase  operational  efficiencies  while
leveraging  their  existing  infrastructure.  We will  continue to focus and enhance our existing  product
lines and  continue to search for  additional  growth  through  mergers and  acquisitions,  while our main
focus in the near future shall be both  expanding  applications  and actively  searching  for  acquisition
opportunities, in the growing RFID field.

The key elements of our strategy are
as follows:

| |  | Increase
 Representations.  We continue to search for additional  companies to represent  through
our          Electronic Components segment.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------

| |  | Expand
Marketing Network. We intend to increase our marketing presence in the United States,
Europe and the Far East, and to expand our distribution channels in these markets through
the use of acquisitions, additional independent distributors and original equipment
manufacturers as well as our own sales representatives.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Acquisition
of companies or businesses that will increase our sales and profit, or acquisition of
complementary technologies or products that we can sell through our existing distribution
network.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Maximize
efficiency for IBM midrange market. Through our Connectivity Solutions segment, we intend
to expand and support our emulation product line for IBM midrange computers. This
includes continuous upgrading and improvement of our connectivity emulation products for
direct, gateway and Internet connection, and Windows emulation and graphics capabilities.
We continually upgrade our client software to ensure its compatibility with each new
Windows platform. We intend to streamline our manufacturing and distribution to better
serve our present client base and access a greater share of the IBM midrange market. We
have already begun to incorporate common components into our products in an effort to
streamline manufacturing and intend to take steps to improve our destination networks.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Web site:We maintain a web
site where potential customers, investors and others can obtain the most updated
information about our activities, products, press releases and financial information. Our
Web site may be found at www.boscorporate.com. The contents of our web site are not
incorporated by reference into this Form 20-F.

# Exchange Controls

See Item 10D.

29

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For other government regulations
affecting the Companys business, see Item 5, under Grants and
Participation.

|4C. | Organizational
Structure
|--- | ------------------------

The Companys wholly owned
subsidiaries include:

In Israel  (1) BOScom
Ltd. (formerly Lynk, a Division of B.O.S. Ltd.). (2) Quasar Telecom (2004) Ltd.
(Quasar Telecom), which obtained the assets BOS acquired in September 2004
from Quasar Communication Systems Ltd. (see item 4A). The assets of Quasar Telecom were
sold to IP Gear Ltd., a subsidiary of Qualmax Inc. as part of the sale of the
Communications Segment in the fourth quarter of 2005. (3) Odem Electronic Technologies
1992 Ltd. (Odem), which we purchased on November 18, 2004 from Odems
existing shareholders, and in which by November 2005 our holdings increased to 100%. Odem,
an Israeli company, is a major solution provider and distributor of electronics components
and advance technologies in the Israeli market (see item 4A).

In Europe  BOScom had a
UK subsidiary, Better On-Line Solutions Ltd., and its subsidiary, Better On-Line Solutions
S.A.S in France, which, until mid-2003, distributed and serviced BOScoms products
abroad. In mid-2003 we decided, due to cost-efficiency considerations, to cease operations
in Europe through the subsidiaries and to market through distributors and resellers, and
the subsidiaries are no longer operational and have been closed.

In the U.S.  (1)
Ruby-Tech Inc., a wholly owned subsidiary of Odem, (2) Lynk USA Inc., a subsidiary of BOS,
and its subsidiary PacInfo (both Delaware corporations) and PacInfos subsidiary,
Dean Tech Technologies Associates, LLC. (Dean Tech), a Texan corporation, and
(3) BOS Delaware Inc. a Delaware corporation. Only Ruby-Tech is still operational.

The voting power we (or our
subsidiaries) have in all subsidiaries, equates to our shareholdings.

The Company also has an interest in
Surf Communication Solutions Ltd. (Surf) in which it has been investing since
1997, and in Qualmax Inc. in which it has been invested since December 2005 (See Item 4A).

|4D. | Property,
Plants and Equipment
|--- | ------------------------------

Our executive offices and
engineering, development, testing, shipping and service operations are located in two
Israeli facilities (in Teradyon and in Rishon Lezion), and occupy a total of approximately
4,092 square meters. BOS and BOScom occupy 3,300 square meters in Teradyon, pursuant to a
lease which expired in December 2005 and currently is under negotiations for its renewal.
Odem occupies 792 square meters in Rishon Lezion, of which 302 square meters are owned by
Odem and the remaining space is rented pursuant to lease agreements for various periods,
with terms that expire within one to four years. In 2005, Quasar Telecom occupied 374
square meters in Rehovot, pursuant to a lease that was assigned to IP Gear commencing
January 1, 2006. The monthly rental fees of the Company and its subsidiaries amounted to
$16,000 in 2005, and currently amount to $12,000.

The facility in Teradyon is located
in a part of Israel which has been designated by the government as a Development
A area. This designation relates to the benefits available to us as an
Approved Enterprise under Israeli law, that entitles us and our shareholders
to reduced income tax rates on our income and on dividend distributions.

We believe that our facilities are
sufficient to accommodate our anticipated needs in the foreseeable future.

30

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# Item 4A: Unresolved
Staff Comments

Not Applicable

# 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.

# Critical Accounting
Policies

# Use of Estimates

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. The Company evaluates its
estimates, including those related to revenue recognition, bad debts, inventories, and
legal contingencies on an ongoing basis. 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, 2005.

# 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.

If there is a sudden and significant
decrease in the fair values of our investments in affiliate companies, we may be required
to write off part of our investments due to impairment. The Companys investment in
an affiliated 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). The
Companys investment in Surf has been included as an affiliated company until
September 30, 2005 (see note 6 to the Consolidated Financial Statements).

31

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During 2005, an impairment of
$1,385,000 has been recorded in equity in losses of an affiliated company in
the statement of operations. In 2004 and 2003, based on managements analysis, no
impairment losses were identified.

# Investment in other
companies

Investment in companies are
investments through which the Company is not able to exercise significant influence over
the investees financial policies and which do not meet the fair value availability
criteria of FAS 115 (readily determined sales price currently available on a
security exchange), consequently such investments are accounted for by the cost
method.

The Companys investment in such
companies is reviewed for impairment whenever events of changes in circumstances indicate
that the carrying amount of the investment may not be recoverable in accordance with APB
No. 18. No impairment has been identified during 2003 through 2005.

# Goodwill, Intangible
Assets and Other Long-Lived Assets

Under current accounting standards,
we make judgments about the remaining useful lives of goodwill, other intangible assets
and other long-lived assets, including assumptions about estimated future cash flows and
other factors to determine the fair value of the respective assets.

We adopted SFAS No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets as of
January 1, 2002. We are required to assess the impairment of long-lived assets, other
than goodwill, tangible and intangible under SFAS No. 144, on a periodic basis, when
events or changes in circumstances indicate that the carrying value may not be
recoverable. Impairment indicators include any significant changes in the manner of our
use of the assets or the strategy of our overall business, significant negative industry
or economic trends and significant decline in our share price for a sustained period.

Upon determination that the carrying
value of a long-lived asset may not be recoverable based upon a comparison of fair value
to the carrying amount of the asset, an impairment charge is recorded. We measure fair
value using discounted projected future cash flows.

We have adopted SFAS No. 142
Goodwill and Intangible Assets issued in July 2001. Pursuant to SFAS
No. 142 goodwill and intangible assets that have indefinite useful lives will not be
subject to amortization, but instead will be tested at least annually for impairment.
Intangible assets that have finite useful lives will continue to be amortized over their
useful lives, but without the constraint of an arbitrary.

Goodwill represents excess of the
costs over the net assets of businesses acquired. SFAS No. 142 requires goodwill to be
tested for impairment at least annually or between annual tests in certain circumstances,
and written down when impaired. 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 income and market approaches. 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.

The Company has recorded no
impairment losses for the years ended December 31, 2005 and 2004 and recorded an
impairment charge on account of fixed assets which amounted to $110,000 for the year ended
December 31, 2003.

32

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# Inventory

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
companys standard pricing basis (see also Note 4 to the Consolidated Financial
Statements). 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.

# Revenue Recognition

The Company sells its Electronic
Component products mainly through direct sales and the Connectivity products mainly
through distributors and resellers channels.

The Company derives its revenues from
the sale of products, license fees for its products, commissions, 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 collectability is reasonably assured.

|Revenues
from license fees are 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
collection 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.
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Revenues from maintenance and support
are recognized ratably over the period of the maintenance contract. The fair value of the
maintenance is determined based on the price charged when it sold separately or renewed.

Revenues from commissions are
recognized upon their actual receipt, since under agreements with suppliers consideration
is received on the basis of collection from customers.

# 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 these 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.

33

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# Stock based compensation

Effective January 1, 2006, we account
for stock-based compensation costs in accordance with Statement of Financial Accounting
Statements Standards No. 123R  Share-Based Payment (SFAS
123R). We utilize the Black-Scholes option pricing model to estimate the fair value
of stock-based compensation at the date of grant, which requires subjective assumptions,
including expected life of the option. Further, as required under SFAS 123R, we estimate
forfeitures for options granted which are not expected to vest. Changes in these inputs
and assumptions can materially affect the measure of estimated fair value of our
stock-based compensation. Until December 31, 2005 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 the market price of the
underlying shares on the date of grant, no compensation expense is recognized.

# Functional currency

Odems functional currency as of
December 31, 2004, was other than the U.S. dollar and was translated into U.S.
dollars. Beginning April 1, 2005, Odems functional currency became the U.S.
dollar, due to significant changes in circumstances which indicated a functional currency
change. These changes included:

| |  | Transition
of budget planning and business performance measurement from New Israeli Shekels (NIS) to
U.S. dollars, as a result of Odems integration with BOS.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Majority
of Odem revenues and expenses became linked to or paid in U.S. dollars.
| | - | --------------------------------------------------------------------------------

In accordance with FAS 52,
Foreign Currency Translation and since the functional currency changed from a
foreign currency to the reporting currency, U.S. dollars, the translation adjustments as
of March 31, 2005, prior to the change have not been removed from equity and the
translated amounts for nonmonetary assets as of March 31, 2005, prior to the change
became the accounting basis for those assets in the periods starting April 1, 2005.

|5A. | Results
of Operations
|--- | ---------------------

# Comparison of 2005 and
2004

Revenues for 2005 were $27,053,000
compared with $8,282,000 in 2004, a 226% increase, which is mainly due to the
consolidation, starting from November 18, 2004, of the results of operation of Odem
(related to the Electronic Component segment).

The Electronic Components segment
accounted for $20,253,000 (or 75% of our consolidated revenues) in 2005, out of which the
sales to the Far East accounted for $6,083,000 (or 22% of our consolidated revenues in
2005). In the second half of 2005 and during the first quarter of 2006, we are facing a
trend of decrease in the sales to the Far East, which is partially offset by growth in
local sales.

The Connectivity segment accounted
for $3,926,000 (or 14% of our consolidated revenues) in 2005. These revenues include
$864,000 related to the PrintBos product line that was sold during 2005 and Thin Client
product line that was closed at the beginning of 2005. Hence, we expect that Connectivity
segment revenues in year 2006 will be lower than what we experienced in 2005. Furthermore,
the trend of customer migration from IBM iSeries to different systems has continued. In
response we have increased our sales and marketing activities as abovementioned and
continue to develop new products and solutions in order to maintain our market share and
maintain revenues from the Connectivity segment. We are continuously seeking additional
distributors and resellers.

Gross profit in 2005 totaled
$7,028,000, representing 25.9% of revenues, compared with $3,674,000, constituting 44.4%
of revenues in 2004. The major reason for the decrease in the gross margin was the
consolidation, starting from November 18, 2004, of the results of operation of Odem whose
gross profit represents 18.9% of revenues (see also Note 19 of the Consolidated Financial
Statements).

34

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Our future gross margin may be lower
than what we experienced during 2005 as a result of the disposal of the Communication
segment whose gross margin during 2005 was 26% (a gross margin which is higher than that
of the Electronic Components segment, which generated the majority of our revenues in
2005. See Note 19a of the Consolidated Financial Statements).

Net research and development costs in
2005 amounted to $2,312,000 compared to $1,804,000 in 2004. The increase in research and
development costs in 2005 is related to the development efforts invested in Quasar Telecom
products, prior to the sale of the Communication segment. Grants and participation from
the Office of the Chief Scientist amounted to $296,000 in year 2005 compared to $492,000
in 2004. These grants were related to the Communication segment that was sold at the end
of 2005 and we do not anticipate additional grants and participation in year 2006.

Sales and marketing expenses
increased to $3,563,000 compared to $1,706,000 in 2004, mainly due to the consolidation,
starting from November 18, 2004, of the results of operation of Odem.

General and administrative expenses
increased to $3,267,000 in 2005 from $1,706,000 in 2004, mainly due to the consolidation,
starting from November 18, 2004, of the results of operation of Odem.

As a result of the foregoing, our
operating loss in 2005 was $2,114,000 compared to an operating loss of $1,541,000 in 2004.
The operating loss in 2005 is attributed to the Communication segment which was sold in
late 2005, and amounted to $2,400,000.

Financial expenses amounted to
$448,000 in 2005 compared with expenses of $158,000 in 2004. The major reason for the
increase from 2004 was related to the convertible note (see also Note 14 to the
Consolidated Financial Statements) and to the consolidation, starting from November 18,
2004, of the results of operation of Odem whose bank loans as of December 31, 2005
amounted to $2,316,000.

Other income for 2005 includes
capital gains of $779,000 related to the sale of the Communication segment and $273,000
related to the sale of the PrintBOS product line.

Taxes on income increased to $204,000
in 2005 from $20,000 in 2004 as result of the consolidation, starting from November 18,
2004, of the results of operation of Odem which has a taxable income.

Equity in losses of an affiliated
company, Surf Communication Solutions Ltd., amounted to $1,750,000 in the 2005 as compared
to $308,000 in 2004. The equity loss in 2005 includes an impairment of $1,385,000 of the
investment in Surf. As of December 2005 our investment in Surf amounted to $722,000.

Minority interest in the earnings of
a subsidiary (Odem) amounted to $223,000 in 2005 as compared to $17,000 in 2004. In
November 2005 the Company increased its holding in Odem to 100%.

As a result, net loss from the
continuing operations for 2005 amounted to $3,605,000 compared to loss of $2,044,000 in
2004. On a per share basis, the net loss from the continuing operations in 2005 was -$0.64
per share compared with a -$0.44 net loss per share in 2004. (For details regarding
computation of net loss per share, see Note 18c to the Consolidated Financial Statements.)

35

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The total net loss for 2005 was
$3,605,000, compared with loss of $2,053,000 in 2004. On a per share basis, the net loss
in 2005 was -$0.64 per share compared with a -$0.441 net loss per share in 2004.

# Comparison of 2004 and
2003

2004s results of operation
reflected the following strategic actions:

| |  | Reorganization
in sales and marketing organization in Europe:
| | - | -------------------------------------------------------------

Up until the second quarter of 2003,
we marketed our BOScom products through subsidiaries in the U.K. and France. Since the
third quarter of 2003, 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, the sales and marketing expenses were reduced in 2004
in comparison to 2003.

| |  | Dividing
the Company operations into three segments:
| | - | ----------------------------------------------------

Commencing in 2004 and subsequent to
the acquisition of a controlling stake of Odem and of most of the assets of Quasar
Communication Systems Ltd. (which were transferred to our subsidiary, Quasar Telecom), the
Company manages its business in three reportable segments, which consist of Connectivity
Solutions, Communication Solutions and supply of Electronic Components (see also Note 19
to the Consolidated Financial Statements). This action was accompanied by an increase in
senior officers which mainly affected the general and administrative expenses which
increased in comparison to 2003.

| |  | Business
Combination:
| | - | ---------------------

The abovementioned acquisitions
partially affected the Companys results of operation, since the results of
operations of Quasar Telecom and Odem were consolidated commencing September 28, 2004 and
November 18, 2004, respectively. As a result, the revenues, cost of goods and general and
administrative expenses were increased in 2004 in comparison to 2003 (see also Note 1b to
the Consolidated Financial Statements).

Revenues for 2004 were $8,282,000
compared with $5,728,000 in 2003, a 44.6% increase, which is mainly due to the
consolidation of Quasar Telecom and Odem operations.

Gross profit in 2004 totaled
$3,674,000, representing 44.4% of revenues, compared with $4,273,000, constituting 74.5%
of revenues in 2003. Cost of revenues of 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
18a to the Consolidated Financial Statements). Excluding such income, the gross profit for
2003 represented 68.6% of revenues compared to 44.4% in 2004. The major reason for the
decrease in the gross margin was the acquisition of Odem in November 2005. Odems
gross profit represents 17% of revenues. The gross profit will continue to decline as a
result of the full inclusion of Odem activity in 2005 and thereafter.

Net research and development costs in
2004 amounted to $1,804,000 compared to $1,846,000 in 2003. Grants and participation from
the Office of the Chief Scientist amounted to $492,000 in 2004 compared to $283,000 in
2003.

Sales and marketing expenses
decreased by 21.7% to $1,706,000 in 2004 compared to $2,178,000 in 2003, mainly due to the
reorganization in sales and marketing which is described above.

General and administrative expenses
increased by 29.4% to $1,705,000 in 2004 compared to $1,317,000 in 2003, mainly due to an
increase in the number of senior officers. Restructuring costs in 2003 amounted to
$678,000 which resulted from ceasing the operation of the Companys subsidiaries in
Europe.

36

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As a result of the foregoing, our
operating loss in 2004 was $1,541,000 compared to an operating loss of $1,746,000 in 2003.

Financial expenses amounted to
$158,000 in 2004 compared with net financial income of $109,000 in 2003. The major reason
for year 2004 financial expenses was related to the convertible note (see also Note 18b to
the Consolidated Financial Statements).

Equity in losses of an affiliated
company refers to investment in Surf which amounted to $308,000 in 2004 compared to
$465,000 in 2003. The investment in a company was stated at equity method, since the
Companys holding in Surf exceeded 20% (see also Note 6 to the Consolidated Financial
Statements).

Minority interest in earning of
subsidiary refers to investment in Odem. The minority rights in Odem amounted to 36.2% of
its earnings (see also Note 1b to the Consolidated Financial Statements).

As a result, net loss from the
continuing operations for 2004 amounted to $2,044,000 compared with loss of $2,057,000 in
2003. On a per share basis, the net loss from the continuing operations in 2004 was $0.44
per share compared with a $0.56 net loss per share in 2003. (For details regarding
computation of net loss per share, see Note 18c to the Consolidated Financial Statements.)

The loss related to the discontinuing
operations for 2004 was $9,000 compared with an income of $2,036,000 in 2003. The income
of 2003 resulted from debt settlement with more than 95% of PacInfos external
creditors for an amount which was significantly lower than the face value of the debt.

The total net loss for 2004 was
$2,053,000, compared with loss of $21,000 in 2003. On a per share basis, the net loss in
2004 was $0.44 per share compared with a $0.01 net loss per share in 2003.

# 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.

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

| |  | increase
the number of products sold,
| | - | -------------------------------------

| |  | acquire
effective distribution channels and manage them,
| | - | --------------------------------------------------------

| |  | develop,
introduce and deliver new products on a timely basis,
| | - | --------------------------------------------------------------

| |  | anticipate
accurately customer demand patterns and
| | - | --------------------------------------------------

| |  | 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.

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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) (see Currency Exchange Rate Risk Management under item 11).

In the years ended December 31 2005,
2004, 2003, 2002, and 2001, the annual inflation rate in Israel as adjusted for the
devaluation of the Israeli currency in relation to the Dollar was (4.5)% 2.8%, 5.7%,
(0.8)%, and (7.8)%, 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 4.603, NIS
4.308, NIS 4.379, NIS 4.737, and NIS 4.416, respectively. As a result, the Company
experienced increases in the Dollar costs of operations in Israel in 2003 and 2004, and
decreases in 2005, 2002 and 2001.

# Effective Corporate Tax
Rate

Pursuant to an amendment to the
income Tax Ordinance, approved by the Israeli parliament on July 25, 2005, Israeli
companies are generally subject to income tax on their taxable income at the rate of 31%
for the year 2006, 29% for 2007, 27% for 2008, 26% for 2009 and 25% for year 2010 and
thereafter.

The effective tax rate payable by a
company such as ours which derives part of its income from an Approved
Enterprise, may be considerably less. See Note 17b 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. Odem and Quasar Telecom operations are subject to regular
income tax rates.

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.

# 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 of the Office of the Chief Scientist
(OCS) of Israels Ministry of Industry, Trade and Labor, are eligible for
grants in exchange for payment to the Government of royalties from the sale of products
developed in accordance with the Program. In order to be eligible, the applicant must be
an Israeli company that proposes to invest in the development of industrial know-how, the
development of new products, the development of new processing or manufacturing procedures
or the development of significant improvements to an existing process or product. A
committee of the OCS reviews the applications, evaluates the feasibility of the proposal,
determines whether or not to approve a grant, and also determines the extent of Chief
Scientist funding (within a range specified by the law) for approved projects. Depending
on the nature of the project, the OCS grants generally amount up to 50% of the approved
research expenses.

38

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Under the terms of the grants we
received from the OCS we are obligated to pay royalties of 3.5% on sales of products
incorporating know-how developed within the framework of each funded program or derived
therefrom (including ancillary services in connection therewith), up to an aggregate of
100% of the dollar-linked value of the total grants received. 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. If any of the manufacturing is performed outside
of Israel, the company would ordinarily be required to pay royalties at an increased rate
and to increase the aggregate repayment amount to between 120% and 300% of the grant
amount, depending on the manufacturing volume that is performed outside Israel, except in
special cases that receive the prior approval of the research committee, and subject to
certain payments to be made to the Israeli Government (generally an amount no less that
the aggregate grants plus interest less royalties paid).

The Research Law also provides that
know-how from the research may not be transferred to third parties in Israel without prior
approval of the research committee. This approval, however, is not required for the sale
or export of any products resulting from such research and development. Approval of such
transfer of know-how may be granted in specific circumstances, only if the recipient
abides by the provisions of the R&D Law and related regulations, including the
restrictions on the transfer of know-how and the obligation to pay royalties in an amount
that may be increased. The R&D Law further provides that the know-how developed under
an approved research and development program may not be transferred to any third parties
outside Israel.

The R&D Law imposes reporting
requirements with respect to certain changes in the ownership of a grant recipient. The
law requires the grant recipient and its controlling shareholders and interested parties
to notify the Office of the Chief Scientist of any change in control of the recipient or a
change in the holdings of the significant stockholders of the recipient that results in a
non-Israeli becoming an interested party directly in the recipient and requires the new
interested party to undertake to the Office of the Chief Scientist to comply with the
R&D Law. In addition, the rules of the Office of the Chief Scientist may require prior
approval of the Office of the Chief Scientist or additional information or representations
in respect of certain of such events.

The funds available for Office of the
Chief Scientist grants out of the annual budget of the State of Israel have been reduced,
and the Israeli authorities have indicated that the government may further reduce or
abolish Office of the Chief Scientist grants in the future.

We recognized grants in the amount of
$296,000 in 2005 and $492,000 in 2004.

As of December 31, 2005, the Company
has an outstanding contingent obligation to pay royalties in respect of OCS grants, in the
amount of approximately $3,500,000, compared to $6,114,000 as of December 31, 2004. The
decrease in the contingent liability is mainly related to the assignment of the
Communication segment contingent liability to IP Gear as part of the sale of the
Communication segment in late 2005.

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. As of December 31, 2005, the Company
has an outstanding contingent obligation to pay royalties of $110,000 with respect to
these grants, compared to $64,000 on December 31, 2004.

39

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# 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. A
peace agreement between Israel and Jordan was signed in 1994. However, as of the date
hereof, Israel has not entered into any peace agreement with Syria or Lebanon. No
prediction can be made as to whether any other written agreements will be entered into
between Israel and its neighboring countries, whether a final resolution of the
areas problems will be achieved, the nature of any such resolution or whether civil
unrest will resume and to what extent such unrest would have an adverse impact on
Israels economic development or on our operations in the future.

There is substantial uncertainty
about how or whether any peace process will develop or what effect it may have upon us.
Since October 2000, there has been a substantial deterioration in the relationship between
Israel and the Palestinians which has resulted in increased violence. The future effect of
this deterioration and violence on the Israeli economy and our operations is unclear. In
January 2006, Hamas, an Islamic movement responsible for many attacks against Israelis,
won the majority of the seats in the Parliament of the Palestinian Authority. The election
of a majority of Hamas-supported candidates is expected to be a major obstacle to
relations between Israel and the Palestinian Authority, as well as to the stability in the
Middle East as a whole. Ongoing violence between Israel and its Arab neighbors and
Palestinians may have a material adverse effect on our business, financial condition or
results of operations.

Despite the limited 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 the expansion of our business.

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.

In recent years Israel has been going
through a period of recession in economic activity, resulting in low growth rates and
growing unemployment. Our operations could be adversely affected if the economic
conditions in Israel continue to deteriorate. In addition, due to significant
economic measures proposed by the Israeli Government, there have been several general
strikes and work stoppages in 2003 and 2004, affecting all banks, airports and ports.
These strikes have had an adverse effect on the Israeli economy and on business, including
our ability to deliver products to our customers. Following the passage by the Israeli
Parliament of laws to implement the economic measures, the Israeli trade unions have
threatened further strikes or work-stoppages, and these may have an adverse effect on the
Israeli economy and our business.

40

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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.

|5B. | Liquidity
and Capital Resources
|--- | -------------------------------

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

As of December 31, 2005, we had
$2,346,000 in cash and cash equivalents, $1,333,000 in marketable securities, $3,563,000
short and long-term loans and positive working capital of $4,200,000.

Net cash used in operating activities
from continuing operations in 2005 was $3,900,000 compared to $1,023,000 in 2004.

During 2005 we used $477,000 in
investing activities, mainly as a result of an investment of $1,124,000 in Odem, grant of
a $1,000,000 loan to IP Gear, net of proceeds of $2,316,000 from redemption of marketable
securities. In year 2004 we used $1,866,000 in investing activities mainly for the
investment in Odem in the amount of $1,443,000.

Net cash provided by financing
activities amounted to $4,159,000 in year 2005 which is mainly a result of the issuance of
a Convertible Note and short term bank loans in the net amount of $2,179,000 and issuance
of shares in the amount of $2,040,000. Net cashed provided by investing activities
amounted to $1,614,000 in year 2004, mainly due to net proceeds from the issuance of a
Convertible Note in the amount of $1,787,000.

The Companys long and short
term loans as of December 31, 2005, amounted to $3,563,000, of which $2,305,000 is loans
from Israeli banks, and the convertible note issued to Laurus Master Fund Ltd. accounts
for the remainder.

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, growth in revenues, acquisition activities,
marketing activities and the level of resources devoted to research and development.

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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, establish distribution channels in new markets and
search for new merger and acquisition opportunities. Aside from the exercise of a
commitment granted to us by Laurus Master Fund to provide additional financing of up to
$1.5 million pursuant to the issuance of a convertible note (discussed below), there is no
assurance that we shall be able to obtain additional financing.

Laurus Convertible Note
Financings

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 bore
interest at a fluctuating interest rate equal at all times to the WSJ prime rate plus 3%,
subject to reduction in any particular month, if the average closing price of our ordinary
Shares for any five consecutive trading days, exceeds the conversion price by at least
25%. The proceeds from the private placement were used for general working capital
purposes and/or mergers and acquisitions.

The Note was convertible into
Ordinary Shares at a price of $3.08 per share. The note provided that if the Company
issues stock in certain types of transactions at a price lower than the initial conversion
price, then the conversion price will be adjusted to a lower price based on a weighted
average formula. As a result of the price per share in the private placement offering
described below (that closed on June 30, 2005), the conversion price of the convertible
note was reduced to $2.9042. The note was secured by a first priority floating charge on
all of the Companys assets and by a first priority fixed charge on all of the
Companys right, title and interest in its wholly-owned subsidiary, BOScom Ltd.

The principal amount of the Note was
repayable in monthly installments, commencing as of October 1, 2004, in the initial amount
of $20,000 eventually increasing to $73,600, and the note provided that it may be paid in
cash or, subject to certain conditions, in ordinary Shares. Interest on the Note was
payable monthly and the note provided that it may be paid in cash or, subject to certain
conditions, in Ordinary Shares. Furthermore, each month, the Investor could have elected
to convert all or a portion of the convertible note monthly payments (comprised of
principal amortization and interest) into ordinary shares. The conversion of the note and
exercise of the warrants are limited by certain restrictions. In any event, the number of
ordinary shares issuable under the note and/or the warrants shall not exceed an aggregate
of 833,085 ordinary shares (subject to certain adjustments). On March 23, 2005, after the
Investor elected to convert $308,000 of the principal sum of the convertible note, the
Investor was issued 100,000 ordinary shares of the Company. On July 14, 2005, the Investor
completed the conversion of the balance of the principal, which had not been previously
converted or repaid, and the accrued interest, into an additional 540,293 ordinary shares,
for approximately $1.58 million.

Pursuant to its undertaking in the
Registration Rights agreement with the Investor the Company filed with the Securities and
Exchange Commission a registration statement on Form F-3 covering the resale of Ordinary
Shares that were issued upon conversion of the Note and that shall be issued upon exercise
of the Warrants. The Registration Rights agreement provided that any delay in registration
and/or effectiveness of the underlying shares of the transaction, or failure to maintain
their effectiveness, will result in penalties to be paid in cash, as liquidated damages.
The registration statement became effective on March 11, 2005. Due to the delay in the
effectiveness of the registration of the shares, we paid the Investor liquidated damages
until March 11, 2005, in the amount of $92,000.

42

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On September 29, 2005, the Company
entered into a Second Securities Purchase Agreement (the Purchase Agreement)
with the Investor, under which the Company issued to the Investor in a private placement
(i) a Secured Convertible Term Note of a $1.5 million principal amount, due September 2008
(the Note), and (ii) a warrant to purchase 73,052 ordinary shares at an
exercise price of $4.04 per share (the Warrant). The Note is convertible into
ordinary shares at a price of $3.08 per share. The principal amount of the Note is
repayable in monthly installments, commencing as of January 2006, in the initial amount of
$15,000 eventually increasing to $55,200. The Note bears interest at a fluctuating
interest rate equal at all times to the WSJ prime rate plus 1.5% which is subject to
reduction under certain conditions. The interest on the note is payable in monthly
installments, together with the principal monthly repayment. The principal amount and the
interest accrued may be paid, subject to certain conditions, in ordinary shares. Each
month, the Investor may elect to convert all or a portion of the convertible note monthly
payments (comprised of principal amortization and interest) into ordinary shares. If the
market price of the ordinary shares at the time of payment is at least 10% greater than
the conversion price per ordinary share, the monthly payment shall be made in the form of
ordinary shares.

The Warrant is exercisable, in whole
or in part, until September 29, 2012, and payment of the exercise price may be made either
in cash or in a cashless exercise (or in a combination of both methods). The
warrant exercise price is also subject to proportional adjustment in the event of
combinations, subdivisions of the ordinary shares or if dividend is paid on the ordinary
shares in ordinary shares.

Pursuant to its undertaking in the
Registration Rights Agreement with the Investor, the Company filed with the Securities and
Exchange Commission a registration statement on Form F-3 covering the resale of ordinary
shares that are issuable upon conversion of the Note and/or exercise of the Warrants,
and/or issuable in payment of principal and interest on the Note. The Registration Rights
Agreement provided that any delay in registration and/or effectiveness of the underlying
shares of the transaction, or failure to maintain their effectiveness, will result in
penalties to be paid in cash, as liquidated damages. The registration statement became
effective on February 8, 2006, and no penalties were incurred.

The note conversion price is subject
to proportional adjustment in the event of stock splits, combinations, subdivisions of the
ordinary shares or if dividend is paid on the ordinary shares in ordinary shares. In
addition, if the Company issues stock in certain types of transactions at a price lower
than the initial conversion price, then the conversion price will be adjusted to a lower
price based on a weighted average formula.

The note is secured by a first
priority floating charge on all of the Companys assets and by a first priority fixed
charge on all of the Companys right, title and interest in its wholly-owned
subsidiaries, BOScom Ltd and Quasar Telecom (2004) Ltd.

Conversion of the note and exercise
of the warrants are limited as follows: at no time shall the note be convertible (or the
warrants be exercised) into that number of ordinary shares which, when added to the number
of ordinary shares otherwise beneficially owned by the Investor holder, exceed (i) 4.99%
of the Companys outstanding ordinary shares, or (ii) 25% of the aggregate dollar
trading volume of the ordinary shares for the 30-day trading period immediately preceding
the conversion or exercise notice. These limitations expire, however, in an event of
default under the note or with 75 days prior notice by the Investor, provided that in no
time shall the Investors beneficial ownership of ordinary shares exceed 19.9% of our
ordinary shares. In addition, the number of ordinary shares issuable under the note and/or
the warrants shall not exceed an aggregate of 625,000 ordinary shares.

The proceeds from the private
placement will be used for general working capital purposes and/or mergers and
acquisitions. The Investor also granted the Company an option, subject to certain
conditions, to call for an additional financing of $1.5 million after April 1, 2006, on
substantially similar terms, except that the note conversion price shall be $4.08 per
share and the warrant exercise price shall be $5.30 per share.

43

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2005 Private Placement

On May 24, 2005 the Company entered
into a Share Purchase Agreement, under which the Company issued and sold to certain
Israeli and European investors, in a private placement offering, 953,698 Ordinary Shares
at a price of $2.30 per share for a consideration of approximately $2,040,000 (net of
issuance expenses amounted to $154,000), and 572,219 warrants to purchase Ordinary Shares
reflecting a 60% warrant coverage, exercisable for three years from their date of
issuance. The exercise price under the warrants is $2.50 per Ordinary Share during for the
first year from the issuance, and increasing to $2.75 per Ordinary Share and $3.03 per
Ordinary Share, on the first and second anniversaries of the issuance, respectively. The
principal investor is the Catalyst Fund L.P., the Companys largest shareholder, that
invested $793,500 and as a result, immediately after the closing of the transaction on
June 30, 2005, held 22.31% of the Companys outstanding share capital
post-transaction. The Company also entered into a Registration Rights Agreement pursuant
to which it agreed to prepare and file with the Securities and Exchange Commission a
registration statement covering the resale of the Ordinary Shares issued to the investors.
Such a registration statement was filed and became effective on February 8, 2006.

Financial Instruments and
Commitments

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 trade
receivables average aging is 75 days and our trade payables aging is approximately
46 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.

|5C. | Research
and Development
|--- | ------------------------

We believe that our future growth is
also dependent 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 2005, gross research and development costs totaled
$2,608,000, compared to $2,296,000 in 2004. The research and development cost of the
Communication segment that was sold in December 2005, amounted to $1,715,000 in year 2005
and $1,627,000 in year 2004.

Our research and development efforts
have been focused on Communication and Connectivity Solutions. 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 $296,000 in 2005, $492,000 in
2004 and $283,000 in 2003. All grants were related to the Communication segment that was
sold in December 2005.

|5D. | Trend
Information
|--- | -----------------

Commencing the second half of year
2003 we completed the transfer of sales and marketing activities of Connectivity and VoIP
products from our subsidiaries abroad to distributors and resellers. We sold our
Communication Solutions segment in late 2005, but this trend is continuing with respect to
the Connectivity segment by increasing the number of distributors and resellers in order
to deepen our penetration in existing markets such as Western Europe and expanding into
new geographical markets such as East Europe.

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In the Connectivity Solutions
segment, the trend of customer immigration from IBM iSeries to different systems has
continued. In response we have increased our sales and marketing activities as
abovementioned and continue to develop new products and solutions in order to maintain our
market share and maintain revenues from the Connectivity segment. We are continuously
seeking additional distributors and resellers.

Odem increased its revenues in 2005
in comparison to 2004. The continuous increase in Odem sales was due to the global and
local expansion and Odems penetration into additional markets. In the second half of
year 2005 and during the first quarter of year 2006, Odem is facing a trend of decrease in
its international sales, especially to the Far East, which is partially offset by growth
in local sales. This trend has an impact on the growth of our revenues and on our working
capital, inter alia due to the fact that the credit days offered to local Israeli
customers are higher than those for customers abroad.

Our future gross margin may be lower
than what we experienced during year 2005 as a result of the disposal of the Communication
segment whose gross margin during year 2005 was 26% (a gross margin which is higher than
that of the Electronic Components segment, which generated the majority of our revenues in
2005. See Note 19a of the Consolidated Financial Statements).

Since the end of year 2003 we
increased our financial resources through four private placements of debt and equity, and
our intention is to further engage in equity and loan financings in order to engage in
acquisition activities, and increase our marketing activities and the level of resources
we devote to research and development. There is, however, no assurance that we shall be
able to obtain such financings.

|5E. | Off-Balance
Sheet Arrangements
|--- | ------------------------------

In 1998, as part of the PacInfo Share
Purchase Agreement between the Company and PacInfos former owners (the
Sellers), the Company may be obligated to grant the Sellers a loan on a full
recourse basis for certain tax payments the Sellers may be liable for, and reimburse the
Sellers for certain interest on taxes that they may owe, currently estimated at
approximately $ 2 million. (see Item 3D).

In September 2004 Odem signed a long
term sale agreement for the supply of electronic components (components). The
agreement provides for a fixed sales price of the components during the term of the
agreement thru December 2008. Absent the flexibility to increase our prices as a result of
increased costs of the components, significant increased costs may adversely impact our
financial results. In addition, under the agreement, we are obligated to hold inventory of
products necessary for three months of the customers production. This requires us to
incur the costs of purchasing inventory without having an outstanding purchase order for
the products. If we are unable to sell products that are purchased to hold in inventory,
we may incur write offs and write downs as a result of slow moving items, technological
obsolescence, excess inventories, discontinued products and products with market prices
lower than cost. Such write offs and write downs could adversely affect our operating
results and financial condition. As of December 31, 2005 we had no write down of write off
of inventory that related to this agreement.

In respect of the Companys
outstanding contingent obligation to pay royalties to the Office of the Chief Scientist
and to the Fund for the Encouragement of Exports, see Item 5A (under the caption
Grants and Participation).

|5F. | Tabular
Disclosure of Contractual Obligations
|--- | ---------------------------------------------

The following table of our material
contractual obligations as of December 31, 2005, summarizes the aggregate effect that
these obligations are expected to have on our cash flows in the periods indicated:

45

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|                          | Payment due by period
|------------------------- | ---------------------
|
|
|
|
|Long-term loans (1)       |                      
|Accrued severance pay (2) |                      
|Liabilities               |                      
|related to                |                      
|discontinued              |                      
|operation (3)             |                      
|Other liabilities         |                      
|reflected  on our         |                      
|Balance sheet (4)         |                      
|Operating lease - cars    |                      
|Purchase                  |                      
|obligation for            |                      
|service and inventory     |                      
|Facilities lease          |                      
|Total                     |                      

|(1) | Does
not include discount of $238,000 that related to the convertible note (see
               note 14 of the Consolidated Financial Statements).
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | This
amount reflects our accrued severance pay liability. Out of this amount,
               $937,000 has been previously funded by our contributions to employee
plans.                During the first quarter of year 2006, $370,000 were paid to
employees as part                of the sale of Communication segment on December 2005.
The time payment of the                rest of accrued severance liability in the amount
of $820,000, cannot be                predicted and, as a result, this amount is
presented in the more than 5 years                column.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | This
amount reflects the unsettled liability to the remaining of PacInfo
               creditors. The time of this payment, in whole or in part, cannot be
predicted                and, as a result, this amount is presented in the more than 5
years column.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | This
amount reflects the trade payables, employees and payroll accruals,
               deferred revenues, accrued expenses and other liabilities and deferred
taxes                presented in our balance sheet.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

46

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In addition, the above table does not
include (i) 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 is a function of future sales, and (ii) contingent legal claims (see note
15 of the Consolidated Financial Statements).

# Item 6: Directors,
Senior Management and Employees

|6A. | Directors
and Senior Management
|--- | -------------------------------

The following is a listing of our
directors, senior officers and key employees:

|Name                       | Age | Position                                       
|-------------------------- | --- | -----------------------------------------------
|Mr. Edouard Cukierman      | 41  | Chairman of the Board of Directors             
|Mr. Adiv Baruch            | 43  | Director, President and Chief Executive Officer
|Mr. Joel Adler             | 52  | Director                                       
|Mr. Avishai Gluck (2)      | 34  | Director                                       
|Mr. Andrea Mandel-Mantello | 47  | Director                                       
|Mr. Ronen Zavlik (1)       | 45  | Director                                       
|Mr. Jean-Marc Bally        | 35  | Director                                       
|Dr. Yael Ilan (1)          | 57  | External Director                              
|Prof. Adi Raveh (1)(2)     | 58  | External Director                              
|Mr. Nehemia Kaufman        | 57  | Chief Financial Officer                        
|Mr. Offer David            | 47  | Chief of Operations                            
|Mr. Shai Sadeh             | 51  | Senior VP, Connectivity Segment                

(1)
          Member of the Audit Committee.

(2)
          Member of the Remuneration Committee.

Mr.
          Edouard Cukierman, 41, has been a director since May 2003, and Chairman of the Company since June 2003. Mr. Cukierman
is the founder and CEO of Catalyst Investments and Chairman of Cukierman & Co. Investment House. Since
1993, Cukierman & Co, Investment House realized 1.7 Billion  of Corporate Finance transactions. Mr.
Cukierman is a former Board member of Orex, MTI Wireless and other technology companies.  He was the
President and CEO of the Astra Fund. He served as a Board member of Otto Capital, a Singapore based VC
fund. He was the former President of the Supervisory Board of Citec-Environment and Services in Paris.
He is currently a Board member of Lamina Technologies in Switzerland. He is also on the Board of Sar-El,
an Israeli Defense Forces volunteer organization. He serves as an Officer of the IDF Spokesman Unit, and
is part of the Hostage & Crisis Negotiation Team (Reserves). Mr. Cukierman holds an MBA from INSEAD,
Fontainebleau, France and a B.Sc from the Technion - Israel Institute of Technology.

Mr.
          Adiv Baruch, 43, has been a director since February 2004 and the
          Companys President and CEO service provider since January 1, 2004. From
          June 2004 he also serves as the CEO service provider of the Companys
          subsidiary, BOScom Ltd. From 1999 to 2003 he served as Executive VP Business
          Development of Ness Technologies, and has expertise in the Telecom and High-tech
          industries. Mr. Baruch is also a former partner and active director of IPEX,
          acquired by Ness. He has served as founder and an executive or director for
          several IT companies and Internet start-ups, and was significantly involved in
          the M&A process and in assisting these companies in their global expansion.
          Mr. Baruch is actively involved as the chairman of the Israeli Export Institute
          Hi-Tech and Telecom Division, and serves as a director in several public and
          private companies, including MLL Software Industries Ltd. and Maayan Ltd., two
          Israeli public company traded on the TASE, as well as for Zone 4 Play Inc. He
          has a B.Sc. in Information Systems and Industrial Engineering from the Technion
           Israel Institute of Technology.

47

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Mr.
          Joel Adler, 52, has been a director since June 2005. Mr. Adler is a partner
          in Speechly Bircham, a leading law firm in the City of London. He specializes in
          mergers & acquisitions and corporate finance work, in particular
          international corporate transactions. Joel advises a number of major Israel
          based companies on their business activities in the UK and Europe and on IPO of
          foreign companies on the London Stock Exchange ( AIM ).  Mr. Adler joined
          Speechly Bircham as a partner in 1999 from Rakisons (now part of US law firm
          Steptoe & Johnson), where he was head of the corporate department for 12
          years. Previously was with other leading law firms in London Herbert Oppenheimer
          Nathan & Vandyck, London (now Denton Wilde Sapte) and D JF Reeman. He is a
          member of the Israeli Bar and worked for the well known Israeli law firm Caspi
          & Co for two years. Mr. Adler holds a law degree from Bar Ilan University in
          Israel, and a LLM from London University. He was born and educated in Vienna.

Mr.
          Avishai Glück, 34, has been a director since February 2004. He serves
          as the Executive Vice President of Catalyst Investments. Mr. Glück has
          financial management, accounting and tax consultation experience, as well as
          extensive knowledge of the Israeli high tech market, having screened hundreds of
          companies for Catalyst and as a senior corporate consultant at E&Y Israel.
          Mr. Glück currently serves as a director in Onset Technology Ltd. Prior to
          joining Catalyst, he held the position of Corporate Finance Consultant and
          accountant with Ernst & Youngs Israeli affiliate Kost Forer &
          Gabbay, a leading Israeli CPA firm with a dominant position among Israeli
          technology companies. Mr. Glück has a BA from Tel-Aviv University in
          Accounting and Economics and is a licensed CPA.

Mr.
          Andrea Mandel-Mantello, 47, has been a director since November 2003. Mr.
          Mandel-Mantello is Founder and Partner of Advicorp PLC, a UK Investment Bank
          regulated by the UK Financial Services Authority. From 2000 to 2001 he was an
          advisor to a US based private equity group on business development in Israel.
          Prior to his work at Advicorp, Mr. Mandel Mantello spent 9 years at SBC Warburg
          (now known as UBS) in London in various senior management positions including
          Executive Director of SBC Warburg, member of the Board of SBC Warburg Italia SIM
          S.p.A, and Country Head for Israel. Prior to working at SBCW Mr. Mandel-Mantello
          spent 2 years at Chemical Bank International Ltd. in London and 3 years at Banca
          Nazionale dellAgricoltura in Rome. During his investment banking career
          Mr. Mandel-Mantello has pioneered several financial instruments in Italy
          including securitisations, equity linked products and high yield bonds. He is
          currently on the boards of Telit Plc (telecom equipment) listed on AIM; Coraline
          S.p.A., a company set up to acquire the business of Frette S.p.A. (luxury
          homeware products); and Moto S.p.A., a joint venture between Cremonini S.p.A.
          and Compass Group Plc (motorway restaurants). He holds a Bachelors degree in
          Economics and Political Science from Yale University.

Mr.
          Ronen Zavlik, 45, has been a director since May 2003. He is a partner in the
          CPA firm of Grinberg-Zavlik, which he founded in 1987. His firm provides a wide
          range of audit, tax consultancy and CFO services to a
          wide variety of companies. Mr. Zavlik provides internal auditing
          services to a number of large companies whose shares are traded on the
          Tel Aviv Stock Exchange, including Maariv Holdings Ltd, Extra Plastic
          Ltd., Israel Land Development Malls and Shopping Centers Ltd., Rapid Vision
          Ltd., and Optima Management and Investments 66 Ltd. Mr. Zavlik holds a B.A.
          in Accountancy and Business Management from the College of Management in
          Tel-Aviv. Mr. Zavlik is a licensed CPA in Israel and a member of the Institute
          of Certified Public Accountants in Israel.

48

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Mr.
          Jean-Marc Bally, 35, was elected to the Board in May 2006. Since March 2006
          he has been serving as the General Partner & Managing Director of Schneider
          Electric Ventures, a venture capital company with 50 Millions under
          management. Previously, Mr. Bally was an Investment Partner at Schneider
          Electric Ventures for 5 years where he was responsible for communications and IT
          industries investments across Europe focusing in particular on microtechnologies
          and electronics. Mr Bally currently serves as a director in Ixiasoft Inc
          (Canada), ConnectBlue ab (Sweden), Tracetel SA (France) and HBA SA (France) and
          holds an observer position in Microbridge Technologies Inc. (Canada), Netasq SA
          (France) and Tronics Microsystems SA (France). Prior to his engagement
          with Schneider Electric Ventures, Mr. Bally spent 5 years in Corporate Finance
          in Schneider Electric SA. Mr Bally holds a Masters (License) degree in
          Mathematics from Blaise Pascal University  Clermont-Ferrand, an additional
          Masters degree in Business Management from Grenoble Graduate School of Business,
          and an executive education from INSEAD.

Dr.
          Yael Ilan, 57, has been an external director since November 2002. Dr. Ilan is the president of Yedatel Ltd., an
economic consulting company, and serves as a director of CI Systems in the technology sector. Until 1998
she served on the board of Bezeq - Israels Telecommunication Company in which she headed the committee
of technological policy and infrastructure and was a member of the audit committee and the committee for
strategic planning and investment. From 1998 through 2000 she served as an external director of Elron
Industries. In 2000-01 she founded and managed Optichrom, an optical component start-up. From 1995
through 2000 Dr. Ilan served as the head of program of the Broad Band Communication, a consortium of
MAGNET  the Israeli Government hi-tech cooperation initiative. From 2002 Dr. Ilan serves as the
industrial coordinator in the Electrical Engineering Department of the Technion. Dr. Ilan holds a Ph.D.
in industrial engineering from Stanford University, a Ph.D. in physical chemistry from the Hebrew
University and a Masters degree in business administration from the Hebrew University.

Prof.
          Adi Raveh, 58, has been an external director since February 2003. Prof.
          Raveh is a professor and head of the B.A. Program at the School of Business
          Administration, Hebrew University, Jerusalem. Since 1998 he serves as an
          external director at Clal Insurance Company Ltd. Since 2002 he serves as the
          Chairman of the Board of Jerusalem Capital Markets Underwriting limited. He also
          serves as a director of Meitav  a Mutual Funds Management company (since
          1995), and as a director of Peilim  a Portfolio Management company 
          part of Bank Hapoalim Group (since 1996). Since 1992 he is a director who
          represents the Hebrew University at Hi-Tech  a Technology Entrepreneurship
          located at Har-Hahotzvim, Jerusalem. Prof. Raveh also serves as a director of
          two start-up companies: A.D.M (Advanced Dialysis Methods Ltd.) and Virtouch Ltd.
          Between 1994-1999 he served as a director and a member of the executive
          committee of the Bank of Jerusalem, Ltd. Between 1996-1998 he served as a member
          of an ad-hoc committee of the Council of Higher Education. In 1999 he served as
          a member of the Budget Committee for Research at the Israel Science Foundation.
          Prof. Raveh holds a Ph.D. from the Hebrew University. He is the author of about
          50 professional publications, was a visiting professor at Stanford University,
          Columbia University and Baruch College, N.Y., and has received a number of
          grants and honors.

Mr.
          Nehemia Kaufman, 57, has been a CFO and financial service provider to the
          Company through Mocha Global Managerial Services Ltd. (Mocha
          Global), of which he is the Managing Director, since September 2002.
          Before then, from May 2002, he served as CFO and financial services provider
          through Mocha Global, of the Companys subsidiary, BOScom Ltd. From 1999 to
          2002 he co-founded and served as CFO of Trellis Photonics Ltd., from 1997 to
          1999 Mr. Kaufman was self-employed as a CFO service provider, from 1995 to 1997
          he served as CFO of Computer Direct Ltd. (TASE: CMDR), and from 1993 through
          1995 he served as CFO of Rogosin Enterprises Ltd. (TASE: ROGO). Mr. Kaufman
          holds an MBA degree from the Hebrew University in Jerusalem (graduated with
          distinction) and a BA degree in Economics and Business Administration from Haifa
          University.

Mr.
          Offer David, 47, has been Chief of Operations since August 2004. From 2003
          to 2004, Mr. David was Projects Dept. Manager at Arkal Filtration and Water
          Treatment Systems, and from 1977 to 2003 he was with the Israel Navy, where he
          held select command assignments, retiring as a Captain (Navy). Mr. David has an
          MBA in Business Management from Haifa University Graduate School of Business
          Administration, a B.Sc. in Chemical Engineering from the Technion  Israel
          Institute of Technology, and graduated a 1-year course at the Naval Command
          College (NCC  Millennium class) in Newport, Rhode Island in the USA.

49

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Mr.
          Shai Sadeh, 51, has been Senior VP, Connectivity Segment since April 2004.
          Previously, from 1994 to 2004 he served in several executive capacities at
          Sintec/Formula Group; he was the founder and CEO of Tochna Veod, a Formula Group
          company; Manager of IBM iSeries (AS/400) Technical Support team; and founder of
          the Sintec Group Professional Services Division. Mr. Sadeh has a BA in Social
          Sciences from Tel Aviv University and has studied towards an MBA at the
          University of Tel Aviv.

In addition, Mr. Zvi
Greengold, 54, is an observer at Board of Director meetings. Mr. Greengold served as a
director from June 2002 to August 2004, and served as Chairman from September 2002 to June
2003. He also provides consultancy services to BOScom. Mr. Greengold is currently
self-employed in the field of industrial management, promotion and consulting, and serves
as Chairman of Polysac Ltd., an Israeli public company traded on the TASE, and Chairman of
the Economic Management of Kibbutz Ein-Gedi.

|6B. | Board
Compensation
|--- | ------------------

The directors who are not executive
officers are paid a fee for their services as directors to the extent that such fees are
approved by a general meeting of our shareholders. Until February 18, 2003, only the
Companys external directors were paid for their service on the Companys Board
of Directors and its committees. As resolved by the shareholders, the external directors
are compensated according to the maximum rate permitted (now and in the future) by Israeli
law and regulation. The current rates for companies the size of ours, are an annual fee of
approximately $5,750, and a participation fee in meetings of approximately $300. On
February 18, 2003 the shareholders approved compensation for all directors who are not
employees or consultants(1), including directors appointed in the future, at
the same rate the external directors of the Company are paid. On June 26, 2003, the Board
of Directors resolved to reduce the annual fee for all directors by 18%, effective July 1,
2003, as part of a cost reduction plan, and on June 29, 2005 the annual fee was reinstated
as before the 18% reduction, retroactively from January 1, 2005. Additionally, the
Companys directors are granted options (see Share Ownership ahead). The
Company does not have any contracts with any of its non employee/consultant directors,
that would provide for benefits upon termination of service.

The following table presents the
total compensation paid to or accrued on behalf of all of our directors and officers as a
group for the year ended December 31, 2005:

---

1    
          However, on August 5, 2004 the shareholders approved an exception  that
          Edouard Cukierman, Chairman of the Board, will receive remuneration
          (retroactively from the date of his nomination in May 2003) as a Board member,
          under the same terms as all other directors, despite his being (indirectly) a
          controlling shareholder and senior executive of Cukierman & Co. Investment
          House Ltd. (a service provider to the Company). Additionally, in August 2004 the
          shareholders ratified the audit committee and Board of Directors
          resolutions that the consulting fee paid to Mr. Zvi Greengold, be in addition to
          the remuneration and options Mr. Greengold received as a director of the Company
          until August 2004.

50

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|                                | Salaries, Directors' Fees,
Service Fees2, Commissions and
Bonuses | Pension, Retirement and
Similar Benefits
|------------------------------- | ----------------------------------------------------------------- | ----------------------------------------
|
|
|
|
|All directors and officers as a |                                                                   |                                         
|group (then 16 persons)         |                                                                   |                                         

Such remuneration does not include
amounts expended by the Company for expenses, including business association dues and
expenses reimbursed to said officers, and other fringe benefits commonly reimbursed or
paid by companies in the location in which the particular executive officer of the Company
is located, as the case may be.

|6C. | Board
Practices
|--- | ---------------

Our Board of Directors is currently
comprised of nine directors, including two external directors. The directors are elected
at the annual shareholders meeting, by a simple majority, to serve until the next annual
meeting of our shareholders and until their respective successors are elected and
qualified, with the exception of the external directors who, by rule of the Companies Law
1999, serve for three years. Our Articles of Association provide that the number of
directors in the Company (including external directors) shall be determined from time to
time by the annual general meeting of shareholders, provided that it shall not be less
than four nor more than eleven. Our Articles of Association provide that the directors may
appoint additional directors (whether to fill a vacancy or to expand the Board) so long as
the number of directors so appointed does not exceed the number of directors authorized by
shareholders at the annual general meeting, and such appointees shall serve until the next
annual general meeting.

The Company has determined that
Messrs. Adler, Bally, Glück, Mandel-Mantello, Zavlik and Raveh and Ms. Ilan, who
constitute a majority of the Board of Directors, are independent directors under the
applicable Nasdaq Stock Market requirements.

Under the Companies Law and the
regulations promulgated pursuant thereto, Israeli companies whose shares have been offered
to the public in, or that are publicly traded outside of, Israel are required to appoint
at least two natural persons as external directors. No person may be appointed
as an external director if the person, or a relative, partner or employer of the person,
or any entity under the persons control, has or had, on or within the two years
preceding the date of the persons appointment to serve as an external director, any
affiliation with the company to whose board the external director is proposed to be
appointed or with any entity controlling or controlled by such company or by the entity
controlling such company. The term affiliation includes an employment relationship, a
business or professional relationship maintained on a regular basis, control and service
as an office holder (which term includes a director).

In addition, no person may serve as
an external director if the persons position or other business activities create, or
may create, a conflict of interest with the persons responsibilities as an external
director or interfere with the persons ability to serve as an external director or
if the person is an employee of the Israel Securities Authority or of an Israeli stock
exchange. If, at the time of election of an external director, all other directors are of
the same gender, the external director to be elected must be of the other gender. The
external directors must have professional qualifications to serve as a director, and at
least one of the external directors must be a financial expert.

---

|2      We receive CFO services from Mocha Global Managerial Services Ltd., and the
          services are provided by Mr. Nehemia Kaufman. We receive managerial/CEO services
          from Signum Ltd., and the services are provided by Mr. Adiv Baruch. Figure also
          includes consulting and other fees paid to Cukierman & Co. Investment House
          Ltd., of which Mr. Edouard Cukierman, the Companys Chairman, is
          (indirectly) a controlling shareholder.
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

51

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External directors are elected for a
term of three years and may be re-elected for one additional three-year term. Each
committee of a companys Board of Directors that has the authority to exercise powers
of the Board of Directors is required to include at least one external director and its
audit committee must include all external directors.

External directors are elected at the
general meeting of shareholders by a simple majority, provided that the majority includes
at least one-third of the shareholders who are not controlling shareholders, who are
present and voting, or that the non-controlling shareholders who vote against the election
hold one percent or less of the voting power of the company.

Under the Companies Law an external
director cannot be dismissed from office unless: (i) the Board of Directors determines
that the external director no longer meets the statutory requirements for holding the
office, or that the external director is in breach of the external directors
fiduciary duties and the shareholders vote, by the same majority required for the
appointment, to remove the external director after the external director has been given
the opportunity to present his or her position; (ii) a court determines, upon a request of
a director or a shareholder, that the external director no longer meets the statutory
requirements of an external director or that the external director is in breach of his or
her fiduciary duties to the company; or (iii) a court determines, upon a request of the
company or a director, shareholder or creditor of the company, that the external director
is unable to fulfill his or her duty or has been convicted of specified crimes.

Our Articles of Association provide
that a director may appoint, by written notice to us, any individual to serve as an
alternate director, up to a maximum period of one month, if the alternate is not then a
member of the Board. Any alternate director shall have all of the rights and obligations
of the director appointing him or her and shall be subject to all of the provisions of the
Articles of Association and the Companies Law. Unless the time period or scope of any such
appointment is limited by the appointing director, such appointment is effective for all
purposes for a period of one month, but in any event will expire upon the expiration of
the appointing directors term, removal of the alternate at an annual general
meeting, the bankruptcy of the alternate, the conviction of the alternate for an offense
under Section 232 of the Companies Law, the legal incapacitation of the alternate, the
removal of the alternate by court order or the resignation of the alternate. Currently, no
alternate directors have been appointed. A director may appoint an alternate to serve in
his place as a member of a committee of the Board of Directors, even if the alternate
currently serves as a director, as long as he does not already serve as a member of that
committee.

Officers serve at the discretion of
the Board or until their successors are appointed.

According to the provisions of our
Articles of Association and the Companies Law, the Board of Directors convenes in
accordance with the Companys requirements, and at least once every three months. In
practice, the Board of Directors convenes more often. Furthermore, our Articles of
Association provide that the Board of Directors may also pass resolutions without actually
convening, provided that all the directors entitled to participate in the discussion and
vote on a matter that is brought for resolution agree not to convene for discussion of the
matter. Resolutions passed without convening, shall be passed by an ordinary majority
(just as in the case of convened meetings) and shall have the same effect as resolutions
passed at a duly convened meeting.

In accordance with the requirements
of the Nasdaq Stock Market, commencing on July 31, 2005, nominees for directors will be
recommended for selection by a majority of the independent directors.

52

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Audit Committee:

The Companies Law requires public
companies to appoint an audit committee comprised of at least three directors, including
all of the external directors, and further stipulates that the chairman of the Board of
Directors, any director employed by or providing other services to a company and a
controlling shareholder or any relative of a controlling shareholder may not be members of
the audit committee. The responsibilities of the audit committee include identifying flaws
in the management of a companys business, making recommendations to the Board of
Directors as to how to correct them and deciding whether to approve actions or
transactions which by law require audit committee approval. An audit committee may not
approve an action or transaction with a controlling shareholder or with an office holder
unless at the time of approval two external directors are serving as members of the audit
committee and at least one participated in the meeting at which the action or transaction
was approved.

In order to comply with the
Sarbanes-Oxley Act of 2002, the Board of Directors has expanded the role of the
Companys Audit Committee to provide assistance to the Board of Directors in
fulfilling its legal and fiduciary obligations with respect to matters involving the
accounting, auditing, financial reporting and internal control functions of the Company.
In carrying out these duties, the Audit Committee must meet at least once in each fiscal
quarter with management at which time, among other things, it reviews, and either approves
or disapproves, the financial statements of the Company for the immediately preceding
fiscal quarter and conveys its conclusions in this regard to the Board of Directors. The
Audit Committee also monitors generally the services provided by the Companys
external auditors to ensure their independence, and reviews, and either approves or
disapproves, all audit and non-audit services provided by them. The Companys
external and internal auditors must also report regularly to the Audit Committee at its
meetings, and the Audit Committee discusses with the Companys external auditors the
quality, not just the acceptability, of the accounting principles, the reasonableness of
significant judgments and the clarity of disclosures in the Companys financial
statements, as and when it deems it appropriate to do so.

Under the Sarbanes-Oxley Act of 2002,
the Audit Committee is also responsible for the appointment, compensation, retention and
oversight of the work of the Companys external auditors. However, under Israeli law,
the appointment of external auditors requires the approval of the shareholders of the
Company. Accordingly, the appointment of the external auditors is approved and recommended
to the shareholders by the Audit Committee and ratified by the shareholders. Furthermore,
pursuant to the Companys Articles of Association, the Board of Directors is the
organ that has the authority to determine the compensation of the external auditors,
however, the Board of Directors recently delegated its authority to the audit committee,
so that a second discussion by the Board of Directors shall not be necessary.

The Company has determined that the
members of the audit committee meet the applicable Nasdaq Stock Market and SEC
independence standards.

In 2003 the Company adopted an Audit
Committee Charter which sets forth the responsibilities of the committee. A copy of this
charter is available on the Companys website.

Remuneration Committee:

The role of the Remuneration
Committee is to provide assistance and make recommendations to the Board of Directors
regarding matters related to the compensation of employees of the Company. The
Remuneration Committee of the Company meets on an ad hoc basis, and in the past has not
always been active. Under the Israeli Companies Law, generally the Remuneration Committee
may only make recommendations to the Board of Directors concerning the grant of options
(and in some cases, such grants may need approval of the audit committee, the Board of
Directors and the shareholders as well).

53

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Commencing July 31, 2005, in
accordance with Nasdaq rules, the compensation of the Companys chief executive
officer and other executive officers is recommended to the Board of Directors by a
majority of the independent directors on the Companys Board of Directors.

|6D. | Employees
|--- | ---------

As of December 31, 2005, we employed
98 employees (including employees of our subsidiaries as well). All of our employees are
employed in Israel. Of the 98 employees, 20 employees are in administration and finance,
31 employees in marketing and sales, 26 employees in research and development, 6 employees
in technical support, and 15 employees in manufacturing and related activities. Following
the sale of the Communication segment in December 2005, the number of employees reduced to
70 employees as of March 31, 2006. As of December 31, 2004, we employed 93 employees
worldwide. As of December 31, 2003, we employed 57 employees worldwide (the increase in
the number of employees in 2004 compared to 2003, is mainly due to the acquisition of
Odem). We believe that our relations with our employees are satisfactory. We have not
experienced a collective labor dispute or strike.

Israeli labor laws are applicable to
all of our employees in Israel. The laws principally concern the length of the work day,
minimum daily wages for professional workers, contributions to a pension fund, insurance
for work-related accidents, allotment of vacation and sickness days, procedures for
dismissing employees, determination of severance pay and other conditions of employment.

All Israeli employers, including us,
are required to provide a certain escalation of wages in relation to the increase in the
Israeli Consumer Price Index. The specific formula of such escalation varies according to
agreements reached between the Government of Israel, the Manufacturers Association
and the Histadrut, the general labor union in Israel. The majority of our employees are
covered by comprehensive life and pension insurance policies. The remainder are covered by
retirement accounts. Israeli employees and employers are required to pay predetermined
sums to the Israel National Insurance Institute which amounts also include, since January
1, 1995, payments for national health insurance.

|6E. | Share
Ownership
|--- | ---------------

As of May 31, 2006, out of our
directors and officers, then consisting of 11 persons, only Mr. Edouard Cukierman, Mr.
Baruch Adiv and Mr. Joel Adler, all directors of the Company, held ordinary shares of the
Company. Mr. Edouard Cukierman held 21,666 ordinary shares, Mr. Baruch Adiv held 65,000
ordinary shares, and Mr. Joel Adler held 108,695 ordinary shares3. As of May
31, 2006 we have granted our officers and directors options to acquire an aggregate of
879,758 ordinary shares under our Stock Option Plans4. The average exercise
price of these options is $2.85 per option. Of these options, none have been exercised
until now and 336,733 had vested as of May 31, 2006.

---

3    
          Mr. Joel Adler, a director of the Company, is one of the beneficiaries of a
          discretionary trust that owns Brada Investments Limited, a shareholder of the
          Company. Number of ordinary shares does not include 65,217 options of Brada
          Investments Limited to purchase ordinary shares of the Company.

4    
          Includes options granted to Mocha Global Managerial Services Ltd. and to Signum
          Ltd.. Does not include 65,217 options of Brada Investments Limited, a
          shareholder of the Company owned by a discretionary trust of which Mr. Joel
          Adler, a director of the Company, is one of the beneficiaries.

54

---

---

On February 18, 2003 the
Companys shareholders approved the grant of 7,500 options to any future first-time
director, who is not an employee or paid consultant of the Company. The terms and
conditions of the grant, as approved by the shareholders, are as follows: the exercise
price shall be $1.84; the options will vest over a three year period from the date of
grant (one-third vesting every year) and be exercisable within five years from the date of
grant. As the share price has fluctuated over the past year, at the recommendation of the
Board of Directors the shareholders resolved on August 5, 2004, that future issuances to
new directors will have an exercise price equal to the average closing price of the shares
on the Nasdaq National Market on the 20 trading days preceding their appointment.

The shareholders approved on August
5, 2004, that Edouard Cukierman, Chairman of the Board, will be granted 7,500 options
under the same terms as all other directors, despite his being (indirectly) a controlling
shareholder and senior executive of Cukierman & Co. Investment House Ltd. (a service
provider to the Company), and therefore not eligible for options according to the current
shareholder resolution.

The shareholders also approved on
June 29, 2005 to grant all directors of the Company (including external directors), who
are not employees or consultants of the Company (or who have been granted options similar
to all directors despite their employment and/or services), an additional 7,500 options to
purchase ordinary shares of the Company on the third anniversary of their service as
directors, under the same terms approved by the shareholders on February 18, 2003 and as
amended on August 5, 2004.

On June 29, 2005, the shareholders
approved the grant of 20,000 options to purchase ordinary shares of the Company under the
2003 Israeli Share Option Plan, to Signum Ltd., the company that provides management
services to the Company, as a bonus for year 2004, at an exercise price of $3.08 per
share, vesting over 24 months from date of grant in 24 equal parts, 1/24 per month,
exercisable until five years from date of grant. The shareholders also approved, as a
bonus for the year 2005, subject to the Company achieving profitability in the financial
statements as of December 31, 2005, to grant Signum Ltd. an additional 20,000 options
under the 2003 Israeli Share Option Plan, at an exercise price of $3.08 per share, with a
date of grant as of the date the Board approves profitable financial statements for the
year 2005, vesting over 12 months from date of grant in 12 equal parts, 1/12 per month,
exercisable until five years from date of grant. However, the milestone was not reached
and the options were not granted.

On May 18, 2006 the shareholders
approved to (i) grant Mr. Adiv Baruch5 a bonus of 65,000 ordinary shares (for
no consideration), (ii) to grant Mr. Edouard Cukierman, the Chairman of the Board of
Directors, a bonus of 21,666 ordinary shares (for no consideration), and (iii) to grant
Signum Ltd. and Edouard Cukierman 187,100 options and 233,876 options, respectively, to
purchase ordinary shares of the Company, pursuant to the Companys 2003 Israeli Share
Option Plan, at an exercise price of $2.68 which is equal to the average closing price of
the Companys shares on the Nasdaq National Market on the 20 trading days preceding
the shareholders meeting date at which the grant was approved (the Grant
Date), to be vested in three equal parts on the first, second and third anniversary
of the Grant Date, for a maximum exercise period of 3 years from the vesting date of each
portion of the Grant.

# Share Option Plans

The purpose of the Share Option Plans
is to enable us to attract and retain qualified persons as employees, officers, directors,
consultants and advisors and to motivate such persons by providing them with an equity
participation in the company. The Section 102 Plan is designed to afford qualified
optionees certain tax benefits under the Israel Income Tax Ordinance. The Share Option
Plans will expire 10 years after their adoption, unless terminated earlier by the Board of
Directors.

---

5    
          Mr. Baruch is one of the controlling shareholders of Signum Ltd., that provides
          management services to the Company, and serves, pursuant to the management
          agreement in the capacity of President and Chief Executive Officer of the
          Company and also, since February 2004, serves as a director.

55

---

---

The Share Option Plans are
administered by the Board of Directors which has broad discretion, subject to certain
limitations, to determine the persons entitled to receive options.

Under the Share Option Plans, the
terms and conditions under which options are granted and the number of shares subject
thereto shall be determined by the Board of Directors. The Board of Directors also has
discretion to determine the nature of the consideration to be paid upon the exercise of an
option under the Share Option Plans. Such consideration generally may consist of cash, or,
at the discretion of the Board of Directors, cash and a recourse promissory note.

Stock options issued as incentive
stock options pursuant to the ISO/RSO Plan will only be granted to our employees,
including those of all subsidiaries. The exercise price of incentive stock options issued
pursuant to the ISO/RSO Plan must be at least equal to the fair market value of the
ordinary shares as of the date of grant. The price per share under options awarded
pursuant to the Section 102 Plan may be any price determined by the Board.

The ordinary shares acquired upon
exercise of an option are subject to certain restrictions on transfer, sale or
hypothecation. Options are exercisable and restrictions on disposition of shares lapse
pursuant to the terms of the individual agreements under which such options were granted
or shares issued.

Due to a tax reform in Israel, after
January 1, 2003 the Company may not grant options pursuant to an old Section
102 Plan. Therefore, the Company may not grant any more options pursuant to the 2000 and
1995 Plans described below. Previous grants under these Plans remain unaffected. In any
event, after the adoption of the 2003 Plan (see below), the Board of Directors resolved
that no further grants shall be made from the previously adopted plans.

2003 Plan

In May 2003 the Companys
shareholders approved the adoption of the 2003 Israeli Stock Option Plan, pursuant to
which 625,000 ordinary shares were reserved for purchase by the employees, directors,
consultants and service providers of the Company and its subsidiaries. Subsequently, the
shareholders approved an increase of the shares reserved for issuance under the Plan, to 1
million, and then to 1.5 million. The Board of Directors has resolved that no further
grants shall be made from the previous plans. The Company has elected the benefits
available under the capital gains alternative. Pursuant to the election made
by the Company, capital gains derived by optionees arising from the sale of shares derived
from the exercise of options granted to them under Section 102, will be subject to a flat
capital gains tax rate of 25% (instead of the gains being taxed as salary income at the
employees marginal tax rate). However, as a result of this election, the Company
will no longer be allowed to claim as an expense for tax purposes the amounts credited to
such employees as a benefit when the related capital gains tax is payable by them, as the
Company was previously entitled to do. The Company may change its election from time to
time, as permitted by the Tax Ordinance. There are various conditions that must be met in
order to qualify for these benefits, including registration of the options in the name of
a trustee (the Trustee) for each of the employees who is granted options. Each
option, and any ordinary shares acquired upon the exercise of the option, must be held by
the Trustee for a period commencing on the date of grant and ending no earlier than 24
months after the date of grant.

As of December 31, 2005, we had
572,503 options outstanding under the 2003 plan, 30,000 at an exercise price of $3.08 per
share, 314,282 at an exercise price of $3.00 per share, 15,000 at an exercise price
between $2.28 to $2.48 per share, 140,221 at an exercise price between $1.84 to $2.00 per
share, and 73,000 at an exercise price of less than $0.01 per share. 292,909 options were
vested as of December 31, 2005.

56

---

---

2001 Plan

In March 2002, the Companys
shareholders approved the adoption of the 2001 Stock Option Plan, pursuant to which
250,000 ordinary shares were reserved for purchase by the Companys employees,
directors, consultants or service providers, as determined by the Board of Directors or
its authorized sub-committee. As of December 31, 2005, we had 98,741 options outstanding
under this plan, 75,000 at an exercise price of $4.00 per share and 23,741 at an exercise
price of $6.80 per share. All of the outstanding options had vested as of December 31,
2005.

2000 Plan

In April 2001, the Companys
shareholders approved our 2000 Employees Incentive Share Option Plan, pursuant to which
112,500 ordinary shares were reserved for purchase. The plan is subject to Section 102 of
the Israeli Income Tax Ordinance. As of December 31, 2005, we had 40,825 options
outstanding under this plan, 33,325 at an exercise price of $28.00 per share and 7,500 at
an exercise price of $6.80 per share. All of the outstanding options had vested as of
December 31, 2005.

1999 Plan

In November 1999, the Companys
shareholders approved the adoption of the 1999 Stock Option Plan (incentive and restricted
stock options). The 1999 plan has 193,750 ordinary shares reserved in its favor. As of
December 31, 2005, 44,257 of the options granted under this plan had been exercised, and
no options were outstanding.

1995 Plans

In December 1995, we adopted the
following plans: (i) the Stock Option Plan (Incentive and Restricted Share Options) (the
ISO/RSO Plan), which provides for the grant of incentive and restricted stock
options and (ii) the Section 102 Stock Option/Stock Purchase Plan (the Section 102
Plan and together with the ISO/RSO Plan, the Share Option Plans).

The Share Option Plans provide for
the grant of options to purchase up to an aggregate of 50,000 ordinary shares. As of
December 31, 2005, 22,300 of the options granted under this plan had been exercised, and
there were 9,463 more options outstanding, 7,213 at an exercise price of $17.00 per share,
and 2,250 at an exercise price of $18.00 per share. All of the outstanding options had
vested as of December 31, 2005.

# Item 7: Major
Shareholders and Related Party Transactions

|7A. | Major
Shareholders
|--- | ------------------

We are not directly or indirectly
owned or controlled by another corporation or by any foreign government.

The following table presents, to the
best of our knowledge, certain information as of May 31, 2006 with respect to each
shareholder known to the Company to be the beneficial owner of more than 5% of our
outstanding ordinary shares. Except where indicated, we believe, based on information
provided by the owners, that the beneficial owners of the ordinary shares listed below
have sole investment and voting power with respect to those shares. Applicable percentage
ownership in the following table is based on 6,702,534 shares outstanding as of May 31,
2006.

57

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|                                      | Shares Beneficially Owned
|------------------------------------- | -------------------------
|
|
|
|
|Catalyst Fund, LP (1)                 |                          
|3 Daniel Frisch Street,               |                          
|Tel-Aviv 64731, Israel                |                          
|Jacob and Sara Neuhof (2)             |                          
|5 Yitzhak Berger Street,              |                          
|Rishon Letzion 75260, Israel          |                          
|Officers and directors as a group (3) |                          

(1)
          Does not include 207,000 options to purchase ordinary shares.

(2)
          Jacob Neuhof holds 225,861 ordinary shares and his spouse, Sara Neuhof, holds
          224,274 ordinary shares. As they are husband and wife, each is deemed to
          indirectly hold the shares of the other, however, each disclaims beneficial
          ownership of the shares of the other.

(3)
          Does not include 879,758 options to purchase ordinary shares of the Company
          granted and currently held by Officers and/or Directors of the Company. Does not
          include 65,217 options of Brada Investments Limited, a shareholder of the
          Company owned by a discretionary trust of which Mr. Joel Adler, a director of
          the Company, is one of the beneficiaries.

The changes in holdings of the major
shareholders over the last three years, are detailed to the best of our knowledge in the
table below:

|Holdings as of:       | December 31, 2003 | December 31, 2004 | December 31, 2005
|--------------------- | ----------------- | ----------------- | -----------------
|
|
|
|
|Catalyst Fund, LP     |                   |                   |                  
|Jacob and Sara Neuhof |                   |                   |                  

The shareholders holdings
reflect their voting rights. The Companys major shareholders do not have different
voting rights than other shareholders, with respect to their shares.

As of May 31, 2006, there were 32
record holders of ordinary shares, of which 7 were registered with addresses in the United
States, representing approximately 57% of the outstanding ordinary shares. However, the
number of record holders in the United States is not representative of the number of
beneficial holders nor is it representative of where such beneficial holders are resident
since many of the ordinary shares are held of record by brokers and other nominees.

|7B. | Related
Party Transactions
|--- | --------------------------

# M&A Addendum to the
Services Agreement of Cukierman & Co.

In 2003, the Companys audit
committee and Board of Directors approved the engagement of Cukierman & Co. Investment
House Ltd., to provide non-exclusive investment-banking services and business development
services to the Company, effective as of April 15, 2003. Cukierman & Co. is a company
indirectly controlled by Mr. Edouard Cukierman, who, since June 26, 2003, serves as
Chairman of our Board of Directors, and is a co-manager of the Catalyst Fund, the
Companys largest shareholder. For its services, Cukierman & Co. is paid a
monthly sum of $10,000 plus VAT, 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. The agreement provided that the success
fees for securing M&A transactions shall be discussed by the parties and drafted as a
future addendum to the agreement. Such an addendum was approved on August 22, 2004, and it
provides Cukierman & Co. with a success fee of 3.5% of the proceeds exchanged in an
M&A transaction (see also Note 20a to the Consolidated financial statements).

58

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# Consulting Agreement
between BOScom and Israel Gal

On June 29, 2005, at the
recommendation of the audit committee and the Board of Directors, the shareholders
approved a consultancy agreement between BOScom and Xorcom Ltd., a company controlled by
Israel Gal, who was a director of the Company until May 10, 2005 and who was employed by
the Company and BOScom in various positions, the most recent as CTO of VOIP products in
BOScom. On December 31, 2004 the employment was terminated and Mr. Gal began providing
consultancy services (as well as aid in the preparation of the Chief Scientist proposal
and outsourcing of hardware) to BOScom, through his company, Xorcom Ltd. The term of the
consultancy agreement was January 1, 2005 through June 30, 2005. The amount paid for Mr.
Gals consulting services amounted to $83,000, which was equal to the amount borne by
the employer with respect to his salary as of December 31, 2004.

# Assignment of Voting
Rights to Mr. Yair Shamir

On February 5, 2004 the Audit
Committee and Board of Directors approved an Assignment and Assumption Agreement, between
the Company, Catalyst Investments L.P, and Mr. Yair Shamir (who was at the time a director
of the Company and the Chairman of Catalyst Investments), according to which the voting
rights in all but one of the Surf shares that the Company has an option to purchase from
Catalyst (see Note 6 to the Consolidated Financial Statements), have been assigned to Yair
Shamir. Pursuant to the agreement, Yair Shamir irrevocably undertook to assign the voting
rights to the Company immediately upon the earlier to occur of the following, and subject
to the receipt of a written request from the Company to effect such assignment: a) at the
time Surfs shares are offered to the public in a public offering pursuant to a
registration statement filed by Surf under the Securities Act of 1933 or a similar act of
another jurisdiction, or b) the Company exercises its option to purchase the additional
shares from Catalyst. In January 2006, the option to purchase from Catalyst shares in Surf
expired.

# Indemnity Undertakings
by the Company to its Directors and Officers

On February 18, 2003, the
Companys shareholders approved indemnity undertakings to its directors and officers
(including future directors and officers as may be appointed from time to time), in excess
of any insurance proceeds, not to exceed, in the aggregate over the years, a total amount
of $2,500,000 (two and a half million dollars). On May 18, 2006, at the recommendation of
the audit committee and the Board of Directors, the shareholders approved amendments to
the indemnity undertakings, in light of changes to the Israeli Companies Law 1999.

# Private Placement with
Certain Investors, Including Catalyst

On June 30, 2005 the Company closed a
Share Purchase Agreement with certain investors, including the Catalyst Fund L.P., which
is the Companys largest shareholder. See Item 5B.

|7C. | Interests
of Experts and Counsel
|--- | --------------------------------

Not applicable.

59

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# 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 revenues
of the Company has been as follows:

|Year | export revenues | % of all revenues
|---- | --------------- | -----------------
|
|
|
|
|2005 |                 |                  
|2004 |                 |                  
|2003 |                 |                  

Legal Proceedings

In July 2002, the Company received a
claim letter from a car leasing vendor, under which it claims that the Companys
termination notice of the leasing agreement in March 2002 constituted a breach of the
agreement and the car vendor is demanding compensation of which the nominal sum is
approximately $292,000. No legal proceeding has yet been filed. At this stage, according
to the Companys counsel assessment, the prospects of vendor to prevail and recover a
significant amount, seem remote. The financial statements do not include any provision for
this claim.

In September 2003, a supplier filed a
legal claim in the amount of $107,000 against the Companys subsidiary (Odem). The
claim alleges the breach of an agreement for the purchase of products. The Companys
legal counsel is unable to reasonably estimate the outcome of this claim. In addition, the
Companys management believes that the chances of the claim to succeed are remote.
Accordingly, no provision has been included in the financial statements in respect of this
claim.

In March 2006, BOSâNOVA EURL, a
French company and former distributor of the Company, filed against the Company and others
a claim with the French Tribunal, in the amount of 1.4 million Euros, alleging breach of
exclusive distributor rights in France. An initial hearing is scheduled to take place in
France on June 29, 2006. This claim follows a previous motion for temporary injunctive
relief that was filed against the Companys new French distributor, said motion
ultimately denied by French Trade Tribunal. The Company intends to petition the French
Trade Tribunal to transfer the claim to an Israeli court in accordance with the choice of
jurisdiction clause of the original distribution agreement and in that case the
assessments of the Companys management is that the prospects of plaintiff to prevail
and recover a significant amount, are remote. The Companys management is not yet
able to assess the probability of successfully defending the existing claim if it is
ultimately tried before the French Tribunal. The financial statements do not include any
provision in respect of this claim.

On May 10, 2006 the Company received
a written demand from IDEAL Software GmbH (IDEAL), a German corporation, in
which it claims that the Company owes IDEAL 1.13 million EUR for license fees including
interest. In 1999, the Company and IDEAL entered into a license agreement according to
which the Company was granted the right to distribute IDEALs print engine embedded
into the Companys PrintBOS product, and was to buy IDEALs license for each
installation for an agreed upon price. IDEAL claims that the number of installations
performed by the Company in its PrintBOS product during the period of 1999 thru 2005,
exceeded the licenses bought by the Company. The parties agreed that Company will
cooperate with an Auditor appointed by IDEAL to check the number of licenses distributed
by the Company. Based upon the Auditors report rendered on May 1, 2006, IDEAL sent
the above-mentioned demand letter. The Company rejects IDEALs demand, inter
alia due to the fact that it is based on erroneous findings contained in the
Auditors report. On June 11, 2006 the Company filed with the Haifa District Court in
Israel a claim seeking, among other remedies, a declaratory judgment stating that the
Auditors report is materially flawed and should be disregarded. The Companys
German counsel is of the opinion that a German court, if and when IDEAL files a claim
against the Company in Germany pursuant to its demand, might very well summarily bar such
a claim and transfer the matter to the jurisdiction of an Israeli court or stay such a
claim until a verdict is handed down in the claim filed by the Company with the Haifa
District Court. However, if such a claim is ultimately tried in Germany, then German
counsel is of the opinion that there is a fair probability that the Company will be able
to successfully defend a portion of the claim, the size of which cannot yet be determined.
At this early stage the Company is not yet able to assess the final outcome of this
demand. The financial statements do not include any provision in respect of this claim.

60

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Dividend Policy

The Company does not currently have a
dividend policy. 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 that time.
This will include our earnings and financial condition. We may only pay cash dividends in
any fiscal year, out of profits, as defined under Israeli law. Any dividends
paid out of Approved Enterprise earnings (i.e. tax exempt income) will be liable to tax.
As we cannot currently distribute dividends, no provision has been made for this
additional tax in our Financial Statements.

|8B. | Significant
Changes
|--- | -------------------

Not applicable.

# Item 9: The Offer and
Listing.

|9A. | Offer
and Listing Details
|--- | -------------------------

Since April 1996, our ordinary shares
were traded, and our warrants, until they expired on April 2, 2000, were traded in the
over-the-counter market in the United States, as quoted on the NASDAQ Small Capitalization
Market under the symbol BOSC and BOSCW, respectively. In September
2000, our shares started to be traded on the NASDAQ National Market. In January 2002, our
shares began trading also on the Tel-Aviv Stock Exchange, under the symbol
BOSC, pursuant to the dual-listing regulations of the Israeli Securities
Authority.

Prices set forth below are high and
low reported closing prices for our ordinary shares as reported by NASDAQ for the period
indicated. All share prices have been retroactively adjusted to reflect the 1:4 reverse
stock split effected May 29, 2003.

61

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|Period |  | High | Low                 
|------ |  | ---- | --------------------
|
|
|
|
|2001   |  |      | Annual              
|
|2002   |  |      | Annual              
|
|2003   |  |      | Annual              
|
|2004   |  |      | Annual              
|       |  |      | First Quarter       
|       |  |      | Second Quarter      
|       |  |      | Third Quarter       
|       |  |      | Fourth Quarter      
|
|2005   |  |      | Annual              
|       |  |      | First Quarter       
|       |  |      | Second Quarter      
|       |  |      | Third Quarter       
|       |  |      | Fourth Quarter      
|
|       |  |      | December            
|
|2006   |  |      | January             
|       |  |      | February            
|       |  |      | March               
|       |  |      | April               
|       |  |      | May                 
|       |  |      | June (until June 15)

|9B. | Plan
of Distribution
|--- | --------------------

Not applicable.

|9C. | Markets
|--- | -------

Our securities are traded on the
NASDAQ Stock Exchange (symbol BOSC) and the Tel-Aviv Stock Exchange (symbol
BOSC).

|9D. | Selling
Shareholders
|--- | --------------------

Not applicable.

|9E. | Dilution
|--- | --------

Not applicable.

|9F. | Expenses
of Issue
|--- | -----------------

Not applicable.

# Item 10: Additional
Information.

|10A. | Share
Capital
|---- | -------------

Not applicable.

|10B. | Memorandum
and Articles of Association
|---- | --------------------------------------

In March 2002 the Company adopted new
Articles of Association, in view of the Israeli Companies Law, 1999. Since, certain
articles of the Article of Association have been amended.

Set forth below is a summary of
certain provisions governing our share capital. This summary is not complete and should be
read together with our Memorandum and Articles of Association, copies of which have been
filed as exhibits to the Annual Report.

|1. | Objects
of the Company:
|-- | -----------------------

The companys objects and
purposes are outlined in the Memorandum of Association. These objects include: the
development of sophisticated interfaces for IBM mainframe computers; the export of hi-tech
products to Europe and the USA; and research, development and manufacture of products in
the sphere of communication networks. The Companys Articles of Association (Article
2) allow it to engage in any legal business.

62

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|2. | Provisions
related to the directors of the Company:
|-- | ---------------------------------------------------

(a)
          Approval of Certain Transactions under the Companies Law:

We are subject to the provisions of
the Israeli Companies Law 1999, which became effective on February 1, 2000.

The Companies Law codifies the
fiduciary duties that an Office Holder has to the Company. An Office Holder is
defined in the Companies Law as any Director, General Manager or any other Manager
directly subordinate to the General Manager and any other person with similar
responsibilities.

An Office Holders fiduciary
duties consist of a Duty of Loyalty and a Duty of Care.

The Duty of Loyalty includes: the avoidance
of any conflict of interest between the Office Holders position in the company and
his personal affairs; the avoidance of any competition with the company; the avoidance of
any exploitation of any business opportunity of the Company in order to receive personal
advantage for himself or others; and a duty to reveal to the Company any documents or
information relating to the Companys affairs that the Office Holder has received due
to his position.

The Duty of Care requires an Office
Holder to act at a level of care that a reasonable Office Holder in the same position
would employ under the same circumstances. This includes the duty to utilize reasonable
means to obtain (1) information regarding the appropriateness of a given action brought
for his approval or performed by him by virtue of his position and (2) all other
information of importance pertaining to the foregoing actions.

Under the Companies Law, all
arrangements with regard to the compensation of Office Holders who are not Directors
require the approval of the Board of Directors. Arrangements regarding the compensation of
Directors require Audit Committee, Board and Shareholder approval.

The Companies Law requires that an
Office Holder of a company promptly disclose to the companys Board of Directors any
personal interest that he or she may have, and all related material information known to
him in connection with any existing or proposed transaction by the company. This
disclosure must be made by the Office Holder, whether orally or in writing, no later than
the first meeting of the Companys Board of Directors which discusses the particular
transaction. An Office Holder is deemed to have a personal interest if he,
certain members of his family, or a corporation in which he or any one of those family
members is a 5% or greater shareholder or exercises or has the right to exercise control,
has an interest in a transaction with the company. An Extraordinary
Transaction is defined as a transaction  other than in the ordinary course of
business, not on market terms, or that is likely to have a material impact on the
companys profitability, assets or liabilities.

In the case of a transaction that is
not an Extraordinary Transaction, after the office holder complies with the above
disclosure requirements, only board approval is required. The transaction must not be
adverse to the companys interests. In the case of an Extraordinary Transaction, the
companys Audit Committee and the Board of Directors, and, under certain
circumstances, the shareholders of the company must approve the transaction, in addition
to any approval stipulated by the Articles of Association. An Office Holder who has a
personal interest in a matter that is considered at a meeting of the Board of Directors or
the Audit Committee may not be present at this meeting or vote on this matter, unless a
majority of the members of the Board of Directors or Audit Committee, respectively, have a
personal interest in the matter, in which case they may all be present and vote, after
which the matter must be approved by the shareholders of the Company.

63

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(b)
          Borrowing powers exercisable by the Directors are not specifically outlined in
          the Companys Articles of Association, however, according to Article 15:
          Any power of the Company which has not been vested in another organ
          pursuant to the Companies Law or the articles may be exercised by the Board of
          Directors.

(c)
          The Companys Articles of Association do not contain provisions regarding
          the retirement of directors under an age limit requirement, nor do they contain
          a provision requiring a Director to hold any Company shares in order to qualify
          as a Director.

For further reference to the Articles
of Association regarding the Companys directors, see Item 6.

|3. | With
regard to the rights, preferences and restrictions attaching to the shares, the Companys
Articles of Association provide the following:
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------

(a),(c),(d):  Dividends,  Rights to Share in the
Company's  Profits and Rights to Share in any  Surplus  upon Liquidation

All holders of paid-up ordinary
shares of the Company have an equal right to participate in the distribution of (i)
dividends, whether by cash or by bonus shares; (ii) Company assets; and (iii) the
Companys surplus assets upon winding up, all pro rata to the nominal value of the
shares held by them (Articles 4.2.2, 4.2.3 and 7.3).

The Board of Directors is the organ
authorized to decide upon the distribution of dividends and bonus shares (Article 26). The
shareholders who are entitled to a dividend are the shareholders on the date of the
resolution for the dividend or on a later date if another date is specified in the
resolution on the dividends distribution. If the Board of Directors does not
otherwise determine, any dividend may be paid by way of a cheque or payment order that
shall be sent by mail in accordance with the registered address of the shareholder or
person entitled thereto, or in the case of registered joint shareholders to the
shareholder whose name appears first in the shareholders register in relation to the
joint shareholding. Every such cheque shall be drawn up to the order of the person to whom
it is being sent. The receipt of a person who on the date of the dividends
declaration is listed in the shareholders register as the holder of any share or, in
the case of joint shareholders, of one of the joint shareholders shall serve as
confirmation of all the payments made in connection with such share. For the purpose of
implementing any resolution pursuant to the provisions of this paragraph, the Board of
Directors may settle, as it deems fit, any difficulty arising in relation to the
distribution of the dividend and/or bonus shares, including determine the value for the
purpose of the said distribution of certain assets and resolve that payments in cash shall
be made to members in reliance upon the value thus determined, determine regulations in
relation to fractions of shares or in relation to non-payment of amounts less than
NIS 200.

(b) Voting Rights

All holders of paid-up ordinary
shares of the Company have an equal right to participate in and vote at the Companys
general meetings, whether ordinary or special, and each of the shares in the Company shall
entitle its holder, present at the meeting and participating in the vote, himself, by
proxy or through a voting instrument, to one vote (Article 4.2.1). Shareholders may vote
either in person or through a proxy or voting instrument, unless the Board of Directors
prohibited voting through a voting instrument on a certain matter and stated so in the
notice of the meeting (Articles 14.1 and 14.6). A resolution at the general meeting shall
be passed by an ordinary majority unless another majority is specified in the Companies
Law or the Companys Articles of Association (Article 14.3).

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Directors of the Company stand for
reelection at every annual meeting (Article 16.2) and not at staggered intervals, with the
exception of the External directors who are appointed for a period of 3 years under the
Israeli Companies Law, 1999. The Articles do not provide for cumulative voting.

(e) Redemption

The Company may, subject to any
applicable law, issue redeemable securities on such terms as determined by the Board of
Directors, provided that the general meeting of shareholders approves the Board of
Directors recommendation and the terms determined (Article 27).

(g) Capital Calls by the
Company

The Board of Directors may only make
calls for payment upon shareholders in respect of monies not yet paid for shares held by
them (Article 7.2).

(h) Discrimination

No provision in the Companys
Articles of Association discriminates against an existing or prospective holder of
securities, as a result of such shareholder owning a substantial amount of shares.

|4. | Modification
of Rights of Holders of Stock
|-- | ------------------------------------------

The general meeting of shareholders
may resolve to create new shares of an existing class or of a new class with special
rights and/or restrictions (Article 9.1).

So long as not otherwise provided in
the shares issue terms and subject to the provisions of any law, the rights attached
to a particular class of shares may be altered, after a resolution is passed by the
Company and with the approval of a resolution passed at a general meeting of the holders
of the shares of such class or the written agreement of all the class holders. The
provisions of the Companys Articles of Association regarding general meetings shall
apply, mutatis mutandis, to a general meeting of the holders of a particular class of
shares (Article 10.1). The rights vested in the holders of shares of a particular class
that were issued with special rights shall not be deemed to have been altered by the
creation or issue of further shares ranking equally with them, unless otherwise provided
in such shares issue terms (Article 10.2).

The above mentioned conditions are
not more onerous than is required by law.

|5. | Annual
General Meetings and Extraordinary General Meetings
|-- | ----------------------------------------------------------

General meetings shall be convened at
least once a year at such place and time as determined by the Board of Directors but no
later than 15 months from the last general meeting. Such general meetings shall be called
annual meetings. The Companys other meetings shall be called
special meetings (Article 12.1). The annual meetings agenda shall
include a discussion of the Board of Directors reports and the financial statements
as required at law. The annual meeting shall appoint an auditor, appoint the directors
pursuant to these articles and discuss all the other matters which must be discussed at
the Companys annual general meeting, pursuant to these articles or the Law, as well
as any other matter determined by the Board of Directors (Article 12.2).

The Board of Directors may convene a
special meeting pursuant to its resolution and it must convene a general meeting if it
receives a written requisition from any one of the following (hereinafter referred to as
requisition) (i) two directors or one quarter of the directors holding office;
and/or (ii) one or more shareholders holding at least 5% of the issued capital and at
least 1% of the voting rights in the Company; and/or (iii) one or more shareholders
holding at least 5% of the voting rights in the Company (Article 12.3). A requisition must
detail the objects for which the meeting must be convened and shall be signed by the
persons requisitioning it and sent to the Companys registered office. The
requisition may be made up of a number of documents in an identical form of wording, each
of which shall be signed by one or more of the persons requisitioning the meeting (Article
12.4). Where the Board of Directors is required to convene a special meeting, it shall do
so within 21 days of the requisition being submitted to it, for a date that shall be
specified in the invitation and subject to the law (Article 12.5).

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Notice to the Companys members
regarding the convening of a general meeting shall be sent to all the shareholders listed
in the Companys shareholders register at least 21 days prior to the meeting
and shall be published in other ways insofar as required by the law. The notice shall
include the agenda, proposed resolutions and arrangements with regard to a written vote.
The accidental omission to give notice of a meeting to any member, or the non-receipt of
notice sent to such member, shall not invalidate the proceedings at such meeting (Article
12.6).

The shareholders entitled to
participate in and vote at the general meeting are the shareholders on the date specified
by the Board of Directors in the resolution to convene the meeting, and subject to the law
(Article 14.1).

No discussions may be commenced at
the general meeting unless a quorum is present at the time of the discussions
commencement. A quorum is the presence of at least two shareholders holding at least 331/3%
of the voting rights (including presence through a proxy or a voting instrument), within
half an hour of the time fixed for the meetings commencement (Article 13.1). If no
quorum is present at a general meeting within half an hour of the time fixed for the
commencement thereof, the meeting shall be adjourned for one week, to the same day, time
and place, or to a later time if stated in the invitation to the meeting or in the notice
of the meeting (hereinafter referred to as the adjourned meeting) (Article
13.2). The quorum for the commencement of the adjourned meeting shall be any number of
participants.

The Articles of Association provide
that all shareholder resolutions shall be passed by an ordinary (simple) majority of the
votes cast, unless another majority is specified in the Companies Law or in the Articles
(Article 14.3).

|6. | Limitations
on the rights to own securities
|-- | -------------------------------------------

There are no limitations on the
rights to own the Companys securities, including the rights of non-residents or
foreign shareholders to do so.

|7. | Change
of Control
|-- | -----------------

Under the Companies Law, a merger is
generally required to be approved by the shareholders and Board of Directors of each of
the merging companies. Shareholder approval isnt required if the company that will
not survive is controlled by the surviving company. Additionally, the law provides some
exceptions to the shareholder approval requirement in the surviving company. If the share
capital of the company that will not be the surviving company is divided into different
classes of shares, the approval of each class is also required, unless determined
otherwise by the court. A majority of votes approving the merger shall suffice, unless the
company (like ours) was incorporated in Israel prior to the Companies Law of 1999, in
which case a majority of 75% of the voting power is needed in order to approve the merger.
Additionally, unless the court determines differently, a merger will not be approved if it
is objected to by a majority of the shareholders present at the meeting, after excluding
the shares held by the other party to the merger, by any person who holds 25% or more of
the other party to the merger and by the relatives of and corporations controlled by these
persons. Upon the request of a creditor of either party to the proposed merger, the court
may delay or prevent the merger if it concludes that there exists a reasonable concern
that, as a result of the merger, the surviving company will be unable to satisfy the
obligations of any of the parties of the merger. Also, a merger can be completed only
after all approvals have been submitted to the Israeli Registrar of Companies and provided
that 30 days have elapsed since shareholder approval was received and 50 days have elapsed
from the time that a proposal for approval of the merger was filed with the Registrar.

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The Companies Law also provides that
an acquisition of shares in a public company must be made by means of a tender offer if,
as a result of the acquisition, the purchaser would become a holder of 25% or more of the
voting power at general meetings. This rule does not apply if there is already another
holder of 25% or more of the voting power at general meetings. Similarly, the Companies
Law provides that an acquisition of shares in a public company must be made by means of a
tender offer if, as a result of the acquisition, the purchaser would become a holder of
more than 45% of the voting power of the company. This rule does not apply if someone else
already holds 45% of the voting power of the company. An acquisition from a 25% or 45%
holder, which turns the purchaser into a 25% or 45% holder respectively, does not require
a tender offer. An exception to the tender offer requirement may also apply when the
additional voting power is obtained by means of a private placement approved by the
general meeting of shareholders. These tender offer requirements do not apply to companies
whose shares are listed for trading outside of Israel if, under local law or the rules of
the stock exchange on which their shares are traded, there is a limitation on the
percentage of control which may be acquired or the purchaser is required to make a tender
offer to the public.

Under the Companies Law, a person may
not acquire shares in a public company if, after the acquisition, he will hold more than
90% of the shares or more than 90% of any class of shares of that company, unless a tender
offer is made to purchase all of the shares or all of the shares of the particular class.
The Companies Law also provides that as long as a shareholder in a public company holds
more than 90% of the companys shares or of a class of shares, that shareholder shall
be precluded from purchasing any additional shares (an exemption exists where the
shareholder held prior to and following February 2000, over 90% of any class of shares, in
which case he may purchase additional shares by a tender offer that was accepted by a
majority of the offerees). If a tender offer is accepted and less than 5% of the shares of
the company are not tendered, all of the shares will transfer to the ownership of the
purchaser. If 5% or more of the shares of the company are not tendered, the purchaser may
not purchase shares in a manner which will grant him more than 90% of the shares of the
company.

|8. | Disclosing
share ownership
|-- | --------------------------

The Company has no bylaw provisions
governing the ownership threshold, above which shareholder ownership must be disclosed.

|10C. | Material
Contracts
|---- | ------------------

All material contracts have been
described in detail throughout this form, wherever applicable.

|10D. | Exchange
Controls
|---- | -----------------

All exchange control restrictions
imposed by the State of Israel have been removed, although there are still reporting
requirements for foreign currency transactions. Legislation remains in effect, however,
pursuant to which currency controls can be imposed by administrative action at any time.

Pursuant to the General Permit issued
by the Israeli Controller of Foreign Currency, at the Bank of Israel (under the Currency
Control Law, 1978), non-residents of Israel who purchase our ordinary shares will be able
to convert any proceeds from the sale of these ordinary shares, as well as dividend and
liquidation distributions, if any, into non-Israeli currency, provided that Israeli Income
Tax has been paid (or withheld) on such amounts (to the extent applicable).

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There are no limitations on the
Companys ability to import and export capital.

|10E. | Taxation
|---- | --------

The following is a summary of the
material Israeli tax consequences, Israeli foreign exchange regulations and certain
Israeli government programs affecting the Company.

To the extent that the discussion is
based on new tax or other legislation that has not been subject to judicial or
administrative interpretation, there can be no assurance that the views expressed in the
discussion will be accepted by the tax or other authorities in question. The discussion is
not intended, and should not be construed, as legal or professional tax advice and is not
exhaustive of all possible tax considerations.

ISRAELI TAX CONSIDERATIONS

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 corporation 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. The tax reform also
substantially changes the taxation of capital gains.

# General Corporate Tax
Structure

Israeli companies are generally
subject to income tax on their taxable income at the rate of 31% for the year 2006, 29%
for 2007, 27% for 2008, 26% for 2009 and 25% for year 2010 and thereafter, and are subject
to capital gains tax at a rate of 25% for capital gains (other than gains deriving from
the sale of listed securities) derived after January 1, 2003.

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

The Law for the Encouragement of
Capital Investments, 1959 (the Investment Law) provides certain tax and
financial benefits to investment programs that have been granted such status. The
Investment Law provides that a proposed capital investment in eligible facilities may,
upon application to the Investment Center of the Ministry of Industry and Trade of the
State of Israel, be designated as an Approved Enterprise. Each certificate of
approval for an Approved Enterprise relates to a specific investment program delineated
both by its financial scope, including its capital sources, and by its physical
characteristics, e.g., the equipment to be purchased and utilized pursuant to the program.
The tax benefits derived from any such certificate of approval relate only to taxable
income attributable to the specific Approved Enterprise. If a company has more than one
approval or only a portion of its capital investments are approved, its effective tax rate
is the result of a weighted combination of the applicable rates. Income derived from
activity that is not integral to the activity of the enterprise should not be divided
between the different enterprises and should not enjoy tax benefits.

The principal stated objectives of
the Investment Law are to promote the development of industry, the creation of jobs and
the growth of exports. An amendment to the Investment Law that became effective on April
1, 2005, limits the scope of enterprises which may be approved by the Investment Center by
setting criteria for the approval of a facility as an Approved Enterprise, such as
provisions generally requiring that at least 25% of the Approved Enterprises income
will be derived from export. Additionally, the amendment enacted major changes in the
manner in which tax benefits are awarded so that companies no longer require Investment
Center approval in order to qualify for tax benefits (although approval is required if
grants are sought). Rather, a company may claim the tax benefits offered by the Investment
Law directly in its tax returns, provided that its facilities meet the criteria for tax
benefits set out by the amendment (a Benefited Enterprise). We cannot assure
that we will receive approvals in the future for Approved or Benefited Enterprise status.

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Generally, taxable income of a
company derived from an Approved Enterprise is subject to company tax at a maximum rate of
25% (subject to the percentage of the foreign shareholders holding in the company), rather
than at the regular rate, for the benefit period. This period is ordinarily seven years or
up to ten years if the company qualifies as Foreign Investors Company, commencing
with the year in which the Approved Enterprise first generates taxable income, and is
limited to 12 years from completion of the investment under the approved plan
(commencement of production) or 14 years from the date of approval, whichever is earlier.
The Investment Law also provides that a company that has an Approved Enterprise is
entitled to accelerated depreciation on its property and equipment that are included in an
approved investment program.

A company owning an Approved
Enterprise may elect to receive an alternative package of benefits, in lieu of entitlement
to grants. Under the alternative package, a companys undistributed income derived
from an Approved Enterprise will be exempt from company tax for a period of between two
and ten years from the first year of taxable income, depending on the geographic location
of the Approved Enterprise within Israel, and such company will be eligible for a reduced
tax rate for the remainder, if any, of the otherwise applicable benefits period.

The tax-exempt income attributable to
the Approved or Benefited 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, the Company will be to tax in respect of the gross
amount of the dividend at the otherwise applicable rate of 25%, (or lower in the case of a
qualified foreign investment company which is at least 49% owned by non-Israeli
residents). Dividends paid out of income derived by an Approved or Benefited Enterprise
(or out of dividends received from a company whose income is derived from a Benefited
Enterprise) are generally subject to withholding tax at the rate of 15% (deductible at
source). The reduced rate of 15% is limited to dividends and distributions out of income
derived from an Approved or Benefited Enterprise during the benefits period and actually
paid at any time up to 12 years thereafter (this time limit does not apply to an FIC).

However, the Investment Law provides
that terms and benefits included in any certificate of approval already granted will
remain subject to the provisions of the Law as they were on the date of such approval.
Therefore a facility that was approved as an Approved Enterprise prior to the amendment
will generally not be subject to the provisions of the amendment.

The Investment Center of the Ministry
of Industry and Trade granted BOScom an Approved Enterprise status under the alternative
package of benefits. Since BOScom is located in Zone A, the portion of income
derived from this Approved Enterprise program will be exempt from tax for a period of ten
years, commencing when BOScom begins to realize net income from this programs. The period
of tax benefits of BOScom Approved Enterprise has not yet commenced, because we have yet
to realize taxable income. BOS was also granted an Approved Enterprise status which
entitled the BOS for some tax benefits, but during 2002, as part of the transfer of
operations from the BOS to BOScom, all tax benefits that were related to the Approved
Enterprise of BOS, were transferred to BOScom.

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The Investment Center of the Ministry
of Industry and Trade bases its decision as to whether or not to approve an application,
on the criteria set forth in the Investment Law and regulations, the then prevailing
policy of the Investment Center, and the specific objectives and financial criteria of the
applicant. Accordingly, there can be no assurance that any such application will be
approved. In addition, the benefits available to an Approved Enterprise are conditional
upon the fulfillment of conditions stipulated in the Investment Law and its regulations
and the criteria set forth in the specific certificate of approval, as described above. In
the event that a company does not meet these conditions, it would be required to refund
the amount of tax benefits, with the addition of the consumer price index linkage
adjustment and interest. If BOScom derives income from sources other than the Approved
Enterprise, such income will be taxable at the regular corporate tax rate. Odem and Quasar
Telecom do not enjoy the status of an Approved Enterprise.

# Tax Benefits and Grants
for Research and Development

Israeli tax law allows, under certain
conditions, a tax deduction in the year incurred for expenditures (including capital
expenditures) in scientific research and development projects, if the expenditures are
approved by the relevant Israeli government ministry, determined by the field of research,
the research and development is for the promotion of the enterprise and is carried out by
or on behalf of the company seeking such deduction.

In case the tax deduction, in the
year research and development expenditures are incurred, is not approved by the relevant
Israeli government ministry, the Company will be entitled for the tax deduction over a
period of three years.

# Tax Benefits Under the
Law for the Encouragement of Industry (Taxation), 1969

According to the Law for the
Encouragement of Industry (Taxation), 1969, or the Industry Encouragement Law, an
Industrial Company is a company resident in Israel that at least 90% of its
income, in any tax year, determined in Israeli currency, exclusive of income from certain
government loans, capital gains, interest and dividends, is derived from an
Industrial Enterprise owned by it. An Industrial Enterprise is
defined as an enterprise whose major activity in a given tax year is industrial production
activity.

The following preferred corporate tax
benefits are available to Industrial Companies, among others: (a) deduction of purchases
of know-how and patents over an eight-year period for tax purposes; (b) deduction over a
three-year period of expenses involved with the issuance and listing of shares on the Tel
Aviv Stock Exchange or, on or after January 1, 2003, on a recognized stock market outside
of Israel; (c) an election under certain conditions to file a consolidated tax return with
additional related Israeli Industrial Companies that satisfy conditions set forth in the
law; and (d) accelerated depreciation rates on equipment and buildings.

Eligibility for the benefits under
the Industry Encouragement Law is not subject to receipt of prior approval from any
governmental authority.

Until December 31, 2001 the Company
qualified as an Industrial Company within the definition of the Industry
Encouragement Law. In January 2002, subsequent to the Companys restructure
transforming it into a holding company by transferring its industrial operations to its
wholly-owned subsidiary, BOScom, the Company disqualified from being an Industrial
Company and therefore the benefits described above are not available since then. We
believe that BOScom is qualified as an Industrial Company under the Industry Encouragement
Law but we cannot provide any assurance that the Israeli authorities will agree with our
assessment, nor continue to qualify as an Industrial Company or that the benefits
described above will be available in the future.

# Special Provisions
Relating to Taxation Under Inflationary Conditions

The Income Tax Law (Inflationary
Adjustments), 1985, generally referred to as the Inflationary Adjustments Law, is intended
to adjust the corporate tax system to the rate of inflation, i.e., to tax profits on an
inflation-adjusted basis.

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Under the Inflationary Adjustments
Law, results for tax purposes are measured in historical cost terms and are subject to a
series of adjustments based on movements in the Israel consumer price index. We are taxed
under this law. The discrepancy between the change in (1) the Israel consumer price index
and (2) the exchange rate of the NIS to the dollar, each year and cumulatively, may result
in a significant difference between taxable income and the income denominated in dollars
as reflected in our financial statements. In addition, subject to certain limitations,
depreciation of fixed assets and losses carried forward are adjusted for inflation on the
basis of changes in the Israel consumer price index.

The salient features of the
Inflationary Adjustments Law can be described generally as follows:

(a)
          A special tax adjustment for the preservation of equity whereby certain
          corporate assets are classified broadly into fixed (inflation immune) assets and
          non-fixed assets. Where a companys equity, as defined in such law, exceeds
          the depreciated cost of fixed assets, a deduction from taxable income that takes
          into account the effect of the applicable annual rate of inflation on such
          excess is allowed, up to a ceiling of 70% of taxable income in any single tax
          year, with the unused portion permitted to be carried forward, linked to the
          increase in the consumer price index. If the depreciated cost of fixed assets
          exceeds a companys equity, then such excess multiplied by the applicable
          annual rate of inflation is added to taxable income.

(b)
          Subject to certain limitation set forth in the Inflationary adjustments Law,
          depreciation deductions on fixed assets and losses carried forward are adjusted
          for inflation based on the increase in the Israel consumer price index.

(c)
          Gains on the sale of certain listed securities which are taxed at a reduced rate
          with respect to individuals are taxable at a company tax rate in certain
          circumstances. However, dealers in securities are subject to the regular tax
          rules applicable to business income in Israel. As of January 1, 2006, the
          relevant provisions governing taxation of companies on capital gains derived
          from the sale of traded securities are included in the Tax Ordinance, and the
          Adjustments Law no longer includes provisions in this regard.

(d)
          Accelerated depreciation rates on equipment and buildings.

# Capital Gains Tax on
Sales of Ordinary Shares

Israeli law generally imposes a
capital gains tax on the sale of any capital assets by residents of Israel, as defined for
Israeli tax purposes, and on the sale of assets located in Israel, including shares in
Israeli companies by both residents and non-residents of Israel, unless a specific
exemption is available or unless a tax treaty between Israel and the shareholders
country of residence provides otherwise. The law distinguishes between the real gain and
the inflationary surplus. The real gain is the excess of the total capital gain over the
inflationary surplus, computed on the basis of the increase in the Israel consumer price
index between the date of purchase and the date of sale. Generally, up until the 2006 tax
year, capital gains tax was imposed on Israeli resident individuals at a rate of 15% on
real gains derived on or after January 1, 2003 from the sale of shares in, among others,
Israeli companies publicly traded on Nasdaq or on a recognized stock exchange or regulated
market in a country that has a treaty for the prevention of double taxation with Israel
(such as our company). This tax rate was contingent upon the shareholder not claiming a
deduction for financing expenses in connection with such shares (in which case the gain
will be taxed at a rate of 25%), and did not apply to: (i) the sale of shares to a
relative (as defined in the Israeli Income Tax Ordinance); (ii) the sale of shares by
dealers in securities; (iii) the sale of shares by shareholders that report in accordance
with the Inflationary Adjustment Law (that will be taxed at corporate tax rates for
corporations and at marginal rates for individuals); or (iv) the sale of shares by
shareholders who acquired their shares prior to an initial public offering (that may be
subject to a different tax arrangement).

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As of January 1, 2006, the tax rate
applicable to capital gains derived from the sale of shares, whether listed on a stock
market or not, is 20% for Israeli individuals, unless such shareholder claims a deduction
for financing expenses in connection with such shares, in which case the gain will
generally be taxed at a rate of 25%. Additionally, if such shareholder is considered a
significant shareholder at any time during the 12-month period preceding such
sale (i.e. such shareholder holds directly or indirectly, including jointly with others,
at least 10% of any means of control in the company), the tax rate will be 25%. Israeli
companies are subject to the corporate tax rate on capital gains derived from the sale of
shares, unless such companies were not subject to the Adjustments Law (or certain
regulations) at the time of publication of the aforementioned amendment to the Tax
Ordinance, in which case the applicable tax rate is 25%. However, the different tax rates
will not apply to dealers in securities and shareholders who acquired their shares prior
to an initial public offering.

The tax basis of shares acquired
prior to January 1, 2003 will be determined in accordance with the average closing share
price in the three trading days preceding January 1, 2003. However, a request may be made
to the tax authorities to consider the actual adjusted cost of the shares as the tax basis
if it is higher than such average price.

Non-Israeli residents are exempt from
Israeli capital gains tax on any gains derived from the sale of shares of Israeli
companies publicly traded on a recognized stock exchange or regulated market outside of
Israel, provided that such capital gains are not derived from a permanent establishment in
Israel, that such shareholders are not subject to the Inflationary Adjustment Law and that
such shareholders did not acquire their shares prior to the issuers initial public
offering. However, non-Israeli corporations will not be entitled to such exemption, if an
Israeli resident (i) has a controlling interest of 25% or more in such non-Israeli
corporation, or (ii) is the beneficiary or is entitled to 25% or more of the revenues or
profits of such non-Israeli corporation, whether directly or indirectly.

In some instances where our
shareholders may be subject to Israeli tax on the sale of their ordinary shares, the
payment of the consideration may be subject to the withholding of Israeli tax at the
source.

# The US-Israel Tax Treaty

Pursuant to the Convention Between
the Government of the United States of America and the Government of Israel with Respect
to Taxes on Income, as amended (the United States- Israel Tax Treaty), the
sale, exchange or disposition of ordinary shares by a person who qualifies as a resident
of the United States within the meaning of the United States-Israel Tax Treaty and who is
entitled to claim the benefits afforded to such person by the United States- Israel Tax
Treaty (a Treaty United States Resident) generally will not be subject to the
Israeli capital gains tax unless such Treaty United States Resident holds, directly or
indirectly, shares representing 10% or more of the Companys voting power during any
part of the 12- month period preceding such sale, exchange or disposition, subject to
certain conditions. A sale, exchange or disposition of ordinary shares by a Treaty United
States Resident who holds, directly or indirectly, shares representing 10% or more of the
Companys voting power at any time during such preceding 12-month period would be
subject to such Israeli tax, to the extent applicable; however, under the United
States-Israel Tax Treaty, such Treaty United States Resident would be permitted to claim a
credit for such taxes against the United States federal income tax imposed with respect to
such sale, exchange or disposition, subject to the limitations specified in the treaty.
The United States-Israel Tax Treaty does not relate to United States state or local taxes.

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# Taxation of Non-Resident
Holders of Ordinary Shares

Non-residents of Israel are subject
to income tax on income accrued or derived from sources in Israel. These sources of income
include passive income such as dividends, royalties and interest, as well as non-passive
income from services rendered in Israel. On distributions of dividends other than bonus
shares or stock dividends, income tax is withheld at the source at the following rates:
(i) for dividends distributed prior to January 1, 2006  25%; and (ii) for dividends
distributed on or after January 1, 2006, 20%, or 25% for a shareholder that is considered
a significant shareholder at any time during the 12-month period preceding such
distribution; unless a different rate is provided in a treaty between Israel and the
shareholders country of residence. Under the U.S.-Israel Tax Treaty, the maximum tax
on dividends paid to a holder of shares who is a resident of the United States is 25% or
12.5% if such U.S. resident is a corporation which holds, directly or indirectly, shares
representing at least 10% or more of our issued voting power during the part of the tax
year which precedes the date of payment of the dividend and during the whole of its prior
tax year. However, under the U.S.-Israel Tax Treaty and the Investments Law, dividends
generated by an Approved Enterprise (or Benefiting Enterprise) are taxed at the rate of
15%.

# Foreign Exchange
Regulations

Dividends, if any, paid to the
holders of the ordinary shares, and any amounts payable upon dissolution, liquidation or
winding up, as well as the proceeds of any sale in Israel of the ordinary shares to an
Israeli resident, may be paid in non-Israeli currency or, if paid in Israeli currency, may
be converted into dollars at the rate of exchange prevailing at the time of conversion.

# UNITED STATES FEDERAL
INCOME TAXES

The following general discussion sets
forth the material United States federal income tax consequences applicable to the
following persons who purchase, hold or dispose of the ordinary shares as capital assets
(U.S. Shareholders): (i) citizens or residents (as defined for U.S. federal
income tax purposes) of the United States; (ii) corporations or other entities taxable as
corporations created or organized in or under the laws of the United States or any state
thereof; (iii) estates, the income of which is subject to United States federal income
taxation regardless of its source; and (iv) a trust if (a) a U.S. court is able to
exercise primary supervision over its administration and (b) one or more U.S. persons have
the authority to control all of its substantial decisions. This discussion is based on the
provisions of the Internal Revenue Code of 1986, as amended (the Code), United
States Treasury Regulations promulgated thereunder and administrative and judicial
interpretations thereof, all as in effect as of the date of this Annual Report on Form
20-F. This discussion generally considers only U.S. Shareholders that will hold the
ordinary shares as capital assets and does not consider (a) all aspects of U.S. federal
income taxation that may be relevant to particular U.S. Shareholders by reason of their
particular circumstances (including potential application of the alternative minimum tax),
(b) U.S. shareholders subject to special treatment under the U.S. federal income tax laws,
such as financial institutions, insurance companies, broker-dealers, tax-exempt
organizations, financial institutions or foreign individuals or entities, (c) U.S.
Shareholders owning directly or by attribution 10% or more of the Companys
outstanding voting shares, (d) U.S. Shareholders who hold the ordinary shares as part of a
hedging, straddle or conversion transaction, (e) U.S. Shareholders who acquire their
ordinary shares in a compensatory transaction, (f) U.S. Shareholders whose functional
currency is not the dollar, or (g) any aspect of state, local or non-United States tax
law.

THE FOLLOWING SUMMARY DOES NOT
ADDRESS THE IMPACT OF AN INVESTORS INDIVIDUAL TAX CIRCUMSTANCES. ACCORDINGLY, EACH
INVESTOR SHOULD CONSULT HIS OR HER OWN TAX ADVISOR AS TO THE PARTICULAR TAX CONSEQUENCES
TO HIM OR HER OF AN INVESTMENT IN THE ORDINARY SHARES, INCLUDING THE EFFECTS OF APPLICABLE
STATE, LOCAL OR FOREIGN TAX LAWS AND POSSIBLE CHANGES IN THE TAX LAWS.

73

---

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# Dividends Paid on the
Ordinary Shares

Distributions paid on ordinary shares
(including any Israeli taxes withheld) to a U.S. Shareholder will be treated as ordinary
dividend income for United States federal income tax purposes to the extent of the
Companys current and accumulated earnings and profits (as computed for U.S. federal
income tax purposes). Such dividends, which will be treated as foreign source income for
U.S. foreign tax credit purposes, generally will not qualify for the dividends-received
deduction available to corporations. Distributions in excess of such earnings and profits
will be applied against and will reduce the shareholders tax basis in the ordinary
shares and, to the extent in excess of such tax basis, will be treated as gain from a sale
or exchange of such ordinary shares. The amount of the distribution will equal the US
Dollar value of the distribution, calculated by reference to the exchange rate in effect
on the date the distribution is received (or otherwise made available to the U.S.
Shareholders), regardless of whether a payment in Israeli currency is actually converted
to US Dollars at that time. U.S. Shareholders should consult their own tax advisors
concerning the treatment of foreign currency gain or loss, if any, on any Israeli currency
received which is converted into US Dollars subsequent to receipt.

Qualified dividend income received by
an individual (as well as certain trusts and estates) U.S. Shareholder for taxable years
beginning before January 1, 2009 are taxed at reduced rates of either 5 or 15 percent,
depending upon the amount of such shareholders taxable income. If a non-corporate
U.S. Shareholder does not hold ordinary shares for more than 60 days during the 120 day
period beginning 60 days before an ex-dividend date, dividends received on ordinary shares
are not eligible for reduced rates. Dividends received from a foreign corporation that was
a passive foreign investment company (as further discussed below) in either the taxable
year of the distribution or the preceding taxable year are not qualified dividend income.
Qualified dividend income includes dividends received from a qualified foreign
corporation. A qualified foreign corporation includes a foreign
corporation whose shares are readily tradable on an established securities market in the
United States as well as a foreign corporation that is entitled to the benefits of a
comprehensive income tax treaty with the United States which includes an exchange of
information program. Israel and the United States are parties to a comprehensive income
tax treaty which includes an exchange of information program. The United States Treasury
Department will periodically issue guidance regarding which income tax treaties will be
satisfactory for treating a corporation as a qualified foreign corporation. In
the event ordinary shares should not be readily tradable on an established securities
market in the United States, non-corporate U.S. Shareholders should consult their own tax
advisors as to whether any distributions paid on ordinary shares will be taxed for United
States federal income tax purposes at reduced tax rates.

# Credit for Israeli Taxes
Withheld

Subject to certain conditions and
limitations, any Israeli tax withheld or paid with respect to dividends on the ordinary
shares generally will be eligible for credit against a U.S. Shareholders United
States federal income tax liability at such U.S. Shareholders election. The Code
provides limitations on the amount of foreign tax credits that a U.S. Shareholder may
claim, including extensive separate computation rules under which foreign tax credits
allowable with respect to specific categories of income cannot exceed the United States
federal income taxes otherwise payable with respect to each such category of income.
Dividends with respect to the ordinary shares generally will be classified as foreign
source passive income for the purpose of computing a U.S. Shareholders
foreign tax credit limitations for U.S. foreign tax credit purposes. The availability of
the Israeli withholding tax as a foreign tax credit will also be subject to certain
restrictions on the use of such credits, including a prohibition on the use of the credit
to reduce liability for the United States individual and corporate minimum taxes by more
than 90%. Alternatively, U.S. Shareholders that do not elect to claim a foreign tax credit
may instead claim a deduction for Israeli income tax withheld or paid, but only for a year
in which these U.S. Shareholders elect to do so for all foreign income taxes. The rules
relating to foreign tax credits are complex, and you should consult your tax advisor to
determine whether and if you would be entitled to this credit.

74

---

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# Disposition of the
Ordinary Shares

Subject to the discussion under the heading
Passive Foreign Investment Company Status the sale or exchange of ordinary
shares generally will result in the recognition of capital gain or loss in an amount equal
to the difference between the amount realized on the sale or exchange and the U.S.
Shareholders tax basis in the ordinary shares. Such gain or loss generally will be
long-term capital gain or loss if the U.S. Shareholders holding period of the
ordinary shares exceeds one year at the time of the disposition. Certain limitations apply
to the deductibility of capital losses by both corporate and non-corporate taxpayers.
Under the Code, gain or loss recognized by a U.S. Shareholder on a sale or exchange of
ordinary shares generally will be treated as U.S. source income or loss for U.S. foreign
tax credit purposes. Under the tax treaty between the United States and Israel, however,
gain derived from the sale, exchange or other disposition of ordinary shares by a holder
who is a resident of the United States for purposes of the treaty and who sells the
ordinary shares within Israel may be treated as foreign source income for U.S. foreign tax
credit purposes. U.S. Shareholders should consult their own tax advisors regarding the
treatment of any foreign currency gain or loss on any Israeli currency received in respect
of the sale, exchange or other disposition of ordinary shares.

# Passive Foreign
Investment Company Status

A foreign corporation generally will
be treated as a passive foreign investment company (PFIC) if,
after applying certain look-through rules, either (i) 75% or more of its gross
income is passive income or (ii) 50% or more of the average value of its assets is
attributable to assets that produce or are held to produce passive income. Passive income
for this purpose generally includes dividends, interest, rents, royalties and gains from
securities and commodities transactions. The look-through rules require a foreign
corporation that owns at least 25% by value, of the stock of another corporation to treat
a proportionate amount of assets and income as held or received directly by the foreign
corporation.

The Company has not made the analysis
necessary to determine whether or not it is currently a PFIC or whether it has ever been a
PFIC. However, the Company does not believe that it was a PFIC in 2005. However, there can
be no assurance that the Company is not, has never been or will not in the future be a
PFIC. If the Company were to be treated as a PFIC, any gain recognized by a U.S.
Shareholder upon the sale (or certain other dispositions) of ordinary shares (or the
receipt of certain distributions) generally would be treated as ordinary income, and a
U.S. Shareholder may be required, in certain circumstances, to pay an interest charge
together with tax calculated at maximum rates on certain excess distributions,
including any gain on the sale or certain dispositions of ordinary shares. In order to
avoid this tax consequence, a U.S. Shareholder (i) may be permitted to make a
qualified electing fund election, in which case, in lieu of such treatment,
such holder would be required to include in its taxable income certain undistributed
amounts of the Companys income or (ii) may elect to mark-to-market the ordinary
shares and recognize ordinary income (or possible ordinary loss) each year with respect to
such investment and on the sale or other disposition of the ordinary shares. Additionally,
if the Company is deemed to be a PFIC, a U.S. Shareholder who acquires ordinary shares in
the Company from a decedent will be denied the normally available step-up in tax basis to
fair market value for the ordinary shares at the date of the death and instead will have a
tax basis equal to the decedents tax basis if lower than fair market value. Neither
the Company nor its advisors have the duty to or will undertake to inform U.S.
Shareholders of changes in circumstances that would cause the Company to become a PFIC.
U.S. Shareholders should consult their own tax advisors concerning the status of the
Company as a PFIC at any point in time after the date of this Annual Report on Form 20-F.
The Company does not currently intend to take the action necessary for a U.S. Shareholder
to make a qualified electing fund election in the event the Company is
determined to be a PFIC.

75

---

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# Tax Consequences for
Non-U.S. Holders of Ordinary Shares

Except as described in
Information Reporting and Back-up Withholding below, a non-U.S. holder of
ordinary shares will not be subject to U.S. federal income or withholding tax on the
payment of dividends on, and the proceeds from the disposition of, ordinary shares,
unless:

| |  | the
item is effectively connected with the conduct by the non-U.S. holder of a trade or
business in the United States and:
| | - | --------------------------------------------------------------------------------------------------------------------------

| | (i) | in
the case of a resident of a country which has a treaty with the United States, the item
is  attributable to a permanent establishment; or
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------

| | (ii) | in
the case of an individual, the item is attributable to a fixed place of
               business in the United States;
| | ---- | ------------------------------------------------------------------------------------------------------------------------

| |  | the
non-U.S.  holder is an  individual  who holds the ordinary  shares as a capital asset and
is present       in the United  States for 183 days or more in the taxable year of the
 disposition  and does not qualify       for an exemption; or
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the
 non-U.S  .holder  is  subject  to tax under  the  provisions  of U.S.  tax law
 applicable  to U.S. expatriates.
| | - | ---------------------------------------------------------------------------------------------------------------------

# Information Reporting
and Back up Withholding.

A non-corporate U.S. Shareholder may,
under certain circumstances, be subject to information reporting requirements and
backup withholding at a 30% rate on cash payments in the United States of
dividends on, and the proceeds of disposition of, ordinary shares. Backup withholding will
apply only if a U.S. Shareholder: (a) fails to furnish its social security or other
taxpayer identification number (TIN) within a reasonable time after the
request therefore; (b) furnishes an incorrect TIN; (c) is notified by the IRS that it has
failed properly to report payments of interest and dividends; or (d) under certain
circumstances, fails to certify, under penalty of perjury, that it has furnished a correct
TIN and has not been notified by the IRS that it is subject to backup withholding for
failure to report interest and dividend payments. U.S. Shareholders should consult their
tax advisors regarding their qualification for exemption, if applicable. The amount of
backup withholding from a payment to a U.S. Shareholder generally will be allowed as a
credit against such U.S. Shareholders federal income tax liability and may entitle
such U.S. Shareholder to a refund, provided that the required information is furnished to
the IRS.

|10F. | Dividends
and Paying Agents
|---- | ---------------------------

Not applicable.

|10G. | Statement
by Experts
|---- | --------------------

Not applicable.

|10H. | Documents
on Display
|---- | --------------------

The documents concerning the Company
that are referred to in the form may be inspected at the Companys office in Israel.

76

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|10I. | Subsidiary
Information
|---- | ----------------------

For information relating to the
Companys subsidiaries, see Item 4  Organizational Structure as
well as the Companys Consolidated Financial Statements (Items 8 and 18 of this
form).

# Item 11: Quantitative
and Qualitative Disclosure about Market Risk.

# Currency Exchange Rate
Risk Management

The Companys functional
currency is the US Dollar. Since the Company operates in Israel and Europe it manages
assets and liabilities in currencies other than US Dollar such as Israeli Shekel and Euro.

The excess balance of monetary assets
on liabilities in non-dollar currencies in the Balance Sheet as of 31.12.05 and 31.12.04
(Balance Sheet Exposure) is presented in the table below. The data is
presented in US Dollars (in thousands):

|                                                               | December 31, 2005 | December 31, 2004
|-------------------------------------------------------------- | ----------------- | -----------------
|
|
|
|
|Current assets:                                                |                   |                  
|Cash and cash equivalents                                      |                   |                  
|Trade receivables                                              |                   |                  
|Other accounts receivable                                      |                   |                  
|                                                               |                   |                  
|                                                               |                   |                  
|Total assets                                                   |                   |                  
|                                                               |                   |                  
|                                                               |                   |                  
|Current liabilities:                                           |                   |                  
|Short term loans from banks                                    |                   |                  
|Current maturities of long-term bankloans and convertible note |                   |                  
|Trade payables                                                 |                   |                  
|Other accounts payable                                         |                   |                  
|                                                               |                   |                  
|                                                               |                   |                  
|                                                               |                   |                  
|                                                               |                   |                  
|                                                               |                   |                  
|Bank loans (net of current maturities)                         |                   |                  
|                                                               |                   |                  
|Total liabilities                                              |                   |                  
|                                                               |                   |                  
|Net                                                            |                   |                  
|                                                               |                   |                  

(1)
          The above does not include balances in Israeli currency linked to the US dollar.

(2)
          Primarily Euro.

The Company does not use financial
instruments and derivatives, but manages the risk of Balance Sheet Exposure by attempting
to maintain a similar balance of assets and liabilities in Israeli Shekels and the USD
currencies.

77

---

---

The selling prices of our products in
Israel and Europe are collected in the local currency. The purchases and salary expenses
in Israel are paid in the local currency.

A material change in currency
exchange rate of the NIS or Euro compared to the US Dollar may have an effect on the
Companys financial results and cash flow.

# Credit Risk Management

The company sells its products and
purchases products from vendors on credit terms.

The trade receivables of the Company
are derived from sales to customers located primarily in the United States, Europe and
Israel. The Company generally does not require collateral; however, in certain
circumstances, the Company may require letters of credit, other collateral, additional
guarantees or advanced payments.

Provisions are made for doubtful
debts on a specific basis and, in managements opinion, appropriately reflect the
loss inherent in collection of the debts. Management bases this provision on its
assessment of the risk of the debt.

The table below presents the accounts
receivables balance by geographical market as of 31.12.05 and 31.12.04:

|                  | December 31,
|----------------- | ------------
|
|
|
|
|United States     |             
|Europe            |             
|Far East          |             
|Israel and others |             
|                  |             
|                  |             
|                  |             
|                  |             

# Interest Rate Risk

The Companys exposure to market
risk for changes in interest rates, is due to its investment of its surplus funds, loans
and Convertible Note that carried variable interest.

The Company has a conservative
investment policy. According to this policy the Company invests in bank deposits and in
high level marketable securities.

A material change in yields of the
securities which the company invests in and the need of cash before the securities
maturation, may have an effect on the Companys financial results and cash flow.

A material change in interest we
receive on our bank deposits or pay on our loans and Convertible Note may have an effect
on the Companys financial results and cash flow.

# Bank Risk

The Company invests and manages the
majority of its funds in two banks which are among the five largest in Israel.

# Item 12: Description of
Securities Other than Equity Securities.

Not applicable.

78

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# PART II

# Item 13: Defaults,
Dividend Arrearages and Delinquencies.

Not applicable.

# Item 14: Material
Modifications to the Rights of Security Holders and Use of Proceeds.

Not applicable.

# Item 15: Controls and
Procedures

(a)
          Disclosure controls and procedures.

The Companys principal
executive officer and its principal financial officer evaluated the effectiveness of the
Companys disclosure controls and procedures (as defined in Rule 13a-15(e) and
15d-15(e) of the Securities Exchange Act of 1934, as amended) as of the end of the period
covered by this report. Such disclosure controls and procedures are designed to ensure
that information required to be disclosed by the Company is accumulated and communicated
to the appropriate management, including the principal executive officer and financial
officer, on a basis that permits timely decisions regarding timely disclosure. Based on
that evaluation, such principal executive officer and principal financial officer
concluded that the Companys disclosure controls and procedures as of the end of the
period covered by this report have been designed and are functioning effectively to
provide reasonable assurance that the information required to be disclosed by the Company
in reports filed under the Securities Exchange Act of 1934, as amended, is recorded,
processed, summarized and reported within the time periods specified in the SECs
rules and forms.

(b)
          Change in Internal Control over Financial Reporting.

There were no changes in the
Companys internal controls over financial reporting that occurred during the fiscal
year ended December 31, 2005, that have materially affected or are reasonably likely to
materially affect these controls.

(c)
          Other.

The Company believes that a control
system, no matter how well designed and operated, can not provide absolute assurance that
the objectives of the control system are met, and no evaluation of controls can provide
absolute assurance that all control issues and instances of fraud, if any, with the
Company have been determined.

# Item 16: [Reserved]

# Item 16A: Audit
Committee Financial Expert

The Companys Board of Directors
has determined that Prof. Adi Raveh and Mr. Ronen Zavlik, both members of the audit
committee, are audit committee financial experts, as defined by the applicable
SEC regulations. The experience of each is listed under Item 6A. Both are
independent under the applicable SEC and Nasdaq regulations.

# Item 16B: Code of Ethics

The Company has adopted a Code of
Ethics applicable to its executive officers, directors and all other employees. A copy of
the code is posted on our website and may also be obtained, without charge, upon a written
request addressed to the Companys investor relations department.

79

---

---

# Item 16C: Principal
Accountant Fees and Services

The Companys principal
accountants for the years 2004 and 2005 were Kost Forer Gabbay & Kasierer, a member of
Ernst & Young Global.

The table below summarizes the audit
and other fees paid and accrued by the Company and its consolidated subsidiaries to Kost
Forer Gabbay & Kasierer, during each of 2004 and 2005:

|                       | Year Ended December 31, 2005 | Year Ended December 31, 2004
|---------------------- | ---------------------------- | ----------------------------
|
|
|
|
|Audit Fees             |                              |                             
|Audit-Related Fees (1) |                              |                             
|Tax Fees (2)           |                              |                             
|All Other Fees (3)     |                              |                             
|Total                  |                              |                             

|(1) | Audit-related
fees are fees related to assurance and associated                services that
traditionally are performed by the independent auditor, including
               consultation concerning reporting standards.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Tax
fees are fees for professional services rendered by the                Companys
auditors with respect to tax advice related to acquisitions and                tax
compliance with the Israeli law for encouragement of investment, and
               issuance of annual tax reports.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | All
Other Fees are fees for consulting services rendered by the                Companys
auditors with respect to government incentives.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------

Audit Committees pre-approval
policies and procedures:

The Audit Committee is responsible
for the oversight of the independent auditors work, including the approval of
services provided by the independent auditor. These services may include audit,
audit-related, tax or other services, as described above. On an annual basis the audit
committee pre-approves audit and non-audit services to be provided to the Company by its
auditors, listing the particular services or categories of services, and sets forth a
specific budget for such services. Additional services not covered by the annual
pre-approval may be approved by the Audit Committee on a case-by-case basis as the need
for such services arises. Furthermore, the Audit Committee has authorized the Committee
Chairman to pre-approve engagements of the Companys auditors so long as the fee for
each such engagement does not exceed $5,000 and so long as the engagement is notified to
the Committee at its next subsequent meeting. Any services pre-approved by the Audit
Committee (or by the Chairman) must be permitted by applicable law. Once services have
been pre-approved, the audit committee receives a report on a periodic basis regarding the
extent of the services actually provided and the fees paid.

# Item 16D: Exemptions
from the Listing Standards for Audit Committees

Not applicable to
Registrant

# Item 16E: Purchases of
Equity Securities by the Issuer and Affiliated Purchasers

The Company (or anyone acting on its
behalf) did not purchase any of the Companys securities in 2005.

80

---

---

# PART III

# Item 17: Financial
Statements

Not applicable.

# Item 18: Financial Statements

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

|                                             | Page       
|-------------------------------------------- | -----------
|
|
|
|
|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 - F-7  
|Statements of Cash Flows                     | F-8 - F-10 
|Notes to Consolidated Financial Statements   | F-11 - F-47

The audited financial statements
filed as part of this Form 20-F are identical to the audited financial statements that
were filed as part of the Form 6-K on March 27, 2006, except for the addition of Note 21.

# Item 19: Exhibits

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

|1.1 |  | Memorandum
of Association, as amended.
|--- |  | --------------------------------------

|1.2 |  | Articles
of Association, as amended.
|--- |  | ------------------------------------

|4.1 |  | Form
of Indemnification Agreement between the Company and its officers and directors, as
amended.
|--- |  | -------------------------------------------------------------------------------------------------

|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 (incorporated by reference to the Companys Annual Report on Form
20-F filed on June 17, 2004).
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.3 |  | Services
Agreement, dated as of April 15, 2003, between Cukierman & Co. Investment House Ltd.,
BOScom Ltd. and the Registrant (incorporated by reference to the Companys Annual
Report on Form 20-F filed on June 17, 2004).
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.4 |  | M&A
Addendum to the Service Agreement, as of August 22, 2004, between Cukierman &Co.
Investment House Ltd., BOScom Ltd. and the Registrant (incorporated by reference to the
Companys Annual Report on Form 20-F filed on June 27, 2005).
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.5 |  | Management
Agreement between Signum Ltd., Adiv Baruch and the Registrant, dated as of January 1,
2004 (incorporated by reference to the Companys Annual Report on Form 20-F filed on
June 17, 2004).
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.6 |  | Securities
Purchase Agreement and Master Security Agreement and Registration Rights Agreement, dated
as of June 10, 2004, by and between Laurus Master Fund Ltd. and the Registrant
(incorporated by reference to the Companys Annual Report on Form 20-F filed on June
17, 2004), and Amendment no. 1 to the Securities Purchase Agreement dated as of November
16, 2004 (incorporated by reference to the Companys Registration Statement on Form
F-3 no. 333-117529).
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

81

---

---

|4.7 |  | Securities
Purchase Agreement and Master Security Agreement, dated as of September 29, 2005, by and
between Laurus Master Fund Ltd. and the Registrant (the Secured Convertible Term Note,
Ordinary Shares Purchase Warrant and Registration Rights Agreement are incorporated by
reference to the Companys Registration Statement on Form F-3 no. 333-130048).
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.8 |  | Distribution
Agreement, dated as of January 15, 2003, by and between BOScom Ltd. and BOSaNOVA Inc.
(incorporated by reference to the Companys Annual Report on Form 20-F/A filed on
January 6, 2005).
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.9 |  | Asset
Purchase Agreement, dated as of September 29, 2004, by and between Quasar Communication
Systems Ltd. and the Registrant (incorporated by reference to the Companys
Registration Statement on Form F-3 no. 333-117529).
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.10 |  | Share
Purchase Agreement, dated as of November 2, 2004, by and between Jacob and Sara Neuhof,
Odem Electronic Technologies 1992 Ltd. and the Registrant (incorporated by reference to
the Companys Registration Statement on Form F-3 no. 333-117529).
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.11 |  | Agreement,
 dated as of September 29, 2005, by and between Jacob and Sara Neuhof and the
 Registrant,          for the purchase of the shares of Odem Electronic  Technologies
1992 Ltd. held by the Jacob and Sara          Neuhof.
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.12 |  | Share
Purchase  Agreement,  dated as of November 2, 2004, by and between Telsys Ltd., Odem
Electronic          Technologies 1992 Ltd. and the Registrant  (incorporated by reference
to the Company's  Registration          Statement on Form F-3 no. 333-117529).
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.13 |  | Share
 Purchase  Agreement,  dated as of  October  31,  2005,  by and  between  Telsys  Ltd.
 and the          Registrant.
|---- |  | --------------------------------------------------------------------------------------------------------------------------

|4.14 |  | Share
Purchase Agreement, dated as of May 24, 2005, by and between certain investors and the
Registrant (incorporated by reference to the Companys Annual Report on Form 20-F
filed on June 27, 2005).
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.15 |  | Asset
Purchase  Agreement and Amendments no. 1 and 2 to Agreement,  dated as of July 18, 2005,
August          31, 2005 and September 25, 2005, respectively,  by and between BOSCom,
Consist Technologies Ltd. and          Consist  International  Inc., and Escrow Agreement
and Amendment no. 1 to Escrow  Agreement  between          the parties, dated as of July
18, 2005 and August 31, 2005, respectively.
|---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.16 |  | Asset
 Purchase  Agreement,  Amendment no. 1 to the  Agreement and Amendment no. 2 to the
 Agreement,          dated as of October 26, 2005, November 2, 2005, and December 31,
2005, respectively,  by and between          Qualmax, Inc., BOScom Ltd. and the
Registrant;  Loan Agreement dated as of December 31, 2005, by and          between
Qualmax Ltd. and the Registrant;  Registration  Rights  Agreement,  dated as of December
31,          2005, by and between Qualmax Inc. and the  Registrant;  and Form of warrant
dated as of December 31,          2005, issued by Qualmax Inc. to the Registrant.
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.17 |  | The
 Registrant's  Israeli  2003 Share  Option  Plan  (incorporated  by  reference  to the
 Company's          Registration Statement on Form S-8 No. 333-11650).
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

|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.
|---- |  | --------------------------------------------------------------------------

|10.2 |  | Consent
of Kesselman & Kesselman, a member of PriceWaterhouseCoopers International Limited.
|---- |  | -------------------------------------------------------------------------------------------

|12.1 |  | Certification
by Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities
Exchange Act of 1934.
|---- |  | -----------------------------------------------------------------------------------------------------------------------------

82

---

---

|12.2 |  | Certification
by Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities
Exchange Act of 1934.
|---- |  | -----------------------------------------------------------------------------------------------------------------------------

|13.1 |  | 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.
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------

83

---

---

# 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 annual report on its behalf.

B.O.S. Better Online Solutions Ltd.

|By: /s/ Adiv Baruch
Adiv BaruchPresident and Chief Executive Officer |  | By: /s/ Nehemia Kaufman
Nehemia KaufmanChief Financial Officer
|---------------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------

Date: June 28, 2006

84

---

---

# B.O.S. BETTER ONLINE
SOLUTIONS LTD.

# AND ITS SUBSIDIARIES

# CONSOLIDATED FINANCIAL
STATEMENTS

# AS OF DECEMBER 31, 2005

# U.S. DOLLARS IN
THOUSANDS

# INDEX

|                                                                 | Page       
|---------------------------------------------------------------- | -----------
|                                                                 |            
|Report of Independent Auditors Registered Public Accounting Firm | F-2        
|                                                                
|Consolidated Balance Sheets                                      | F-3 - F-4  
|                                                                
|Consolidated Statements of Operations                            | F-5        
|                                                                
|Statements of Changes in Shareholders' Equity                    | F-6 - F-7  
|                                                                
|Consolidated Statements of Cash Flows                            | F-8 - F-10 
|                                                                
|Notes to Consolidated Financial Statements                       | F-11 - F-47



---

---

| |   |                                                                  |   |                                           
| | - | ---------------------------------------------------------------- | - | ------------------------------------------
| | n | Kost Forer Gabbay & Kasierer3 Aminadav St.Tel-Aviv 67067, Israel | n | Phone: 972-3-6232525Fax:     972-3-5622555

# REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM

# To the Shareholders of

# B.O.S. BETTER ONLINE
SOLUTIONS LTD.

We
have audited the accompanying consolidated balance sheets of B.O.S Better Online Solutions
Ltd. (the Company) and subsidiaries as of December 31, 2005 and 2004, 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, 2005. 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 December 31, 2004 financial statements of Odem Electronic
Technologies 1992 Ltd (Odem) a subsidiary, whose statements reflect total
assets constituting 30.6% as of December 31, 2004, and total revenues for the period from
November 18, 2004 (date of acquisition of Odem) to December 31, 2004 constituting 23.5% of
the related consolidated total revenues. Those statements were audited by other auditors
whose reports have been furnished to us, and our opinion, insofar as it relates to amounts
included for Odem, is based solely on the reports of the other auditors. Those auditors
expressed an unqualified opinion on those statements in their report dated March 25, 2005.

We
conducted our audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are free of
material misstatement. We were not engaged to perform an audit of the Companys
internal control over financial reporting. Our audit included consideration of internal
control over financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an opinion on the
effectiveness of the Companys internal control over financial reporting. Accordingly
we express no such opinion. An audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management and evaluating the
overall financial statement presentation. We believe that our audits and the report of the
other auditors provide a reasonable basis for our opinion.

In
our opinion, based on our audits and the report of 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 at December 31,
2005 and 2004, and the consolidated results of their operations and their cash flows for
each of the three years in the period ended December 31, 2005, in conformity with
U.S. generally accepted accounting principles.

|                 |                                 
|---------------- | --------------------------------
|Tel-Aviv, Israel | KOST FORER GABBAY & KASIERER    
|March 27, 2006   | A Member of Ernst & Young Global

F - 2

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
|-----------------------------------
|AND ITS SUBSIDIARIES               
|CONSOLIDATED BALANCE SHEETS        
|                                   
|U.S. dollars in thousands          

|                                                                             | December 31,
|---------------------------------------------------------------------------- | ------------
|
|
|ASSETS                                                                       |             
|                                                                             |             
|CURRENT ASSETS:                                                              |             
|Cash and cash equivalents                                                    |             
|Marketable securities (Note 5)                                               |             
|Trade receivables (net of allowance for doubtful accounts of $ 3 and $ 38 at |             
|December 31, 2005 and 2004, respectively)                                    |             
|Other accounts receivable and prepaid expenses (Note 3)                      |             
|Inventories (Note 4)                                                         |             
|                                                                             |             
|                                                                             |             
|Total current assets                                                         |             
|                                                                             |             
|                                                                             |             
|LONG-TERM ASSETS:                                                            |             
|Long term marketable securities (note 5)                                     |             
|Severance pay fund                                                           |             
|Investment in an affiliated company (note 6)                                 |             
|Investment in other companies (note 7)                                       |             
|                                                                             |             
|                                                                             |             
|Total long-term assets                                                       |             
|                                                                             |             
|                                                                             |             
|OTHER ASSETS                                                                 |             
|                                                                             |             
|                                                                             |             
|PROPERTY, PLANT AND EQUIPMENT, NET (Note 8)                                  |             
|                                                                             |             
|                                                                             |             
|GOODWILL (Note 10)                                                           |             
|                                                                             |             
|                                                                             |             
|CUSTOMER LIST AND OTHER INTANGIBLE ASSETS, NET (Note 9)                      |             
|                                                                             |             
|                                                                             |             
|ASSETS RELATED TO DISCONTINUED OPERATIONS (Note 1c)                          |             
|                                                                             |             
|                                                                             |             
|                                                                             |             
|                                                                             |             

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

F - 3

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.                       
|----------------------------------------------------------
|AND ITS SUBSIDIARIES                                      
|CONSOLIDATED BALANCE SHEETS                               
|                                                          
|U.S. dollars in thousands, except share and per share data

|                                                                            | December 31,
|--------------------------------------------------------------------------- | ------------
|
|
|
|
|LIABILITIES AND SHAREHOLDERS' EQUITY                                        |             
|                                                                            |             
|CURRENT LIABILITIES:                                                        |             
|Short term loans from banks (Note 11)                                       |             
|Current maturities of long-term bank loans and convertible note             |             
|Trade payables                                                              |             
|Employees and payroll accruals                                              |             
|Deferred revenues                                                           |             
|Accrued expenses and other liabilities (Note 12)                            |             
|                                                                            |             
|                                                                            |             
|Total current liabilities                                                   |             
|                                                                            |             
|                                                                            |             
|LONG-TERM LIABILITIES:                                                      |             
|Bank loans (net of current maturities) (Note 13)                            |             
|Convertible note (net of current maturities) (Note 14)                      |             
|Put option issued to minority shareholders in a subsidiary                  |             
|Deferred taxes                                                              |             
|Accrued severance pay                                                       |             
|                                                                            |             
|                                                                            |             
|Total long-term liabilities                                                 |             
|                                                                            |             
|                                                                            |             
|MINORITY INTEREST IN A SUBSIDIARY                                           |             
|                                                                            |             
|                                                                            |             
|LIABILITIES RELATED TO DISCONTINUED OPERATIONS (Note 1c)                    |             
|                                                                            |             
|                                                                            |             
|COMMITMENTS AND CONTINGENT LIABILITIES (Note 15)                            |             
|                                                                            |             
|SHAREHOLDERS' EQUITY (Note 16):                                             |             
|Share capital                                                               |             
|Ordinary shares of NIS 4.00 par value: Authorized: 8,750,000 shares at      |             
|December 31, 2005 and 2004; Issued and outstanding: 6,589,385 and 4,737,658 |             
|shares at December 31, 2005 and 2004, respectively;                         |             
|Additional paid-in capital                                                  |             
|Deferred stock-based compensation                                           |             
|Accumulated other comprehensive income                                      |             
|Accumulated deficit                                                         |             
|                                                                            |             
|                                                                            |             
|Total shareholders' equity                                                  |             
|                                                                            |             
|                                                                            |             
|Total liabilities and shareholder's equity                                  |             
|                                                                            |             

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

F - 4

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.             
|------------------------------------------------
|AND ITS SUBSIDIARIES                            
|CONSOLIDATED STATEMENTS OF OPERATIONS           
|                                                
|U.S. dollars in thousands, except per share data

|                                                                | Year ended December 31,
|--------------------------------------------------------------- | -----------------------
|
|
|
|
|Revenues                                                        |                        
|Cost of revenues                                                |                        
|Reversal of Royalties (Note 18a)                                |                        
|                                                                |                        
|                                                                |                        
|Gross profit                                                    |                        
|                                                                |                        
|                                                                |                        
|Operating costs and expenses:                                   |                        
|Research and development                                        |                        
|Less - grants and participation                                 |                        
|Sales and marketing                                             |                        
|General and administrative                                      |                        
|Restructuring and related costs                                 |                        
|                                                                |                        
|                                                                |                        
|Total operating costs and expenses                              |                        
|                                                                |                        
|                                                                |                        
|Operating loss                                                  |                        
|Financial income (expenses), net (Note 18b)                     |                        
|Other income, net (Note 1c)                                     |                        
|                                                                |                        
|                                                                |                        
|Loss before taxes on income                                     |                        
|Taxes on income (Note 17)                                       |                        
|                                                                |                        
|                                                                |                        
|Net loss after taxes                                            |                        
|                                                                |                        
|Equity in losses of an affiliated company                       |                        
|Minority interest in earnings of a subsidiary                   |                        
|                                                                |                        
|                                                                |                        
|Loss from continuing operations                                 |                        
|Income (loss) related to discontinued operations (Note 1c)      |                        
|                                                                |                        
|                                                                |                        
|Net loss                                                        |                        
|                                                                |                        
|                                                                |                        
|Basic and diluted net loss per share from continuing operations |                        
|(Note 18c)                                                      |                        
|                                                                |                        
|                                                                |                        
|Basic and diluted net income (loss) per share from discontinued |                        
|operations (Note 18c)                                           |                        
|                                                                |                        
|                                                                |                        
|Basic and diluted net loss per share (Note 18c)                 |                        
|                                                                |                        

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

F - 5

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.          
|---------------------------------------------
|AND ITS SUBSIDIARIES                         
|STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
|                                             
|U.S. dollars in thousands, except share data 

|                               | Ordinaryshares | Sharecapital | Additionalpaid incapital | Deferredstock-basedcompensation | Accumulatedothercomprehensiveincome | Treasuryshares | Accumulateddeficit | Totalcomprehensiveloss | Totalshareholders'
equity
|------------------------------ | -------------- | ------------ | ------------------------ | ------------------------------- | ----------------------------------- | -------------- | ------------------ | ---------------------- | -------------------------
|
|
|
|
|Balance at January 1, 2003     |                |              |                          | 3,177,264                       |                                     | $              | 3,690              |                        | $                        
|                               |                |             
|Issuance of shares related to  |                |             
|share swap transaction         |                |              |                          | 633,102                         |                                     |                | 537                |                        |                          
|Issuance of shares related to  |                |             
|the private placement          |                |              |                          | 357,143                         |                                     |                | 82                 |                        |                          
|Stock-based compensation       |                |             
|related to warrants issued     |                |             
|to service providers           |                |              |                          | -                               |                                     |                | -                  |                        |                          
|Net loss                       |                |              |                          | -                               |                                     |                | -                  |                        |                          
|Total other comprehensive loss |                |              |                          | -                               |                                     |                | -                  |                        |                          
|                               |                |              |                          |                                 |                                     |                |                    |                        |                          
|Total comprehensive loss       |                |              |                          |                                 |                                     |                |                    |                        |                          
|                               |                |              |                          |                                 |                                     |                |                    |                        |                          
|                               |                |             
|Balance at December 31, 2003   |                |              |                          | 4,167,509                       |                                     |                | 4,309              |                        |                          
|                               |                |             
|Deferred employee share-based  |                |             
|compensation                   |                |              |                          | -                               |                                     |                | -                  |                        |                          
|Amortization of deferred       |                |             
|employee stock-based           |                |             
|compensation                   |                |              |                          | -                               |                                     |                | -                  |                        |                          
|Issuance of shares related to  |                |             
|the acquisitions of Quasar     |                |             
|and Odem, net                  |                |              |                          | 570,149                         |                                     |                | 514                |                        |                          
|Stock based compensation       |                |             
|related to warrants issued     |                |             
|to service providers           |                |              |                          | -                               |                                     |                | -                  |                        |                          
|Warrants issued related to     |                |             
|convertible note               |                |              |                          | -                               |                                     |                | -                  |                        |                          
|Other comprehensive loss       |                |             
|Net loss                       |                |              |                          | -                               |                                     |                | -                  |                        |                          
|Unrealized gain on available   |                |             
|for sales marketable           |                |             
|securities                     |                |              |                          | -                               |                                     |                | -                  |                        |                          
|Foreign currency translation   |                |             
|adjustments                    |                |              |                          | -                               |                                     |                | -                  |                        |                          
|                               |                |              |                          |                                 |                                     |                |                    |                        |                          
|Total comprehensive loss       |                |              |                          |                                 |                                     |                |                    |                        |                          
|                               |                |              |                          |                                 |                                     |                |                    |                        |                          
|                               |                |             
|Balance at December 31, 2004   |                |              |                          | 4,737,658                       |                                     |                | 4,823              |                        |                          
|                               |                |              |                          |                                 |                                     |                |                    |                        |                          

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

F - 6

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.          
|---------------------------------------------
|AND ITS SUBSIDIARIES                         
|STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
|                                             
|U.S. dollars in thousands, except share data 

|                               | Ordinaryshares | Sharecapital | Additionalpaid incapital | Deferredstock-basedcompensation | Accumulatedothercomprehensiveincome | Treasuryshares | Accumulateddeficit | Totalcomprehensiveloss | Total
shareholders'
equity
|------------------------------ | -------------- | ------------ | ------------------------ | ------------------------------- | ----------------------------------- | -------------- | ------------------ | ---------------------- | --------------------------
|
|
|
|
|Balance at January 1, 2005     |                |              |                          | 4,737,658                       |                                     | $              | 4,823              |                        | $                         
|                               |                |             
|Amortization of deferred       |                |             
|employee stock-based           |                |             
|compensation                   |                |              |                          | -                               |                                     |                | -                  |                        |                           
|Conversion of convertible note |                |              |                          | 640,293                         |                                     |                | 570                |                        |                           
|Issuance of shares related to  |                |             
|acquisition of Odem, net       |                |              |                          | 232,603                         |                                     |                | 202                |                        |                           
|Issuance of shares related to  |                |             
|the private placement, net     |                |              |                          | 953,743                         |                                     |                | 815                |                        |                           
|Exercise of employee options   |                |              |                          | 25,088                          |                                     |                | 22                 |                        |                           
|Stock-based compensation       |                |             
|related to warrants issued     |                |             
|to service providers           |                |              |                          | -                               |                                     |                | -                  |                        |                           
|Warrants issued related to     |                |             
|convertible note               |                |              |                          | -                               |                                     |                | -                  |                        |                           
|Net loss                       |                |              |                          | -                               |                                     |                | -                  |                        |                           
|Loss on available for sales    |                |             
|marketable securities          |                |              |                          | -                               |                                     |                | -                  |                        |                           
|Foreign currency translation   |                |             
|adjustment                     |                |              |                          | -                               |                                     |                | -                  |                        |                           
|                               |                |              |                          |                                 |                                     |                |                    |                        |                           
|Total comprehensive loss       |                |              |                          |                                 |                                     |                |                    |                        |                           
|                               |                |              |                          |                                 |                                     |                |                    |                        |                           
|                               |                |             
|Balance at December 31, 2005   |                |              |                          | 6,589,385                       |                                     | $              | 6,432              |                        | $                         
|                               |                |              |                          |                                 |                                     |                |                    |                        |                           

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

F - 7

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.  
|-------------------------------------
|AND ITS SUBSIDIARIES                 
|CONSOLIDATED STATEMENTS OF CASH FLOWS
|                                     
|U.S. dollars in thousands            

|                                                                     | Year ended December 31,
|-------------------------------------------------------------------- | -----------------------
|
|
|
|
|Cash flows from operating activities:                                |                        
|Net loss                                                             |                        
|Adjustments to reconcile net loss to net cash used in operating      |                        
|activities:                                                          |                        
|Loss (income) from discontinued operations                           |                        
|Depreciation and amortization of intangible assets                   |                        
|Amortization of premium and accretion of accrued interest on         |                        
|available-for-sale marketable securities                             |                        
|Impairment of property and equipment                                 |                        
|Increase (decrease) in accrued severance pay, net                    |                        
|Equity in losses of an affiliated company                            |                        
|Minority interest in earnings in a subsidiary                        |                        
|Stock based compensation related to employees                        |                        
|Capital gain from sale of product line                               |                        
|Capital gain from sale of Communication Division                     |                        
|Net loss from decrease in value of put options                       |                        
|Capital loss from sale of property and equipment                     |                        
|Gain on sale of marketable securities                                |                        
|Stock based compensation related to warrants issued to service       |                        
|providers                                                            |                        
|Financial expenses related to warrants issued in connection with     |                        
|long-term convertible note                                           |                        
|Decrease (increase) in trade receivables                             |                        
|Decrease in deferred taxes                                           |                        
|Decrease in other accounts receivable and prepaid expenses           |                        
|Increase in inventories                                              |                        
|Increase (decrease) in trade payables                                |                        
|Decrease in employees and payroll accruals, deferred revenues,       |                        
|accrued expenses and other liabilities                               |                        
|                                                                     |                        
|Net cash used in operating activities from continuing operations     |                        
|Net cash used in operating activities from discontinued operations   |                        
|                                                                     |                        
|Net cash used in operating activities                                |                        
|                                                                     |                        
|                                                                     |                        
|Cash flows from investing activities:                                |                        
|Purchase of property and equipment                                   |                        
|Proceeds from sale of property and equipment                         |                        
|Proceeds from sale of product line                                   |                        
|Payment on account of sale of Communication division                 |                        
|Investment in long-term marketable securities                        |                        
|Proceeds from redemption of marketable securities                    |                        
|Investment in an affiliated company                                  |                        
|Acquisitions, net of cash acquired (a,b)                             |                        
|Realization of restricted cash                                       |                        
|                                                                     |                        
|                                                                     |                        
|Net cash provided by (used in) investing activities                  |                        
|                                                                     |                        
|                                                                     |                        
|Cash flows from financing activities:                                |                        
|Repayment of short term and long term bank loans                     |                        
|Proceeds from short term bank loans                                  |                        
|Proceeds from long term convertible note and warrants, net of        |                        
|issuance expenses                                                    |                        
|Payment of  long term convertible note                               |                        
|Proceeds from issuance of shares and exercise of options, net        |                        
|Issuance expenses related to investment in an affiliated company     |                        
|                                                                     |                        
|Net cash provided by financing activities from continuing operations |                        
|Net cash used in financing activities from discontinued operations   |                        
|                                                                     |                        
|Net cash provided by financing activities                            |                        
|                                                                     |                        
|                                                                     |                        
|Decrease in cash and cash equivalents                                |                        
|Decrease in cash and cash equivalents from discontinued operations   |                        
|Effect of exchange rate changes on cash and cash equivalents         |                        
|Cash and cash equivalents at the beginning of the year               |                        
|                                                                     |                        
|                                                                     |                        
|Cash and cash equivalents at the end of the year                     |                        
|                                                                     |                        

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

F - 8

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.  
|-------------------------------------
|AND ITS SUBSIDIARIES                 
|CONSOLIDATED STATEMENTS OF CASH FLOWS
|                                     
|U.S. dollars in thousands            

|                                                               | Year ended December 31,
|-------------------------------------------------------------- | -----------------------
|
|
|
|
|Supplemental disclosure of cash flow activities:               |                        
|                                                               |                        
|(i) Net cash paid during the year for:                         |                        
|Interest                                                       |                        
|                                                               |                        
|                                                               |                        
|Income tax                                                     |                        
|                                                               |                        
|                                                               |                        
|(ii) Non-cash activities:                                      |                        
|                                                               |                        
|Investment in an affiliated company against issuance of shares |                        
|                                                               |                        
|                                                               |                        
|Conversion of convertible note into shares                     |                        
|                                                               |                        
|                                                               |                        
|Sale of Communication division in consideration for shares in  |                        
|Qualmax                                                        |                        
|                                                               |                        
|                                                               |                        
|Sale of PrintBos                                               |                        
|Consideration                                                  |                        
|Disposal of fixed assets                                       |                        
|Disposal of liability                                          |                        
|Related expenses                                               |                        
|                                                               |                        
|                                                               |                        
|Capital gain                                                   |                        
|                                                               |                        
|                                                               |                        
|Sale of Communication division                                 |                        
|Consideration, net                                             |                        
|Disposal of tangible and intangible assets                     |                        
|Related expenses                                               |                        
|                                                               |                        
|                                                               |                        
|Capital gain                                                   |                        
|                                                               |                        
|                                                               |                        
|(a) Acquisition of Quasar:                                     |                        
|                                                               |                        
|Fair value of net assets acquired (excluding cash and cash     |                        
|equivalents) and liabilities assumed at acquisition date:      |                        
|                                                               |                        
|Less - amount acquired by issuance of shares                   |                        
|                                                               |                        
|                                                               |                        
|                                                               |                        
|                                                               |                        

F - 9

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.  
|-------------------------------------
|AND ITS SUBSIDIARIES                 
|CONSOLIDATED STATEMENTS OF CASH FLOWS
|                                     
|U.S. dollars in thousands            

|                                                            | Year ended December 31,
|----------------------------------------------------------- | -----------------------
|
|
|
|
|(b) Acquisition of Odem:                                    |                        
|                                                            |                        
|Fair value of net tangible assets acquired (excluding cash  |                        
|and cash equivalents) and liabilities assumed at            |                        
|acquisition date:                                           |                        
|Fair value of net intangible assets acquired at acquisition |                        
|date:                                                       |                        
|                                                            |                        
|Less -                                                      |                        
|Amount acquired by issuance of shares                       |                        
|Payables                                                    |                        
|Add-                                                        |                        
|Cancellation of Put and Call options                        |                        
|                                                            |                        
|                                                            |                        
|                                                            |                        
|                                                            |                        

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

F - 10

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.                        
|-----------------------------------------------------------
|AND ITS SUBSIDIARIES                                       
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 1: |  | GENERAL
|------- | - | -------

| | a. | B.O.S.
Better Online Solutions Ltd. is an Israeli corporation (together with its
               subsidiaries the Company).
| | -- | ----------------------------------------------------------------------------------------------------------------------------

| | The
Companys wholly-owned subsidiary BOScom Ltd. (BOScom) develops high
technology connectivity solutions that provide PC emulation products for the IBM iSeries
(AS/400). BOScom was involved in cross platform printing solutions answering a demand for
central printing and output management solutions in organizations which was sold during
2005 (see note 1c).
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | B.O.S.
                     Communication Division Segment included: BOScoms business of
                    communication solutions which provide multi-path, intelligent routing
voice over                     IP gateways and the Companys wholly-owned subsidiary
Quasar Telecom (2004)                     Ltd. (Quasar), which provide
communication solutions based on                     cellular technology. The assets and
liabilities of the Communication Segment                     have been disposed of as
part of the disposal of the Communication Division (see                     note 1c)
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
September and November 2005, the Company purchased an additional 23.9% and 12.3%,
respectively, of the outstanding shares of Odem Electronic Technologies 1992 Ltd.
(Odem). Following these purchase, the Company owns 100% of Odem. Odem is a
solutions supplier of electronic components and systems to the technologies sector (see
note 1b).
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Companys products are sold and supported directly and through a network of
distributors and value-added resellers.
| | -----------------------------------------------------------------------------------------------------------------------

| | In
addition, the Company holds shares in two affiliated companies:
| | ------------------------------------------------------------------

| | 1) | 8.7%
interest in Surf Communication Solutions Ltd. (Surf), a           developer
and supplier of access and network convergence software solutions to           the wire
line and wireless telecommunications and data communications           industries.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2) | Approximately
16% interest in Qualmax Inc. a US corporation           (Qualmax) which is a
developer and supplier of Voice over IP           technology products and services. The
Companys holdings in Qualmax were           received as the consideration for the
sale of the communication division (See           note 1c).
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | Business
combinations:
| | -- | ----------------------

| | 1) | Acquisition
of Quasar Communication systems Ltd. assets (QCS).
| | -- | ----------------------------------------------------------------

| | In
September 2004, the Company entered into an agreement with QCS, to purchase the assets of
QCS, for an aggregate consideration of $ 539 by the issuance of 285,000 of the
Companys ordinary shares. The assets of QCS were transferred to Quasar Telecom
(2004) Ltd., a wholly owned subsidiary of the Company. The results of Quasars
operations have been included in the consolidated financial statements since September
28, 2004 (the closing date). On December 31, 2005, the Company sold the
assets of Quasar as part of the disposal of the Communication Division.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 11

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.                        
|-----------------------------------------------------------
|AND ITS SUBSIDIARIES                                       
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 1: |  | GENERAL (Cont.)
|------- | - | ---------------

| | The
Company's  consolidated  financial statements reflect the purchase price
                             determined as follows:
| | --------------------------------------------------------------------------------------------------------------------------------

|                       | Quasar
|---------------------- | ------
|
|
|
|
|Issuance of shares (1) |       
|Transaction costs      |       
|                       |       
|                       |       
|Total purchase price   |       
|                       |       

| | (1) | The
value of the Ordinary shares issued was determined based on the average           market
price of the Companys Ordinary shares over the period of two days           before
and after the terms of the transaction were agreed to and announced.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
acquisition has been treated using the purchase method of accounting in accordance with
SFAS141 Business Combinations. The purchase price has been allocated to the
assets acquired and liabilities assumed based on their estimated fair value at the date
of acquisition. The excess of the purchase price over the estimated fair value of the
tangible and intangible assets acquired has been recorded as goodwill.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company has allocated the total cost of the acquisition in 2004 as follows.
| | -------------------------------------------------------------------------------

|Allocation of purchase consideration | Quasar | Estimated
useful life
|------------------------------------ | ------ | ---------------------
|
|
|
|
|Tangible assets                      |        |                      
|Inventory purchase commitment (1)    |        |                      
|Trade name (2)                       |        |                      
|Core technology (3)                  |        |                      
|Distribution networks (4)            |        |                      
|Goodwill                             |        |                      
|                                     |        |                      
|                                     |        |                      
|Total purchase price                 |        |                      
|                                     |        |                      

| | (1) | The
Company purchased Quasar Communication Systems Ltd inventory in the           ordinary
course of business for a cash consideration of $ 517. The fair value of           Quasars
inventory at the purchase date amounted to $ 370. A provision           in the
amount of $ 147 has been recorded at the date of the acquisition.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (2) | The
Companys allocation of purchase price valuated the acquired trade           name
using the relief from royalty approach.
| | --- | -----------------------------------------------------------------------------------------------------------------------------

| | (3) | The
Companys allocation of purchase price valuated the acquired core
          technology using the discounted cash flows to be derived from the sales of
these           products to present value.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 12

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.                        
|-----------------------------------------------------------
|AND ITS SUBSIDIARIES                                       
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 1: |  | GENERAL (Cont.)
|------- | - | ---------------

| | (4) | The
Companys allocation of purchase price valuated the acquired           distribution
networks by calculating the savings realized by the Company through           obtaining a
pre-existing distribution network.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2) | Acquisition
of Odem:
| | -- | --------------------

| | On
November 18, 2004 the Company purchased 63.8% of the outstanding shares of Odem, from Odems
existing shareholders. In consideration for Odems shares the Company (i) issued
290,532 of the Companys ordinary shares subject to lock-upperiods of 2
to 4 years and (ii) paid an amount of $ 1,971 in cash. In addition, Odems selling
shareholders and the Company had certain put and call options, based on performance, with
respect to all of the remaining Odem shares held by such sellers, exercisable for a
consideration comprised of additional cash and issuance of additional ordinary shares of
the Company. The Company recorded assets and liability with respect to these options at
fair value. The put option liability will be measured periodically until it expires or is
exercised and the changes in the fair value will be charged to finance expenses.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
September 29, 2005 and November 1, 2005, the Company purchased an additional 23.9% and
12.3%of the outstanding shares of Odem respectively, from Odems minority
shareholders. Following these purchases, the Company owns 100% of Odem. In consideration
for the 12.3% of Odems shares purchased on November, 2005 the Company paid $ 554,
in cash and for the 23.9% of Odems shares purchase on September, 2005 the Company
(i) issued 232,603 of the Companys ordinary shares subject to lock upperiods
of 2 to 4 years and (ii) $ 716 to be paid in cash.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Companys consolidated financial statements reflect the purchase price determined as
follows:
| | -------------------------------------------------------------------------------------------------

|                        | Odem
|----------------------- | ----
|
|
|
|
|Issuance of shares (1)  |     
|Cash consideration      |     
|Transaction costs       |     
|Cancellation of put and |     
|call options            |     
|                        |     
|                        |     
|Total purchase price    |     
|                        |     

| | (1) | The
value of the Ordinary shares issued was determined based on the average           market
price of the Companys Ordinary shares over the period of two days           before
and after the terms of the transaction were agreed to and announced.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 13

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.                        
|-----------------------------------------------------------
|AND ITS SUBSIDIARIES                                       
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 1: |  | GENERAL (Cont.)
|------- | - | ---------------

| | The
acquisitions have been treated using the purchase method of accounting in accordance with
SFAS141 Business Combinations. The purchase price has been allocated to the
assets and liabilities assumed acquired based on their estimated fair value at the date
of acquisition. The excess of the purchase price over the estimated fair value of the
tangible and intangible assets acquired has been recorded as goodwill.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company has allocated the total cost of Odem acquisition in 2005 as follows.
| | --------------------------------------------------------------------------------

|Allocation of purchase
consideration | November 1,
2005 | September 29,
2005 | Total | Estimated
useful life
|------------------------------------ | ---------------- | ------------------ | ----- | ---------------------
|
|
|
|
|Tangible assets                      |                  |                    | $     | 340                  
|Customer list (1)                    |                  |                    |       | 85                   
|Deferred tax liability               |                  |                    |       | (23                  
|Goodwill                             |                  |                    |       | 138                  
|                                     |                  |                    |       |                      
|                                     |                  |                   
|Total purchase price                 |                  |                    | $     | 540                  
|                                     |                  |                    |       |                      

| | (1) | The
Companys allocation of purchase price valuated the acquired customer           list
by calculating cash flow as a direct result of the customer relationship.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company has allocated the total cost of the acquisition in 2004 as follows:
| | -------------------------------------------------------------------------------

|Allocation of purchase consideration     | Odem | Estimateduseful life
|---------------------------------------- | ---- | --------------------
|
|
|
|
|Cash                                     |      |                     
|Tangible assets                          |      |                     
|Put option to minority shareholders (2)  |      |                     
|Call option to minority shareholders (2) |      |                     
|Customer list (1)                        |      |                     
|Deferred tax liability                   |      |                     
|Goodwill                                 |      |                     
|                                         |      |                     
|                                         |      |                     
|Total purchase price                     |      |                     
|                                         |      |                     

| | (1) | The
Companys allocation of purchase price valuated the acquired customer           list
by calculating cash flow benefit as a direct result of the customer
          relationship.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (2) | The
put and call options were valuated by using the Black & Scholes option
          pricing model.
| | --- | ---------------------------------------------------------------------------------------------------

F - 14

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.                        
|-----------------------------------------------------------
|AND ITS SUBSIDIARIES                                       
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 1: |  | GENERAL (Cont.)
|------- | - | ---------------

| | The
following unaudited pro forma financial information presents the Companys results
of operations as if the acquisitions had occurred as of the beginning of the fiscal years
2003 and 2004, after giving effect to certain adjustments, including amortization of
intangible assets. The unaudited pro forma financial information does not necessarily
reflect the results of operations that would have occurred, and is not necessarily
indicative of results which may be obtained in the future.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                               | Year endedDecember 31,2004
|-------------------------------------------------------------- | --------------------------
|
|
|
|
|Pro forma revenues                                             |                           
|                                                               |                           
|                                                               |                           
|Pro forma net loss from continuing operations                  |                           
|                                                               |                           
|                                                               |                           
|Pro forma basic and diluted net loss per share from continuing |                           
|operations                                                     |                           
|                                                               |                           

|c. | 1) | Sale
of product line
|-- | -- | --------------------

| | On
July 18, 2005, BOScom signed an asset purchase agreement with Consist Technologies Ltd.
and Consist International Inc. (collectively, Consist), for the sale of its
PrintBOS product line in consideration of $ 500 and a contingent payment in each of
the next three years equal to 6-10% of future revenues exceeding $1,000 per year,
generated by Consist from the PrintBOS product line. The Company has accounted for a gain
of $ 273 in 2005. As of December 31, 2005, the Company has received $ 375 and the
remaining $ 125 has been placed in escrow, pending repayment of royalties to the Office
of the Chief Scientist (OCS) on sales of PrintBOS products.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2) | Sale
of Communication Division:
| | -- | -------------------------------

| | On
December 31, 2005, the Company sold its Communications Division Segment (hereinafter
Communications Division), including its property and equipment, goodwill,
technology, trade name, existing distribution channels and related contingent liability
to the Office of the Chief Scientist to IP Gear Ltd. (IP Gear), a wholly
owned Israeli subsidiary of Qualmax. The consideration paid to the Company in the
transaction was approximately 3.2 million Qualmax shares of common stock constituting
approximately 16% of Qualmaxs total issued and outstanding Common Stock and $800 in
royalties to be paid at a rate of 4% from future revenues IP Gear will generate from the
disposed division (Royalties) with the entire $ 800 due no later than 90 days
from the third anniversary of the closing of the transaction. Additional shares may be
issued to the Company at the end of four consecutive fiscal quarters following the
closing of the transaction, contingent upon IP Gear generating by then a certain level of
revenues from the disposed division (Earn Out Shares). The maximum number of
Earn Out Shares that may further be issued to the Company is approximately 1 million,
constituting an additional 5%, of Qualmax outstanding shares. The Company received
certain piggy-back registration rights with respect to the Qualmax shares. The Company
does not have a representative on the Board of Directors of Qualmax.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 15

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.                        
|-----------------------------------------------------------
|AND ITS SUBSIDIARIES                                       
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 1: |  | GENERAL (Cont.)
|------- | - | ---------------

| | The
Company accounted for its holdings in Qualmax shares on the cost basis since these shares
are restricted stock.
| | -------------------------------------------------------------------------------------------------------------------

| | In
addition, the Company and IP Gear entered into an Outsourcing Agreement, pursuant to
which the Company will provide IP Gear with certain operating services relating to the
sold Communications Division. The first three months of services will be provided for no
charge and IP Gear shall pay for these services starting from April 2006. IP Gear can
elect to pay for the services rendered in April thru June 2006 by issuance to the Company
of Qualmax shares valued at a predetermined price of $1.43 per share. The Company
undertook to provide these services at least until December 31, 2006 (12 months from
closing).
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company also granted a bridge loan to IP Gear in the amount of $1,000. The term of the
loan is three years and it bears interest equal to the Prime rate plus 2.5%, up to a
maximum of 12%. In the first 18 months, IP Gear shall pay only the interest accrued on
the loan and monthly principal and interest payments shall commence thereafter. The loan
granted to IP Gear is secured by a first priority floating charge, which may be
subordinated to a charge in favor of Bank of America, NA in the event such charge is
recorded. In addition repayment is guaranteed by Qualmax Inc.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
loan agreement provides that if the disposed division would incur in the first quarter of
2006, losses that exceed $250, the principal amount to be repaid under the loan shall be
reduced by the excess losses. In such event, Qualmax shall issue to the Company
additional shares of Common Stock against such reduction, valued at a predetermined price
of $1.43 per share. In addition, the loan shall be immediately repaid in the event
Qualmax raises by way of equity financing (or a series of equity financings) an aggregate
amount equal to at least $ 4,500.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Qualmax
also issued to the Company a five-year warrant for the purchase of up to 107,143 shares,
constituting less than 1%, of its outstanding shares in Qualmax, at the exercise price of
$2.80 per share (Warrants). The Company received certain piggy-back
registration rights with respect to the shares underlying the warrant.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                                            | December 31,2005
|--------------------------------------------------------------------------- | ----------------
|
|
|
|
|Consideration:                                                              |                 
|Approximately 3.2 million ordinary shares of Qualmax (1)                    |                 
|107,143 warrants (2)                                                        |                 
|Loan granted to IP Gear                                                     |                 
|                                                                            |                 
|Total consideration                                                         |                 
|                                                                            |                 
|                                                                            |                 
|Cost:                                                                       |                 
|Disposal  of  inventory,  property  and  equipment  and  intangible  assets |                 
|related to the Communication segment                                        |                 
|Transactions related cost                                                   |                 
|                                                                            |                 
|Total cost                                                                  |                 
|                                                                            |                 
|                                                                            |                 
|Capital gain                                                                |                 
|                                                                            |                 

| | (1) | Valuated
at $ 1.43 per share
| | --- | ----------------------------

| | (2) | Valuated
at $ 0.97 per warrant
| | --- | ------------------------------

F - 16

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.                        
|-----------------------------------------------------------
|AND ITS SUBSIDIARIES                                       
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 1: |  | GENERAL (Cont.)
|------- | - | ---------------

| | The
Company has not accounted for the Communication Division as a discontinued operation due
to its continuing involvement reflected in the loan and the outsourcing agreement, in
accordance with EITF 03-13.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | d. | Discontinued
operations:
| | -- | ------------------------

| | On
June 1, 1998, the Company acquired 100% of the share capital of Pacific Information
Systems Inc. (Pacinfo), a U.S. corporation. Pacinfo was a reseller of
computer networking products.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | During
the fourth quarter of 2002, the Company initiated a plan to cease operations of Pacinfo.
| | -----------------------------------------------------------------------------------------------

| | The
results of operations including revenues, operating expenses and other income and
expenses of Pacinfo for 2004 and 2003 have been reclassified in the accompanying
statements of operations as discontinued operations. The Companys balance sheets at
December 31, 2005 and 2004 reflect the net assets and liabilities of Pacinfo as
liabilities and assets related to discontinued operations.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

|                                                          | December 31,
|--------------------------------------------------------- | ------------
|
|
|
|
|Cash                                                      |             
|Trade receivables, other receivables and prepaid expenses |             
|Property and equipment, net                               |             
|                                                          |             
|                                                          |             
|Assets of discontinued operations                         |             
|                                                          |             
|                                                          |             
|Trade payables                                            |             
|Accrued expenses and other liabilities                    |             
|                                                          |             
|                                                          |             
|Liabilities of discontinued operations                    |             
|                                                          |             

| | The
results of operations, including revenues, cost of revenues and operating expenses of
Pacinfos operations for 2004 and 2003 have been reclassified in the statements of
operations. Taxes were not attributed to the discontinued operations due to utilization
of losses from previous years, for which a valuation allowance was provided.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Summarized
selected financial information of the discontinued operations is as follows:
| | ---------------------------------------------------------------------------------------

|                  | Year ended December 31,
|----------------- | -----------------------
|
|
|
|
|Revenues          |                        
|                  |                        
|                  |                        
|Net income (loss) |                        
|                  |                        

F - 17

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.                        
|-----------------------------------------------------------
|AND ITS SUBSIDIARIES                                       
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 2: |  | SIGNIFICANT ACCOUNTING POLICIES
|------- | - | -------------------------------

| | The
 consolidated  financial  statements are prepared  according to United States generally
              accepted accounting principles ("U.S. GAAP").
| | -------------------------------------------------------------------------------------------------------------------------------------------------------

| | a. | Use
of estimates:
| | -- | -----------------

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

| | 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 operates. 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.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
functional currency of the Odem subsidiary, whose functional currency as of December 31,
2004, was other than dollar and has been translated into U.S. dollars, has changed on
April 1, 2005, due to significant changes in circumstances initiated by management,
which consisting of; Odem transition from New Israeli Shekels (NIS) to U.S. dollars of
Odems majority sales, majority expenses and budget, which indicate a functional
currency change. In accordance with FAS 52, Foreign Currency Translation and
since the functional currency changed from a foreign currency to the reporting currency,
dollars, the translation adjustments as of March 30, 2005, prior to the change have not
been removed from equity and the translated amounts for nonmonetary assets as of March 30,
2005, prior to the change became the accounting basis for those assets in the periods
starting April 1, 2005.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | Principles
of consolidation:
| | -- | ----------------------------

| | The
consolidated financial statements include the accounts of the Company and its
subsidiaries. Inter-company transactions and balances including profits from
inter-company sales not yet realized outside the Company 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.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 18

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.                        
|-----------------------------------------------------------
|AND ITS SUBSIDIARIES                                       
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 2: |  | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|------- | - | ---------------------------------------

| | 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 (FAS 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. Until November 30, 2005,
debt securities have been classified as held-to-maturity since the Company had the
positive intent and ability to hold the securities to maturity and they 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. Beginning December 1, 2005, the debt securities are classified as available-for-sale since
the Company does not have the intent to hold the securities to maturity, and are stated
at fair value. Due to the change in classification of the securities to available-for-sale,
the unrealized holding gain at the date of transfer has been reported in other
comprehensive income.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Available-for-sale
securities are carried at fair value with unrealized gains, and are reported as a
separate item under other comprehensive loss.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------

| | f. | Inventories:
| | -- | ------------

| | Inventory
write-offs are provided to cover risks arising from slow-moving items or technological
obsolescence. As of December 31, 2005 and 2004, inventory is presented net of $ 100
and $ 300, respectively, for technological obsolescence and slow moving items (see
also Note 4).
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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.
| | -------------------------------------------------------------------------------------------------------------------------------------

| | g. | 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 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.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | h. | 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.
The Companys investment in Surf has been included as an affiliated company until
September 30, 2005 (see note 6).
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 19

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.                        
|-----------------------------------------------------------
|AND ITS SUBSIDIARIES                                       
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 2: |  | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|------- | - | ---------------------------------------

| | The
investment in an affiliated company represents investments in Ordinary shares and
Preferred shares of that Company. The Company applies EITF 99-10, Percentage Used
to Determine the Amount of Equity Method Losses. Accordingly, losses of the
affiliated company are recognized based on the ownership level of the particular security
of the affiliated company held by the Company.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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).
During 2005, an impairment of 1,385 has been recorded in equity in losses of an
affiliated company in the statement of operations. In 2004 and 2003, based on
managements analyses, no impairment losses were identified.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | i | Investment
in other companies:
| | - | ------------------------------

| | Investment
in companies are investments through which the Company is not able to exercise
significant influence over the investees financial policies and which do not meet
the fair value availability criteria of FAS 115 (readily determined sales price
currently available on a security exchange), consequently such investments are
accounted for by the cost method.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Companys investment in such companies is reviewed for impairment whenever events of
changes in circumstances indicate that the carrying amount of the investment may not be
recoverable in accordance with APB No. 18. No impairment has been identified during 2005.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | j. | Property
plant and equipment:
| | -- | -----------------------------

| | Property,
plant 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:
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                               | %       |                                              
|------------------------------ | ------- | ---------------------------------------------
|
|
|
|
|Computers and software         | 20 - 33 | (mainly 33%)                                 
|Office furniture and equipment | 6 - 15  | (mainly 10%)                                 
|                               |         | (over the period of the lease 10 years or the
|Leasehold improvements-        | 10      | shorter of the life of the assets)           
|Vehicles                       | 15     
|Plant                          | 4      

| | k. | Impairment
of long-lived assets:
| | -- | --------------------------------

| | The
Companys long-lived assets 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. The Company has recorded impairment losses of $ 0, $ 0 and $ 110 for the
years ended December 31, 2005, 2004 and 2003, respectively.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 20

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.                        
|-----------------------------------------------------------
|AND ITS SUBSIDIARIES                                       
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 2: |  | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|------- | - | ---------------------------------------

| | l. | Goodwill:
| | -- | ---------

| | Goodwill
represents excess of the costs over the net assets of businesses acquired. SFAS No. 142
requires goodwill to be tested for impairment at least annually or between annual tests
in certain circumstances, and written-down when impaired. 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 income and market
approaches. 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. During 2005,
2004 and 2003 no impairment losses have been identified.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | m. | 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s 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 releases are insignificant.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | n. | Severance
pay:
| | -- | --------------

| | The
Companys liability for severance pay for Israeli resident employees is calculated
pursuant to the Israeli severance pay law based on the most recent salary of the
employees multiplied by the number of years of employment as of the balance sheet date.
Employees are entitled to one months salary for each year of employment or a
portion thereof. The Companys liability for 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 2005, 2004 and 2003 amounted to $ 256, $ 214 and $ 178,
respectively.
| | --------------------------------------------------------------------------------------------

F - 21

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.                        
|-----------------------------------------------------------
|AND ITS SUBSIDIARIES                                       
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 2: |  | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|------- | - | ---------------------------------------

| | o. | Revenue
recognition:
| | -- | --------------------

| | The
Company sells its products through direct sales, distributors and resellers channels.
| | -----------------------------------------------------------------------------------------

| | The
Company derives its revenues from the sale of products, license fees for its products,
commissions, 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.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Revenues
support are recognized ratably over the period of the support contract. The fair value of
the support is determined based on the price charged when it is sold separately or
renewed.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Revenues
from commissions are recognized upon their actual receipt, since under agreements with
suppliers consideration is received on the basis of collection from customers.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | p. | Warranty:
| | -- | ---------

| | BOScom
provides a warranty of 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. As of December 31, 2005 and 2004, the Companys product warranty amounted
to $ 73 and $ 132, respectively.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | q. | Income
taxes:
| | -- | -------------

| | The
Company accounts for income taxes in accordance with Statement of Financial Accounting
Standards 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 has provided valuation
allowances, in respect of deferred tax assets resulting from tax loss carryforward 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.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 22

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.                        
|-----------------------------------------------------------
|AND ITS SUBSIDIARIES                                       
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 2: |  | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|------- | - | ---------------------------------------

| | r. | 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. 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 are derived from sales to customers located primarily in
Israel, United States and Europe. The Company generally does not require collateral;
however, in certain circumstances, the Company may require letters of credit, other
collateral, additional guarantees or advanced payments. 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
loan granted to IP Gear is secured by a first priority floating charge, which may be
subordinated to a charge in favor of Bank of America, NA in the event such charge is
recorded. In addition repayment is guaranteed by Qualmax Inc. (see note 1c(2)).
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | s. | 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 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 1,506,803, 855,783 and 505,178 for the years ended December 31, 2005, 2004
and 2003, respectively.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | t. | 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.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 23

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.                        
|-----------------------------------------------------------
|AND ITS SUBSIDIARIES                                       
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 2: |  | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|------- | - | ---------------------------------------

| | 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 2005, 2004 and
2003 would have changed to the pro forma amounts shown below:
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                 | Year ended December 31,
|------------------------------------------------ | -----------------------
|
|
|
|
|Net loss from continuing operations as reported  |                        
|Add: stock-based compensation expense determined |                        
|under intrinsic value method                     |                        
|Deduct: stock-based compensation expense         |                        
|determined under fair value method for all       |                        
|awards                                           |                        
|                                                 |                        
|Pro forma net loss from continuing operations    |                        
|Pro forma net income (loss) from discontinued    |                        
|operations                                       |                        
|                                                 |                        
|                                                 |                        
|Pro forma net loss                               |                        
|                                                 |                        
|                                                 |                        
|Basic and diluted earning (loss) per share as    |                        
|reported:                                        |                        
|Continuing operations                            |                        
|                                                 |                        
|Discontinued operations                          |                        
|                                                 |                        
|Net loss                                         |                        
|                                                 |                        
|                                                 |                        
|Pro forma earning (loss) per share:              |                        
|Continuing operations                            |                        
|                                                 |                        
|Discontinued operations                          |                        
|                                                 |                        
|Net loss                                         |                        
|                                                 |                        

| | 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 120%, 68% and 64% in 2005,
2004 and 2003, respectively and using the following weighted average assumptions: (1)
Dividend yield of zero percent for each year; (2) Risk-free interest rate of 4%, 2.5% and
1.8% in 2005, 2004 and 2003, respectively and (3) Expected average lives of the options
of three years from the date of grant as of 2005, 2004 and 2003.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 24

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.                        
|-----------------------------------------------------------
|AND ITS SUBSIDIARIES                                       
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 2: |  | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|------- | - | ---------------------------------------

| | u. | Fair
value of financial instruments:
| | -- | ------------------------------------

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

| | The
carrying amounts of cash and cash equivalents, 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. The fair value of investments in other companies is based on
independent third-party evaluations.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | v. | Reclassification:
| | -- | -----------------

| | Certain
amounts from prior years have been reclassified to conform to the current year
presentation.
| | ----------------------------------------------------------------------------------------------------

| | w. | Impact
of recently issued accounting pronouncements:
| | -- | ----------------------------------------------------

| | In
November 2004, the FASB issued Statement of Financial Accounting Standard No. 150, Inventory
Costs, an Amendment of ARB No. 43, Chapter 4. (SAFS No. 151). SFAS No.
151 amends Accounting Research Bulletin (ARB) No. 43, Chapter 4, to clarify
that abnormal amounts of idle facility expense, freight handling costs and wasted
materials (spoilage) should be recognized as current-period charges. In addition, SFAS
No.151 requires that the allocation of fixed production overheads to the costs of
conversion be based on the normal capacity of the production facilities. SAFS No. 151 is
effective for inventory costs incurred during fiscal years beginning after September 15,
2005. As of December 31, 2005, the Company does not expect that the adoption of SFAS No.
151 will have a material effect on its financial position or results of operations.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
December 16, 2004, the Financial Accounting Standards Board (FASB) issued Statement No.
123 (revised 2004), Share-Based Payment (Statement 123R), which
is a revision of FASB Statement No. 123, Accounting for Stock-Based Compensation(Statement
123). Generally, the approach in Statement 123R is similar to the approach
described in Statement 123. However, Statements 123 permitted, but did not require,
share-based payments to employees to be recognized based on their fair values while
Statement 123R requires all share-based payments to employees to be recognized based on
their fair values. Statement 123R also revises, clarifies and expands guidance in several
areas, including measuring fair value, classifying an award as equity or as a liability
and attributing compensation cost to reporting periods. The new Standard will be
effective for the Company in the first fiscal year beginning after December 15, 2005. On
March 29, 2005, the SEC published Staff Accounting Bulletin (SAB) No. 107,
which provides the staffs views on a variety of matters relating to stock-based
payments. SAB 107 requires stock-based compensation to be classified in the same expense
line items as cash compensation.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company will adopt Statement 123R and SAB 107 as of the financial statements of the first
quarter of 2006.
| | --------------------------------------------------------------------------------------------------------------

F - 25

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 2: |  | SIGNIFICANT
ACCOUNTING POLICIES (Cont.)
|------- | - | ---------------------------------------

| | In
May 2005, the FASB issued Statement of Financial Accounting Standard No. 154 (FAS
154), Accounting Changes and Error Corrections  a replacement of
APB No. 20, Accounting Changes and FAS NO. 3, Reporting Accounting Changes in
Interim Financial Statement. FAS 154 provides guidance on accounting for and
reporting of accounting changes and error corrections.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | APB
Option 20 previously required that most voluntary changes in accounting principle be
recognized by including in net income of the period of the change the cumulative effect
of changing to the new accounting principle. FAS 154 requires retrospective application
to prior periods financial statements of a voluntary change in accounting principle
unless it is impracticable. FAS 154 is effective for accounting changes and corrections
of errors made in fiscal years beginning after December 15, 2005. The Company is
currently assessing the impact of FAS 154 on its results of operations, financial
condition and liquidity.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
June 29, 2005, the FASB issued FSP FAS 115-1 and FAS 124-1. The guidance in FSP FAS 115-1
and FAS 124-1 addresses the determination of when an investment is considered impaired,
whether that impairment is other than temporary, and the measurement of an impairment
loss. The FSP also includes accounting considerations subsequent to the recognition of an
other-than-temporary impairment and requires certain disclosures about unrealized losses
that have not been recognized as other-than-temporary impairments. The guidance in this
FSP amends FASB Statement No. 115, Accounting for Certain Investments in Debt and
Equity Securities, and FASB Statement No. 124, Accounting for Certain
Investments Held by Not-for-Profit Organizations, and adds a footnote to APB
Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock. The
guidance in this FSP nullifies certain requirements of EITF Issue No. 03-1 and supersedes
EITF. Abstracts, Topic D-44, Recognition of Other-Than-Temporary Impairment upon
the Planned Sale of a Security Whose Cost Exceeds Fair Value. The guidance in this
FSP is required to be applied to reporting periods beginning after December 15, 2005.
Because the impact of adopting the provisions of FSP FAS 115-1 will be dependent on
future events and circumstances, management cannot predict such impact.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|NOTE 3: |  | OTHER
ACCOUNTS RECEIVABLE AND PREPAID EXPENSES
|------- | - | ----------------------------------------------

|                                                       | December 31,
|------------------------------------------------------ | ------------
|
|
|
|
|Government authorities - Income tax advances and V.A.T |             
|Grants receivables                                     |             
|Accrued interest on marketable securities              |             
|Prepaid expenses                                       |             
|Other                                                  |             
|                                                       |             
|                                                       |             
|                                                       |             
|                                                       |             

F - 26

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 4: |  | INVENTORIES
|------- | - | -----------

|                                              |  | 
|--------------------------------------------- |  | 
|
|
|
|
|Raw materials (including packaging materials) |  | 
|Products in progress                          |  | 
|Finished products                             |  | 
|                                              |  | 
|                                              |  | 
|                                              |  | 
|                                              |  | 

| | The
inventories are presented net of provision for technological obsolescence and slow-moving
items of $ 100 and $ 300 as of December 31, 2005 and 2004, respectively.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------

|NOTE 5: |  | MARKETABLE
SECURITIES
|------- | - | ---------------------

| | The
following is a summary of securities:
| | -----------------------------------------

|                    | December 31,
|------------------- | ------------
|
|
|
|
|Available-for-sale: |             
|                    |             
|Corporate           |             
|debentures          |             
|                    |             
|                    |             
|Held-to-maturity:   |             
|                    |             
|Corporate           |             
|debentures          |             
|                    |             

| | Aggregate
maturities of available-for-sale securities for years subsequent to December 31, 2005 are:
| | ----------------------------------------------------------------------------------------------------

|                    | Amortized cost | Estimated fair
market value
|------------------- | -------------- | ---------------------------
|
|
|
|
|Available for sale: |                |                            
|                    |                |                            
|2006                |                |                            
|2007                |                |                            
|2008                |                |                            
|                    |                |                            
|                    |                |                            
|                    |                |                            
|                    |                |                            

|NOTE 6: |  | INVESTMENT
IN AN AFFILIATED COMPANY
|------- | - | -----------------------------------

| | Investment
in Surf:
| | -------------------

| | In
November 2001, the Company invested $ 1,000 as part of a private placement in Surf
Communication System Ltd. (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.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 27

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 6: |  | INVESTMENT
IN AN AFFILIATED COMPANY (Cont.)
|------- | - | -------------------------------------------

| | 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 633,102 Ordinary shares, at a purchase price of $ 2.77,
aggregating to $ 1,755 and incurred transaction cost of $ 155. The value of the Ordinary
shares issued was determined based on the average market price of the Companys
ordinary shares over the period including two days before and after the terms of the
transaction were agreed to and announced.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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% and until such purchase shall be granted voting
rights in Surf shares. In the event that Catalyst will sell its remaining shares in Surf
in or prior to January 31, 2006 (or by July 31, 2007, provided that the negotiations with
respect to the sale commenced before January 31, 2006), the Company will be entitled to
the gain that will be realized in such sale. To the best of the Companys knowledge,
Catalyst has not sold its Surf securities as of January 31, 2006, nor entered into
negotiations for their sale. The Company has not exercised the option and it expired on
January 31, 2006.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
a result of this investment, the Company had the ability to exercise significant
influence over Surf. As a result the investment in Surf had become qualified to be
accounted for under 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.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
September 2005, Surf completed a private placement that is considered an event of change
in circumstances that has a significant adverse effect on the fair value of the
investment. Therefore, the Company has evaluated its investment in Surf and determined
that it amounts to $ 722 as of December 31, 2005 based on managements analysis
(supported by an independent third-party valuation). As a result, the Company has
recorded an impairment of $ 1,385, which has been included in the equity in losses of an
affiliated company in the statement of operations for the year December 31, 2005.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Moreover,
following the private placement in Surf, the Companys voting rights have been
diluted to 8.7% of the total voting rights in Surf. As a result, the Company ceased to
have the ability to exercise significant influence over Surf and, accordingly, the
adjusted carrying amount of the investment of $ 722 is accounted for based on the cost
accounting method.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 28

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 6: |  | INVESTMENT
IN AN AFFILIATED COMPANY (Cont.)
|------- | - | -------------------------------------------

| | Summarized
combined financial information of surf for the year in which the investment was accounted
using the equity method was as follows:
| | --------------------------------------------------------------------------------------------------------------------------------------------

|                        | December 31,
2004
|----------------------- | -----------------
|
|
|
|
|Balance sheet items:    |                  
|                        |                  
|Current assets          |                  
|                        |                  
|                        |                  
|Non-current assets      |                  
|                        |                  
|                        |                  
|Current liabilities     |                  
|                        |                  
|                        |                  
|Non-current liabilities |                  
|                        |                  
|                        |                  
|Shareholders' equity    |                  
|                        |                  

|                                             | Year ended December 31,
|-------------------------------------------- | -----------------------
|
|
|
|
|Statement of operations items:               |                        
|                                             |                        
|Revenues                                     |                        
|                                             |                        
|                                             |                        
|Cost of sales                                |                        
|                                             |                        
|                                             |                        
|Operating expenses from continuing operation |                        
|                                             |                        
|                                             |                        
|Net loss                                     |                        
|                                             |                        

|NOTE 7: |  | INVESTMENT
IN OTHER COMPANIES
|------- | - | -----------------------------

| | The
Companys investments in companies comprise of:
| | ---------------------------------------------------

|                                                             | December 31,
2005
|------------------------------------------------------------ | -----------------
|
|
|
|
|Qualmax (see Note 1(b) - disposal of Communication Division) |                  
|                                                             |                  

F - 29

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 8: |  | PROPERTY
AND EQUIPMENT
|------- | - | ----------------------

|                                 | December 31,
|-------------------------------- | ------------
|
|
|
|
|Cost:                            |             
|Computers and software           |             
|Office furniture and equipment   |             
|Leasehold improvements and plant |             
|Vehicles                         |             
|                                 |             
|                                 |             
|                                 |             
|                                 |             
|Accumulated depreciation:        |             
|Computers and software           |             
|Office furniture and equipment   |             
|Leasehold improvements and plant |             
|Vehicles                         |             
|                                 |             
|                                 |             
|                                 |             
|                                 |             
|                                 |             
|Depreciated cost                 |             
|                                 |             

| | Depreciation
expenses amounted to $ 345, $ 300 and $ 307 for the years ended December 31,
2005, 2004 and 2003, respectively.
| | ----------------------------------------------------------------------------------------------------------------------------

|NOTE 9: |  | INTANGIBLE
ASSETS
|------- | - | -----------------

|                          | December 31,
|------------------------- | ------------
|
|
|
|
|Cost:                     |             
|Trade name                |             
|Core technology           |             
|Distribution network      |             
|Customer list             |             
|                          |             
|                          |             
|                          |             
|                          |             
|Accumulated amortization: |             
|Trade name                |             
|Core technology           |             
|Distribution network      |             
|Customer list             |             
|                          |             
|                          |             
|                          |             
|                          |             
|                          |             
|Amortized cost            |             
|                          |             

| | Amortization
expenses amounted to $ 236 and $ 50 for the years ended December 31, 2005 and
2004, respectively.
| | --------------------------------------------------------------------------------------------------------------

F - 30

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 9: |  | INTANGIBLE
ASSETS (Cont.)
|------- | - | -------------------------

| | Estimated
amortization expenses for the years ended:
| | ----------------------------------------------------

|          | December 31,
|--------- | ------------
|
|
|
|
|2006      |             
|2007      |             
|2008      |             
|2009      |             
|2010      |             
|2011-2014 |             

|NOTE 10: |  | GOODWILL
|-------- | - | --------

| | Goodwill
attributed to operating segments for the years ended December 31, 2005 and 2004 is as
follows:
| | -------------------------------------------------------------------------------------------------------

|                                        | Communication | Electronic
component | Total
|--------------------------------------- | ------------- | -------------------- | -----
|
|
|
|
|Balance as of January 1, 2004           |               |                      | $    
|                                        |               |                     
|Acquisition of Odem                     |               |                      |      
|Acquisition of Quasar                   |               |                      |      
|                                        |               |                      |      
|                                        |               |                     
|Balance as of December 31, 2004         |               |                      |      
|                                        |               |                     
|Foreign currency translation adjustment |               |                      |      
|Exercise of options in Odem             |               |                      |      
|Disposal of Communication Division      |               |                      |      
|                                        |               |                      |      
|                                        |               |                     
|Balance as of December 31, 2005         |               |                      | $    
|                                        |               |                      |      

|NOTE 11: |  | SHORT
TERM BANK LOANS
|-------- | - | ---------------------

|    | Weighted
interest
rate | December 31,
|--- | ---------------------- | ------------
|
|
|
|
|NIS |                        |             
|    |                        |             

| | Regarding
collateral given to insure short-term credit and loans see note 13c.
| | ------------------------------------------------------------------------------

F - 31

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 12: |  | ACCRUED
EXPENSES AND OTHER LIABILITIES
|-------- | - | --------------------------------------

|                                                     | December 31,
|---------------------------------------------------- | ------------
|
|
|
|
|Government of Israel - royalties and V.A.T           |             
|Provision for warranty                               |             
|Issuance cost related to accrued convertible note    |             
|Inventory purchase commitment liability              |             
|Accrued expenses on account of business combinations |             
|Other                                                |             
|                                                     |             
|                                                     |             
|                                                     |             
|                                                     |             

|NOTE 13: |  | LONG-TERM
BANK LOANS
|-------- | - | --------------------

| | a. | Classified
by linkage terms and interest rates, the total amount of the loans           is as
follows:
| | -- | ------------------------------------------------------------------------------------------------------

|                              | Weighted
interest
rate | December 31,
|----------------------------- | ---------------------- | ------------
|
|
|
|
|NIS linked to the Israeli CPI |                        |             
|NIS                           |                        |             
|                              |                        |             
|                              |                        |             
|                              |                        |             
|Less - current maturities     |                        |             
|                              |                        |             
|                              |                        |             
|                              |                        |             
|                              |                        |             

| | b. | The
loans mature in the following years after the balance sheet dates:
| | -- | ----------------------------------------------------------------------

|                                | December 31,
|------------------------------- | ------------
|
|
|
|
|First year (current maturities) |             
|Second year                     |             
|Third year                      |             
|Fourth year                     |             
|                                |             
|                                |             
|                                |             
|                                |             

| | c. | Odem
has registered fixed pledges on its real estate, plant and equipment and
          vehicles.
| | -- | -------------------------------------------------------------------------------------------------

F - 32

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 14: |  | LONG-TERM
CONVERTIBLE NOTE
|-------- | - | --------------------------

| | 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 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); and
(ii) a warrant to purchase 130,000 ordinary shares at an exercise price of $ 4.04 per
share (the Warrant). According to the agreement, several fees in the amount
of $ 115 were paid to the Investor. These fees are presented as discount of the principal
convertible loan. The Note is convertible into Ordinary shares at a price of $ 3.08 per
share. The principal amount of the Note is repayable in monthly installments, commencing
September, 2004, in the initial amount of $ 20 eventually increasing to $ 74. The Note
bears prime interest rate plus 3% which subject to reduction in certain conditions. The
Warrant is exercisable, in whole or in part, until June 10, 2011.Pursuant to its
undertaking in the Registration Rights Agreement with the Investor the Company filed with
the Securities and Exchange Commission a registration statement on Form F-3 covering the
resale of Ordinary Shares that are issuable upon conversion of the Note and/or exercise
of the Warrants, and/or issuable in payment of principal and interest on the Note. The
Registration Rights Agreement provided that any delay in registration and/or
effectiveness of the underlying shares of the transaction, or failure to maintain their
effectiveness, will result in penalties to be paid in cash, as liquidated damages. The
registration statement became effective on March 11, 2005. Due to the delay in the
effectiveness of the registration of the shares, the Company paid the Investor liquidated
damages of $92.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Note conversion price is subject to proportional adjustment in the event of stock splits,
combinations, subdivisions of the Ordinary shares or if dividend is paid on the Ordinary
shares in ordinary shares. In addition, if the Company issues stock in certain types of
transactions at a price lower than the initial conversion price, then the conversion
price will be adjusted to a lower price based on a weighted average formula.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
fair value of the warrants was calculated using the Black and Scholes Option Pricing
Model with the following assumptions: a risk-free interest rate of 3.34%, a dividend
yield of 0%, a volatility of the expected market price of the Companys Ordinary
shares of 100% and a weighted-average contractual life of 7 year. The fair value of the
warrants in the amount of $ 99 is presented as a component in shareholders equity.
Since the effective conversion price was grater than the share price at the commitment
date, no beneficial conversion feature exists.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
March 2005, the Investor elected to convert $ 308 of the Convertible note principal into
100,000 Ordinary shares of the Company. Due to the private placement agreement secured by
the Company in June 2005, the conversion price was adjusted to $2.94 per share, and in
July 2005, the Investor completed the conversion of the balance of the Convertible Note
principal, which had not been previously converted or repaid, and the accrued interest
into an additional 540,293 Ordinary shares for approximately $ 1,580.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 33

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 14: |  | LONG-TERM
CONVERTIBLE NOTE (Cont.)
|-------- | - | ----------------------------------

| | In
September 2005, the Company entered into a Second Securities Purchase Agreement (the
Purchase Agreement) with the Investor, under which the Company issued to the
Investor in a private placement (i) a Secured Convertible Term Note of a $ 1,500
principal amount, due September 2008 (the Note), and (ii) a warrant to
purchase 73,052 ordinary shares at an exercise price of $ 4.04 per share (the
Warrant). According to the agreement, several fees in the total amount of $ 116
were paid to the Investor. These fees are presented as a discount of the principal
convertible loan. The Note is convertible into Ordinary shares at a price of $ 3.08 per
share. The principal amount of the Note is repayable in monthly installments, commencing
as of January 2006, in the initial amount of $ 15 eventually increasing to $ 55. The Note
bears prime interest rate plus 1.5% which is subject to reduction under certain
conditions. The Warrant is exercisable, in whole or in part, until September 29, 2012.
Pursuant to its undertaking in the Registration Rights agreement with the Investor the
Company filed with the Securities and Exchange Commission a registration statement on
Form F-3 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. The Registration Rights agreement provided that any delay in
registration and/or effectiveness of the underlying shares of the transaction, or failure
to maintain their effectiveness, will result in penalties to be paid in cash, as
liquidated damages. The registration statement became effective on February 8, 2006.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
note conversion price is subject to proportional adjustment in the event of stock splits,
combinations, subdivisions of the Ordinary shares or if dividend is paid on the Ordinary
shares in Ordinary shares. In addition, if BOS issues stock in certain types of
transactions at a price lower than the initial conversion price, then the conversion
price will be adjusted to a lower price based on a weighted average formula.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
fair value of the warrants was calculated using the Black- Scholes Option Pricing Model
with the following assumptions: a risk-free interest rate of 4.08%, a dividend yield of
0%, a volatility of the expected market price of the Companys Ordinary shares of
100% and a weighted-average contractual life of seven years. The fair value of the
warrants in the amount of $ 144 is offset against the note, amortized over the
period of the note and presented as a component in shareholders equity.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The maturity of the loan is as
follows:

|                                | December 31,
2005 | December 31,
2004
|------------------------------- | ----------------- | -----------------
|
|
|
|
|First year (current maturities) |                   |                  
|Second year                     |                   |                  
|Third year                      |                   |                  
|                                |                   |                  
|                                |                   |                  
|                                |                   |                  
|Less - discount                 |                   |                  
|                                |                   |                  
|                                |                   |                  
|                                |                   |                  
|                                |                   |                  

F - 34

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 15: |  | COMMITMENTS
AND CONTINGENT LIABILITIES
|-------- | - | --------------------------------------

| | a. | Commitments:
| | -- | ------------

| | 1. | Royalty
commitments:
| | -- | --------------------

| | a) | 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.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2005, the Company has an outstanding contingent obligation to pay
royalties in the amount of approximately $ 3,500, in respect of these grants.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b) | 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, 2005, the Company has an outstanding contingent obligation to pay
royalties of $ 110 with respect to these grants.
| | -------------------------------------------------------------------------------------------------------------------------------------

| | 2. | Other
commitments:
| | -- | ------------------

| | The
facilities of the Company are rented under operating lease agreements that expire on
various dates ending in 2009. Minimum future rental payments for 2006 are $ 51, for
2007 $10, for 2008 $10 and for 2009 $6.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Companys motor vehicles are rented under various cancelable operating lease
agreements. The lease agreements for the motor vehicles expire on various dates ending in
2008. The maximum breach of contract fees can amounted to $ 74.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Lease
payments for the facilities occupied by the Company and the Companys motor vehicles
in 2005, 2004 and 2003 amounted to $ 408, $ 385 and $ 426, respectively.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 35

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 15: |  | COMMITMENTS
AND CONTINGENT LIABILITIES (Cont.)
|-------- | - | ----------------------------------------------

| | b. | (1) | In July 2002, the Company received a claim letter from a car leasing           vendor,
under which it claims that the Companys termination notice of the           leasing
agreement in March 2002 constitutes a breach of the agreement and the           vendor is
demanding compensation in which the nominal claim amount is of           $ 292. No
legal proceeding has yet been filed. At this stage, according to           the Companys
counsel assessment, the prospects of vendor to prevail and           recover a
significant amount, seem remote. The financial statements do not           include any
provision in that regard.
| | -- | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (2) | In
September 2003, a supplier filed a legal claim in the amount of $107 against
          the Companys subsidiary. The claim alleges the breach of an agreement for
          the purchase of products. The Companys legal counsel is unable to
          reasonably estimate the outcome of this claim. In addition, the Companys
          management believes that the chances of the claim are remote. Accordingly, no
          provision has been included in the financial statements in respect of this
          claim.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (3) | In
1998, as part of Pacinfo Share Purchase Agreement between the Company and           Mr.
Lee and Ms. Lee (the Seller), the Company may be obligated to           grant
the Sellers a loan on a full recourse basis for certain tax payments the
          Sellers may be liable for and reimburse the Sellers for certain interest on
          taxes that they may owe, currently estimated at approximately $ 2
millions.           The Company will receive a security interest in shares of the Company
that the           Sellers 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. It is possible that the windup of PacInfo during
2002 and           2003 may have triggered such a tax event for the Sellers, which would
result in           an obligation by the Company to lend the Sellers such amount and to
reimburse           them for interest expenses incidental to the tax event. Based on the
          Companys legal consul opinion and management estimation, no provision was
          recorded.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (4) | In
March 2006, BOSâNOVA EURL, a French company and former distributor of           the
Company, field against the Company and others a claim with the French           Tribunal.
The claim is on amount of 1.4 million Euros and it alleges breach of           exclusive
distributor rights in France. An initial hearing is scheduled to take           place in
France on June 29, 2006. This claim follows a previous motion for           temporary
injunctive relief that was field against the Companys new French
          distributor, said motion ultimately denied by French Trade Tribunal. The
Company           assesses the prospects of claim to prevail and recover a significant
amount, are           remote. The financial statements do not include any provision in
that regard.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|NOTE 16: |  | SHAREHOLDERS EQUITY
|-------- | - | --------------------

| | a. | Private
placement:
| | -- | ------------------

| | In
June 2005, the Company completed a private placement for the Companys Ordinary
shares. The Company issued to the investors 953,698 Ordinary Shares at a purchase price
of $ 2.30 per share, for a consideration of approximately $ 2,040 (net of $ 154
in issuance expenses).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 36

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 16: |  | SHAREHOLDERS EQUITY
(Cont.)
|-------- | - | ----------------------------

| | The
private placement included warrants of 572,219 for ordinary shares. The exercise price of
the warrants is $2.50 per ordinary share during the first year from their issue date, and
increasing to $2.75 per ordinary share and $3.03 per ordinary share, on the first and
second anniversaries of the issue date, respectively. The warrant is exercisable, in
whole or in part during a period of three years from issuance, of the warrants. Pursuant
to its undertaking in the Registration Rights Agreement, the Company filed with the
Securities and Exchange Commission a registration statement on Form F-3 covering the
Ordinary Shares (including those underlying the warrants). The registration statement
became effective with no delay on February 8, 2006.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Companys outstanding warrants to shareholders as of December 31, 2005 are as
follows:
| | ------------------------------------------------------------------------------------------

|Issuance date | Warrants for
Ordinary
shares | Exercise
price per
share | Warrants
exercisable | Exercisable
through
|------------- | ---------------------------- | ------------------------ | -------------------- | -------------------
|
|
|
|
|June 2005     |                              |                          |                      | 441,785            
|July 2005     |                              |                          |                      | 130,434            
|              |                              |                          |                      |                    
|              |                              |                         
|              |                              |                          |                      | 572,219            
|              |                              |                          |                      |                    
|              |                              |                          |                      |                    

| | (*) | The
exercise price of the warrants is $2.50 per ordinary share during the first
          year from their issue date, and increasing to $2.75 per ordinary share and
$3.03           per ordinary share, on the first and second anniversaries of the issue
date.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b | Stock
option plans:
| | - | -------------------

| | 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 above mentioned plans. 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, 2005 an aggregate 27,410 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
of up to four years. Options, that are cancelled or forfeited, become available for
future grants.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
June 2005 the Companys shareholders approved an increase of the number of Ordinary
shares reserved for issuance under the 2003 Israeli Stock Option Plan, to 1,000,000. The
additional shares shall be reserved after the registered share capital of the Company is
increased.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
November 18, 2004, upon acquisition of Odem, the Company granted 73,000 options to one of
Odems key employee. Each option can be exercised to purchase one ordinary share of
the Company without consideration. The options vest at the end of three years from the
grant date and expire ten years from the date of the grant. The market price of the
Companys shares on the date of grant was $ 2.5. Accordingly, the Company recorded
in the year ended December 31, 2005, a compensation expense of $ 62. This expense
was included as part of general and administrative expenses.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 37

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 16: |  | SHAREHOLDERS EQUITY
(Cont.)
|-------- | - | ----------------------------

| | Except
for these options, all other options granted to employees in 2005, 2004 and 2003, have an
exercise price equal to or higher than the market value of the Ordinary shares at the
date of grant. The weighted average fair values of the options granted during 2005, 2004
and 2003 were $ 2.13, $ 2.58 and $ 3.91, respectively.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

|                    | Year ended December 31,
|------------------- | -----------------------
|
|
|
|
|Options outstanding |                        
|at beginning of     |                        
|year                |                        
|Changes during the  |                        
|year:               |                        
|Granted             |                        
|Exercise            |                        
|Forfeited or        |                        
|cancelled           |                        
|                    |                        
|                    |                        
|Options outstanding |                        
|at end of year      |                        
|                    |                        
|                    |                        
|Options exercisable |                        
|at the end of the   |                        
|year                |                        
|                    |                        

| | The
options outstanding as of December 31, 2005, have been separated into ranges of exercise
price as follows:
| | --------------------------------------------------------------------------------------------------------------

|Range of
exercise
price | Options
outstanding
as of
December 31,
2005 | Weighted
average
exercise
price | Weighted
average
remaining
contractual
life (years) | Options
exercisable
as of
December 31,
2005 | Weighted
average
exercise
price of
options
exercisable
|----------------------- | ------------------------------------------- | ------------------------------- | --------------------------------------------------- | ------------------------------------------- | ------------------------------------------------------
|
|
|
|
|$            0          |                                             |                                 |                                                     | 73,000                                      |                                                       
|$ 1.84-2.00             |                                             |                                 |                                                     | 140,221                                     |                                                       
|$ 2.28-3                |                                             |                                 |                                                     | 113,000                                     |                                                       
|$          6.8          |                                             |                                 |                                                     | 31,241                                      |                                                       
|$ 17.00-18.00           |                                             |                                 |                                                     | 9,463                                       |                                                       
|$        28.00          |                                             |                                 |                                                     | 33,325                                      |                                                       
|                        |                                             |                                 |                                                     |                                             |                                                       
|                        |                                             |                                
|                        |                                             |                                 |                                                     | 400,250                                     |                                                       
|                        |                                             |                                 |                                                     |                                             |                                                       

| | c. | 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
Black-Scholes option pricing model with the following assumptions: risk-free interest
rate of 1.5%, dividend yields of 0% volatility of 70%, and an expected life of 2.5 years.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 38

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 16: |  | SHAREHOLDERS EQUITY
(Cont.)
|-------- | - | ----------------------------

| | The
compensation expenses that have been recorded in the consolidated financial statements
regarding these warrants for the years 2005, 2004 and 2003 were $ 348, $ 117
and $ 23, respectively.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Companys outstanding warrants to service providers as of December 31, 2005 are as
follows:
| | -----------------------------------------------------------------------------------------------

|Issuance date  | Warrants for
Ordinary
shares | Exercise
price per
share | Warrants
exercisable | Exercisable
through
|-------------- | ---------------------------- | ------------------------ | -------------------- | -------------------
|
|
|
|
|October 2002   |                              |                          |                      | 75,000             
|January 2004   |                              |                          |                      | 216,282            
|June 2004      |                              |                          |                      | 130,000            
|March 2005     |                              |                          |                      | 10,000             
|March 2005     |                              |                          |                      | 10,000             
|June 2005      |                              |                          |                      | 20,000             
|September 2005 |                              |                          |                      | 73,052             
|               |                              |                          |                      |                    
|               |                              |                         
|               |                              |                          |                      | 534,334            
|               |                              |                          |                      |                    

|NOTE 17: |  | TAXES
ON INCOME
|-------- | - | ---------------

| | a. | Reduction
in corporate tax rate:
| | -- | --------------------------------

| | On
June 2004, the Israeli Parliament approved an amendment to the Income Tax Ordinance (No.
140 and Temporary Provision) (the Amendment), which progressively reduces the
regular corporate tax rate from 36% to 35% in 2004, 34% in 2005, 32% in 2006 and to a
rate of 30% in 2007. The amendment was signed and published in July 2004 and is,
therefore, considered enacted in July 2004.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
July 25, 2005, the Knesset (Israeli Parliament) passed the Law for the Amendment of the
Income Tax Ordinance (No. 147), 2005, which prescribes, among others, a gradual decrease
in the corporate tax rate in Israel to the following tax rates: in 2006  31%, in
2007  29%, in 2008  27%, in 2009  26% and in 2010 and thereafter 25%.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Odem
and Quasar operations are subject to regular income tax rate while the Company and BOScom
enjoy the status of an Approved Enterprise, as described below.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | Tax
benefits under the Law for the Encouragement of Capital Investments, 1959           (the
Investment Law):
| | -- | ---------------------------------------------------------------------------------------------------------------

| | The
Companys production facilities have been granted an Approved Enterprisestatus
under the Investment Law, with respect to four separate investment programs. According to
the Investments Law, the Company has elected to receive for the first program
state-guaranteed loans and grants and 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.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 39

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 17: |  | TAXES
ON INCOME (Cont.)
|-------- | - | -----------------------

| | 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 and 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 investments are not subject to the 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 corporate tax rate as described in article a
above.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | BOScom
also has 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s investment programs, which commenced
operations in 1997 and 2002, is 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. Since there was no distribution of dividends with respect to the period ended on
December 31, 2005, the Company did not record a deferred tax liability.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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 as described in article (a)
above.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 40

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 17: |  | TAXES
ON INCOME (Cont.)
|-------- | - | -----------------------

| | On
April 1, 2005, an amendment to the Investment Law came into effect (the Amendment)
and has significantly changed the provisions of the Investment Law. The Amendment limits
the scope of enterprises which may be approved by the Investment Center by setting
criteria for the approval of a facility as an Approved Enterprise, such as provisions
generally requiring that at least 25% of the Approved Enterprises income will be
derived from export. Additionally, the Amendment enacted major changes in the manner in
which tax benefits are awarded under the Investment Law so that companies no longer
require Investment Center approval in order to qualify for tax benefits.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | However,
the Investment Law provides that terms and benefits included in any certificate of
approval already granted will remain subject to the provisions of the law as they were on
the date of such approval. Therefore the Israeli subsidiarys existing Approved
Enterprise will generally not be subject to the provisions of the Amendment. As a result
of the amendment, tax-exempt income generated under the provision of the new law will
subject the Company to taxes upon distribution or liquidation and the Company may be
required to record deferred tax liability with respect to such tax-exempt income. As of
December 31, 2005, the Company did not generate income subject to the provision of the
new law.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | Loss
carryforward:
| | -- | ------------------

| | Domestic
(Israel):
| | ------------------

| | The
Company and its Israeli subsidiary have accumulated losses for Israel income tax purposes
as of December 31, 2005, in the amount of approximately $ 21,600. 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, 2005, the U.S. subsidiaries which were classified as discontinued
operations had U.S. Federal and State net operating loss carryforward of approximately $ 10,264,
that can be carried forward and offset against taxable income and expire through 2022.
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, 2005, B.O.S. U.K. had net operating loss carryforward of approximately $ 3,500.
In February, 2006 B.O.S. U.K. the Company filed with the UK Companies House an
application to dissolve BOS U.K.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | d. | Deferred
income taxes:
| | -- | ----------------------

| | Deferred
income taxes reflect the net tax effect 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
liabilities and assets are as follows:
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 41

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 17: |  | TAXES
ON INCOME (Cont.)
|-------- | - | -----------------------

|                                                         | December 31,
|-------------------------------------------------------- | ------------
|
|
|
|
|Assets  in respect of:                                   |             
|                                                         |             
|Property, plant and equipment                            |             
|Allowances and provisions                                |             
|Net operating loss carry forward                         |             
|                                                         |             
|                                                         |             
|                                                         |             
|Liabilities in respect of intangible assets and goodwill |             
|                                                         |             
|                                                         |             
|Net deferred tax assets before valuation allowance       |             
|Valuation allowance (1)                                  |             
|                                                         |             
|                                                         |             
|Net deferred tax liability                               |             
|                                                         |             
|                                                         |             
|Presented in balance sheet:                              |             
|                                                         |             
|Current assets                                           |             
|Long-term assets                                         |             
|Current liabilities                                      |             
|Long-term liabilities                                    |             
|                                                         |             
|                                                         |             
|Net deferred tax liability                               |             
|                                                         |             
|                                                         |             
|Net deferred tax - domestic                              |             
|                                                         |             

| | (1) | The
Company has provided valuation allowances, for BOS, BOScom and Quasar in
          respect of deferred tax assets resulting from tax loss carryforward 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. | Income
(loss) before taxes on income:
| | -- | -------------------------------------

|         | Year ended December 31,
|-------- | -----------------------
|
|
|
|
|Domestic |                        
|Foreign  |                        
|         |                        
|         |                        
|Total    |                        
|         |                        

F - 42

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 17: |  | TAXES
ON INCOME (Cont.)
|-------- | - | -----------------------

| | f. | Effective
tax
| | -- | -------------

|                                                | Year ended December 31,
|----------------------------------------------- | -----------------------
|
|
|
|
|Loss before taxes on income, as reported in the |                        
|consolidated statements of operation            |                        
|                                                |                        
|                                                |                        
|Statutory tax rate                              |                        
|                                                |                        
|                                                |                        
|Provision at statutory tax rate                 |                        
|Non deductible expenses                         |                        
|Valuation allowance                             |                        
|                                                |                        
|                                                |                        
|Total tax expenses                              |                        
|                                                |                        

| | g. | Tax
assessments:
| | -- | ----------------

| | BOS,
BOScom and Odem have final assessments through the 2000 tax year.
| | ----------------------------------------------------------------------

|NOTE 18: |  | SUPPLEMENTARY
INFORMATION TO STATEMENTS OF OPERATIONS
|-------- | - | -----------------------------------------------------

| | a. | 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 14 a.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. During the fourth quarter of 2005, the Company reversed an additional amount of $84
related to a balance report received from the OCS in the fourth quarter of 2005.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |    |                                            | Year ended December 31,
| | -- | ------------------------------------------ | -----------------------
|
|
|
|
| | b. | Financial income (expenses), net:          |                        
| |    |                                            |                        
| |    | Financial income:                          |                        
| |    | Interest on bank deposits and marketable   |                        
| |    | securities                                 |                        
| |    | Other (mainly foreign currency translation |                        
| |    | income)                                    |                        
| |    |                                            |                        
| |    |                                            |                        
| |    |                                            |                        
| |    |                                            |                        
| |    | Financial expenses:                        |                        
| |    | In respect of long-term bank loans and     |                        
| |    | convertible note                           |                        
| |    | Other (mainly foreign currency translation |                        
| |    | losses)                                    |                        
| |    |                                            |                        
| |    |                                            |                        
| |    |                                            |                        
| |    |                                            |                        
| |    |                                            |                        
| |    |                                            |                        
| |    |                                            |                        

F - 43

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 18: |  | SUPPLEMENTARY
INFORMATION TO STATEMENTS OF OPERATIONS (Cont.)
|-------- | - | -------------------------------------------------------------

| | c. | Loss
per share:
| | -- | ---------------

| | 1. | Numerator:
| | -- | ----------

| |    |                                          |  |  |  
| | -- | ---------------------------------------- |  |  | -
|
|
|
|
| |    | Numerator for basic and diluted net loss |  |  |  
| |    | per share -                              |  | 
| |    | Net loss from continuing operations      |  |  | $
| |    |                                          |  |  |  
| |    |                                          |  | 
| |    | Net income (loss) from discontinued      |  | 
| |    | operation                                |  |  | $
| |    |                                          |  |  |  
| |    |                                          |  | 
| |    | Net loss available to Ordinary           |  | 
| |    | shareholders                             |  |  | $
| |    |                                          |  |  |  
| |    |                                          |  | 
| | 2. | Denominator (in thousands):              |  | 
| |    |                                          |  | 
| |    | Denominator for basic and diluted net    |  | 
| |    | loss per share -                         |  | 
| |    |                                          |  | 
| |    | Weighted average number of shares        |  |  |  
| |    |                                          |  |  |  

|NOTE 19: |  | SEGMENTS
AND GEOGRAPHICAL INFORMATION
|-------- | - | -------------------------------------

| | Commencing
in 2004 and subsequent to the acquisition of Odem and Quasar, the Company managed its
business on three reportable segments, which consisted of Connectivity solutions,
Communication solution and supply of Electronic Components.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Companys management makes financial decisions and allocates resources, based on the
information it receives from its internal management system. The Company allocates
resources and assesses performance for each operating segment using information about
revenues, gross profit and operating income (loss) before interest and taxes.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Segment
information for prior years was not presented on the new basis of segmentation since it
is impracticable to do so.
| | --------------------------------------------------------------------------------------------------------------------------

| | a. | Revenues,
gross profit and operating profit (loss) for operating segments for           the year
ended 2005 and 2004 were as follow:
| | -- | ------------------------------------------------------------------------------------------------------------------------------------

|                  | Year ended December 31, 2005
|----------------- | ----------------------------
|
|
|
|
|Revenues          |                             
|                  |                             
|Gross profit      |                             
|                  |                             
|Operating profit  |                             
|(loss)            |                             
|                  |                             
|Assets related to |                             
|segment           |                             

F - 44

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 19: |  | SEGMENTS
AND GEOGRAPHICAL INFORMATION (Cont.)
|-------- | - | ---------------------------------------------

|                  | Year ended December 31, 2004
|----------------- | ----------------------------
|
|
|
|
|Revenues          |                             
|                  |                             
|Gross profit      |                             
|                  |                             
|Operating profit  |                             
|(loss)            |                             
|                  |                             
|Assets related to |                             
|segment           |                             

| | * | In
December 2005 the Company has disposed of the Communication Division (see note 1(c)).
| | - | ----------------------------------------------------------------------------------------

| | b. | The
following presents total revenues and long-lived assets for the years ended
          December 31, 2005, 2004 and 2003 based on the customers location:
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------

|                  | Year ended December 31,
|----------------- | -----------------------
|
|
|
|
|United States     |                        
|Far East          |                        
|Europe            |                        
|Israel and others |                        
|                  |                        
|                  |                        
|                  |                        
|                  |                        

| | 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).
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | **) | Reclassified.
| | --- | -------------

| | c. | Major
customers data as a percentage of total revenues:
| | -- | --------------------------------------------------------

|           | Year ended December 31,
|---------- | -----------------------
|
|
|
|
|Customer A |                        
|           |                        
|           |                        
|Customer B |                        
|           |                        

| | Major
customers debt balances as of December 31, 2005 and 2004 are $ 1,433 and $ 603,
respectively.
| | ----------------------------------------------------------------------------------------------------

F - 45

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 20: |  | RELATED
PARTIES
|-------- | - | ---------------

| | a. | M&A
Addendum to the Services Agreement of Cukierman & Co.
| | -- | ---------------------------------------------------------

| | In
2003, the Companys audit committee and Board of Directors approved the engagement
of Cukierman & Co. Investment House Ltd., to provide non-exclusive investment-banking
services and business development services to the Company, effective April 15, 2003.
Cukierman & Co. is a company indirectly controlled by Mr. Edouard Cukierman. Since
June 26, 2003, serves as Chairman of the Companys Board of Directors, and he is
also a co-manager of the Catalyst Fund, the Companys largest shareholder. For its
services, Cukierman & Co. is paid a monthly sum of $10,000 plus VAT, 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. The agreement provided that the success fees for securing M&A transactions
shall be discussed and drafted as an Addendum to the Services Agreement. Such an Addendum
was approved on August 22, 2004, and it provides for a success fee of 3.5% of the
proceeds exchanged in such a transaction.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
payments the Company paid according to the Service Agreement are:
| | ---------------------------------------------------------------------

|                                                        | December 31,
|------------------------------------------------------- | ------------
|
|
|
|
|Business development                                    |             
|Success fee in respect of issuance of convertible loan, |             
|investment in Odem and private placements               |             
|                                                        |             
|                                                        |             
|                                                        |             
|                                                        |             

| | Current
liabilities in respect of related parties as of December 31, 2005 and 2004 were $ 23
and $ 234, respectively.
| | ---------------------------------------------------------------------------------------------------------------------

| | b. | Assignment
of Voting Rights to Mr. Yair Shamir
| | -- | ----------------------------------------------

| | On
February 5, 2004 the Audit Committee and Board of Directors approved an Assignment and
Assumption Agreement, between the Company, Catalyst Investments L.P, and Mr. Yair Shamir
(who was at the time director of the Company and the Chairman of Catalyst Investments),
according to which the voting rights in all but one of the Surf shares that the Company
has an option to purchase from Catalyst (see Note 6), have been assigned to Yair Shamir.
Pursuant to the agreement, Yair Shamir irrevocably undertook to assign the voting rights
to the Company immediately upon the earlier to occur of the following, and subject to the
receipt of a written request from the Company to effect such assignment: a) at the time
Surfs shares are offered to the public in a public offering pursuant to a
registration statement filed by Surf under the Securities Act of 1933 or a similar act of
another jurisdiction, or b) the Company exercises its option to purchase the additional
shares from Catalyst. In January 2006, the option to purchase from Catalyst shares in
Surf has expired.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 46

---

---

|B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES   
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except for share and share data)

|NOTE 21: |  | SUBSEQUENT
EVENT (UNAUDITED)
|-------- | - | ----------------------------

| | On
May 10, 2006 the Company received a written demand from IDEAL Software GmbH (IDEAL),
a German corporation, in which it claims that the Company owes IDEAL 1.13 million EUR for
license fees including interest. In 1999, the Company and IDEAL entered into a license
agreement according to which the Company was granted the right to distribute IDEALs
print engine embedded into the Companys PrintBOS product, and was to buy IDEALs
license for each installation for an agreed upon price. IDEAL claims that the number of
installations performed by the Company in its PrintBOS product during the period of 1999
thru 2005, exceeded the licenses bought by the Company. The parties agreed that Company
will cooperate with an Auditor appointed by IDEAL to check the number of licenses
distributed by the Company. Based upon the Auditors report rendered on May 1, 2006,
IDEAL sent the above-mentioned demand letter. The Company rejects IDEALs demand,
inter alia due to the fact that it is based on erroneous findings contained in the Auditors
report. On June 11, 2006 the Company filed with the Haifa District Court in Israel a
claim seeking, among other remedies, a declaratory judgment stating that the Auditors
report is materially flawed and should be disregarded. The Companys German counsel
is of the opinion that a German court, if and when IDEAL files a claim against the
Company in Germany pursuant to its demand, might very well summarily bar such a claim and
transfer the matter to the jurisdiction of an Israeli court or stay such a claim until a
verdict is handed down in the claim filed by the Company with the Haifa District
Court. However, if such a claim is ultimately tried in Germany, then German counsel is of
the opinion that there is a fair probability that the Company will be able to
successfully defend a portion of the claim, the size of which cannot yet be determined.
At this early stage the Company is not yet able to assess the final outcome of this
demand. The financial statements do not include any provision in respect of this claim.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 47

---

---