---

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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, 2006

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)

20 Freiman Street,
Rishon LeZion, 75100, Israel

(Address of
principal executive offices)

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

Securities registered or to be
registered pursuant to Section 12(g) of the Act: NONE

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



---

---

Indicate the number of outstanding
shares of each of the issuers classes of capital or common stock as of the close of
the period covered by the annual report: 6,744,798 Ordinary Shares, nominal value NIS
4.00 per share, as of December 31, 2006; and 8,492,213 Ordinary Shares, nominal value NIS
4.00 per share, as of April 30, 2007.

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                                                    | 28
|ITEM 5: OPERATING AND FINANCIAL REVIEW AND PROSPECTS                                  | 28
|ITEM 6: DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES                                    | 46
|ITEM 7: MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS                             | 57
|ITEM 8: FINANCIAL INFORMATION                                                         | 61
|ITEM 9: THE OFFER AND LISTING                                                         | 62
|ITEM 10: ADDITIONAL INFORMATION                                                       | 64
|ITEM 11: QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK                    | 79
|ITEM 12: DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES                       | 81
|PART II                                                                               | 81
|ITEM 13: DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES                              | 81
|ITEM 14: MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS | 81
|ITEM 15: CONTROLS AND PROCEDURES                                                      | 81

iii

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|                                                                                 |   
|-------------------------------------------------------------------------------- | --
|ITEM 16: [RESERVED]                                                              | 82
|ITEM 16A: AUDIT COMMITTEE FINANCIAL EXPERT                                       | 82
|ITEM 16B: CODE OF ETHICS                                                         | 82
|ITEM 16C: PRINCIPAL ACCOUNTANT FEES AND SERVICES                                 | 82
|ITEM 16D: EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES             | 83
|ITEM 16E: PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS | 83
|PART III                                                                         | 84
|ITEM 17: FINANCIAL STATEMENTS                                                    | 84
|ITEM 18: FINANCIAL STATEMENTS                                                    | 84
|ITEM 19: EXHIBITS                                                                | 84
|SIGNATURES                                                                       | 87

iv

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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, 2006, 2005 and 2004, and the  consolidated  balance sheet
data as of  December  31,  2006 and 2005,  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, 2003 and 2002,- and the  consolidated balance  sheet  data  as  of
 December  31,  2004,  2003  and  2002,  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, 2006,  2005, 2004, 2003
and 2002 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.

Following the sale of the
 Communications  segment,  the Company has accounted for the  Communications segment as a
discontinued operation.  As such, the results of operations,  including revenues, cost of
revenues,  operating expenses and other income and expenses related to the Communications
 segment for years 2005 and 2004,  have been  reclassified  in the  statements of
 operations  and balance sheet as discontinued operations.

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.



---

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

|                                                          | Year Ended December 31,
|--------------------------------------------------------- | -----------------------
|
|
|
|
|Revenues                                                  |                        
|Cost of revenues                                          |                        
|                                                          |                        
|Gross profit                                              |                        
|Operating expenses:                                       |                        
|Research and development, net                             |                        
|Sales and marketing                                       |                        
|General and administrative                                |                        
|Restructuring and related costs                           |                        
|                                                          |                        
|Total operating expenses                                  |                        
|                                                          |                        
|Operating income (loss):                                  |                        
|Financial income (expense), net                           |                        
|Other income (expenses), net                              |                        
|                                                          |                        
|Income (loss) before tax on income                        |                        
|Tax benefit (taxes on income)                             |                        
|Equity in losses of an affiliated company                 |                        
|Minority interest in earnings of a subsidiary             |                        
|                                                          |                        
|Loss from continuing operations                           |                        
|Net income (loss) related to discontinued operations      |                        
|                                                          |                        
|Net income (loss)                                         |                        
|                                                          |                        
|Basic and diluted net loss per share from continuing      |                        
|operations                                                |                        
|                                                          |                        
|Basic and diluted net income (loss) per share from        |                        
|discontinued operations                                   |                        
|                                                          |                        
|Basic and diluted net income (loss) per share             |                        
|                                                          |                        
|Weighted average number of shares used in computing basic |                        
|net earning (loss) per share                              |                        
|                                                          |                        
|Weighted average number of shares used in computing       |                        
|diluted net earning (loss) per share                      |                        
|                                                          |                        

- 2 -

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| |                                        | As of December 31,
| | -------------------------------------- | ------------------
|
|
|
|
| | Cash and Cash Equivalents              |                   
| |                                        |                   
| | Working Capital (*)                    |                   
| |                                        |                   
| | Total Assets                           |                   
| |                                        |                   
| | Short-term banks loan and current      |                   
| | maturities of long-term bank loans and |                   
| | convertible note                       |                   
| |                                        |                   
| | Long-term liabilities                  |                   
| |                                        |                   
| | Minority interest in a subsidiary      |                   
| |                                        |                   
| | Share Capital                          |                   
| |                                        |                   
| | Additional paid in Capital             |                   
| |                                        |                   
| | Shareholders' equity                   |                   
| |                                        |                   
| | (*)Working capital comprises of:       |                   
| |                                        |                   
| | Current assets                         |                   
| |                                        |                   
| | Less: current liabilities              |                   
| |                                        |                   
| |                                        |                   
| |                                        |                   
| |                                        |                   

|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. Our business, financial condition or results of operations could be
materially adversely affected by any of these risks. The risks described below are not the
only risks facing our company. Additional risks and uncertainties that we are not aware of
or that we currently believe are immaterial may also adversely affect our business,
financial condition, results of operation and liquidity. The trading price of our ordinary
shares could decline due to any of these risks, and you may lose all or part of your
investment.

- 3 -

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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.

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
incurred net losses of $3.6 million in 2005, $2.1 million in 2004 and $21,000 in 2003. As
of December 31, 2006, we had an accumulated deficit of $42.6 million. In 2006 we had net
income of $92,000 which was due to income from discontinued operation of $1.6 million .
Our ability to maintain and improve future levels of sales and profitability depends on
many factors, which 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.

- 4 -

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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 Electronic Technologies 1992 Ltd. (Odem), whose sales
accounted for 90% of our total sales in 2006, and 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, which could impede or
strategy of growth through mergers and acquisitions.

Continued
expansion by mergers and acquisitions requires additional financial resources and
especially working capital. If our efforts to raise capital do not succeed, our efforts to
increase our business may be seriously jeopardized.

A significant part of the
revenues of our wholly-owned subsidiary, Odem, is from one major customer, Israel Aircraft
Industries (IAI). Our business relationship with IAI involves the following
risks:

| |  | An interruption in our business relationship with IAI would materially
adversely impact our financial results.
| | - | --------------------------------------------------------------------------------------------------------------

Sales
to IAI accounted for 24% of our revenues in year 2006 and 11% in 2005. An interruption in
our business relationship with IAI 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 sales agreement with a fixed sales price with IAI, may
materially adversely impact our financial results.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

In
September 2004, Odem entered into a long term sales agreement with IAI for the supply of
electronic components for two models of business jets. The agreement provides for a fixed
sales price of the components during the term of the agreement through 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 IAI requires us to hold a large inventory, in order to meet
its short lead time and delivery requirements. If we are unable to
sell this inventory on a timely basis, we could incur charges for
excess and obsolete inventory, which would materially adversely
affect our results of operations.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Under
the agreement with IAI, we are obligated to hold inventory of products necessary for three
months of IAIs production of two models of business jets. 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.

- 5 -

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We may be unable to
maintain and continue developing marketing and distribution arrangements and expand our
reach into overseas markets.

Sales
outside Israel accounted for 29% of our total sales in 2006 and 44% in 2005. 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.In 2006 our sales to
the Far East declined to 9.6% of our total sales from 22% in 2005 and we have decided not
to focus on this market.

In December 2005, we 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., in consideration of common stock of
Qualmax Inc.

On
September 18, 2006, Qualmax announced that it had consummated the transfer of all of its
assets and liabilities to New World Brands, Inc. (New World), in exchange for
Series A Convertible Preferred Stock of New World convertible into common stock with
approximately 86% of the voting power of New World. The shares of common stock of New
World are quoted on the Over the Counter Bulletin Board. Immediately prior to the closing
of this transaction, New World sold all of its former business operations.

In
December, 2006, we closed a transaction with Qualmax and its subsidiaries, New World
Brands and IPGear, pursuant to which we converted approximately $1.5 million payable to us
by Qualmax and IPGear into 5.50652 shares of Series A Convertible Preferred Stock of New
World, which are convertible into approximately 16.5 million shares of New World Common
Stock, reflecting a conversion rate of $0.09 per one share of Common Stock. Conversion of
the Series A Preferred Stock into Common Stock was to take place automatically upon
effectiveness of an amendment to New Worlds certificate of incorporation authorizing
an increase in the number of outstanding shares of Common Stock. On April 27, 2007, New
World Brands announced the conversion of all of its outstanding Series A Convertible
Preferred Stock into shares of Common Stock.

In
connection with the transaction, we agreed to grant New World, contingent upon the
satisfaction of certain conditions, a three-year option to purchase up to 30% of the New
World shares held by us, at prices ranging from $0.12 to $0.24 per share of Common Stock.

In
addition, we agreed to enter into a lock up agreement, restricting the transfer of our
share holdings in Qualmax and in New World, for up to two years.

New
World has a limited operating history on which to judge whether or not this company will
be successful. If New World is not successful in its business or if New Worlds share
price is subject to a prolonged decline, we may lose the value of our investment, and be
required to record an impairment of the investment, which could materially adversely
affect our results of operation.

We have limited order
backlog. If revenue levels for any quarter fall below our expectations, our results of
operations 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 operations.

- 6 -

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---

The sales of our Software
Solutions segment in the United States 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 Software Solutions in the United States through one master distributor. In 2006 and
in 5 our sales of Software Solutions (connectivity products) in the US market accounted
for 7% and 11% of our total sales, respectively, and for approximately 21% and 25% of our
gross profit, respectively. 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.

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s 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 wind up
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.

Our acquisitions may not
always prove successful.

Over
the past years we have pursued the acquisition of businesses, products and technologies
and we intend to continue to search for additional growth through mergers and
acquisitions. However, our acquisitions have not always proven to be successful.
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 a significant part of our gross profit and if sales of these products decline,
it would have a material adverse effect on us.

Our
Software Solutions to the IBM midrange computer communications market contributed 28% of
our gross profit in 2006 and 39% of our gross profit in 2005. If sales of our Software
Solutions 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 our
Software Solutions segment.

- 7 -

---

---

We
have recently begun to expand our range of Software Solutions to include generic, platform
independent software that is no longer solely based on the IBM System i environment and
are also developing and introducing new remote data access communication products.
However, 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 Software
Solutions 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.
|- | ------------------------------------------------------------------------------------------------------------------------

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 in the
normal course of our business, may receive written demands for payments from prospective
plaintiffs,. 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 results 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.

- 8 -

---

---

We may be obligated to
indemnify our 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 attorneys 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 Israeli 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.

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.

- 9 -

---

---

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. A prolonged disruption in supply may force us to redesign and retest our
products.

One
of Odems major suppliers accounted for 12% of our purchases in the year 2006 and for
27% 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 software 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. 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 will not 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.

- 10 -

---

---

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

Our
Company, like other technology companies, has been significantly impacted by the 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.

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 US 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 short and long term bank loans and secured convertible notes in cash,we may not
have enough cash to fund our operations

Our
short and long term bank loans and secured convertible notes contain certain provisions
and restrictions, which if violated, could result in the full principal amounts together
with interest and other amounts becoming immediately due and payable in cash. If such an
event occurred, we might not have the cash resources to repay such indebtedness when due.
In connection with the issuance of the notes, 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
notes may limit our ability to obtain additional financing on favorable terms, or at all.

If
the notes are converted and/or the warrants that were issued with the notes are exercised,
or if we elect to pay principal and/or interest on the notes with our ordinary shares, 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 notes 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.

- 11 -

---

---

Our assets are subject to
security interests in favor of holders of our secured convertible notes.Our failure
to repay the secured convertible notes, if required, could result in legal action against
us, which could require the sale of all of our assets.

The
repayment of our convertible notes is secured by a first priority floating charge on all
of our companys assets, present and future as they may be changing from time to
time, and by a first priority fixed charge on all of our right, title and interest in our
wholly-owned subsidiaries, BOScom Ltd. and Quasar Telecom (2004) Ltd. If we are unable to
repay the secured notes when required, the holders of the notes could commence legal
action against us and foreclose on all of our assets to recover the amounts due. Any such
action would require us to curtail or cease operations.

# 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. In July 2006, Israel became involved in a
major military conflict with the Hizbullah organization in Lebanon, which subjected the
north of Israel to missile attacks. Certain of our facilities are located in the north of
Israel. Israels military operations required the drafting of
a substantial number of reserve soldiers. In addition, the future of the peace
process with the Palestinians is uncertain and has deteriorated due to Palestinian
violence, with the threat of a large-scale attack by Palestinians on Israeli civilians and
key infrastructure remaining a constant concern. 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.

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 our 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.

- 12 -

---

---

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 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 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 export. If BOScom fails to satisfy
such conditions in the future, BOScom could be disqualified from receiving the tax
benefits pursuant to the Approved Enterprise status.

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 BOScoms facilities and programs) would have an adverse effect on the
Companys business 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
is not required if the company that will not survive the merger 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 -

---

---

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 results in the purchaser becoming 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 possibly 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. From January 2005 through May 2007, 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.
| | - | ------------------------------------

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.

- 14 -

---

---

The Companys shares
may be delisted from the NASDAQ Global Market if it does not meet NASDAQs continued
listing 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 Global Market for failure to
meet NASDAQs minimum bid price and shareholders equity requirements ($10
million) for continued listing on the Global 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 Global Market pursuant to a detailed exception to
the NASDAQ Global 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
were subject to delisting from the NASDAQ Global Market for failure to meet NASDAQs
minimum market value of publicly held shares requirement ($5 million) for continued
listing on the Global Market. On November 4, 2004, we were notified by NASDAQ that we had
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 Global 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 Global 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 Global 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 Global Market.

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 Global Market listing, in which case we will
have the right to apply for a transfer of our ordinary shares to the NASDAQ Capital
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 and are subject to the Israeli Companies Law 1999  5759. We design, integrate
and test our products in our facilities in two locations in Israel.

Our executive offices and
engineering, development, testing, shipping and service operations are located in two
Israeli facilities: in Rishon Lezion and in Yoqneam.

Our telephone number is
972-3-954-1000 and our website address is www.boscorporate.com. Our subsidiary Odem
maintains a website showcasing our services in the field of RFID. The website address is
www.yourfid.com. The information contained on, or linked from, our website is not a part
of this report.

We currently manage our operations
through our two wholly-owned subsidiaries:

| |  | Odem
 Electronic  Technologies  1992 Ltd.  which is  engaged  in the  Supply-Chain  Solutions
         segment of our business.
| | - | -------------------------------------------------------------------------------------------------------------------------------

| |  | BOScom
Ltd. that is engaged in the Software Solutions segment of our business; and
| | - | ----------------------------------------------------------------------------------

On November 18, 2004, we purchased
63.8% of Odems issued and outstanding shares from Odems shareholders, in
consideration of $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 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, and converted a convertible loan in the amount of $1,042,000 into
          Preferred Shares in Surf. As a result of this private placement and conversion
          of the loan, the Company held 17% of Surf. In March 2003, the Company purchased
          from Catalyst Investments L.P. (Catalyst) most of the Surf shares
          held by Catalyst as a result of which Catalyst held 16.6% of the outstanding
          Company shares, after the issuance.

In September 2005, Surf executed a
private placement and in June 2006 the Company invested $300,000 in Surf as part of such
private placement, following which we held 7.8% of Surfs issued and outstanding
share capital.

- 16 -

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---

(b)    
          Qualmax Inc. (Pink Sheets: QMXI.PK) and its subsidiaries New World Brands (OTC:
          NWBD.OB) and IP Gear Ltd. Qualmax Inc., is an IT solutions provider focused on
          deployment of best-of breed VoIP, virtual private networks, turnkey network
          design, wireless connectivity and web. On December 31, 2005, we sold our
          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., a wholly owned subsidiary of Qualmax.

The consideration paid to the BOS 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 with the entire $800,000 due no
later than 90 days from the third anniversary of the closing of the transaction.
Additional shares were issuable 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 could 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 issued to BOS, on account of the
abovementioned commitment, 250,000 Earn Out Shares.

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 Qualmax shares and the shares underlying the Warrants. 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 provided IP Gear with
certain operating services relating to the sold Communications Segment, until December 31,
2006. In accordance with the Agreement, the first three months of services were provided
for no charge.

The Company also granted a bridge
loan to IP Gear in the amount of $1,000,000. The term of the loan was three years and it
bore interest equal to the Prime rate plus 2.5%, up to a maximum of 12%. In the first 18
months, IP Gear was to pay only the interest accrued on the loan and monthly principal and
interest payments were to commence thereafter. The loan granted to IP Gear was 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 was guaranteed
by Qualmax Inc.

The loan agreement provided 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 was to 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 June 2006, Qualmax issued to BOS
additional 174,825 shares, further reducing the principal amount of the loan, to $400,000.

In addition, the loan was to 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.

- 17 -

---

---

Our Qualmax holdings as of December
31, 2006, equal approximately 18.0% of Qualmaxs issued and outstanding Common Stock,
including 250,000 earn-out shares and 419,580 shares issued upon conversions during the
first half of 2006, of an aggregate of $600,000 of the bridge loan.

On September 18, 2006, Qualmax
announced that it had consummated the transfer of all of its assets and liabilities to New
World Brands, Inc. (New World, NWBD.OB) in exchange for Series A Convertible
Preferred Stock of New World convertible into common stock with approximately 86% of the
voting power of New World. The shares of common stock of New World are quoted on the Over
the Counter Bulletin Board. Immediately prior to the closing of the transaction, New World
sold all of its former business operations.

On January 10, 2007, we announced
that we closed a transaction with Qualmax and its subsidiaries, New World Brands and
IPGear, pursuant to which converted approximately $1.5 million payable to us by Qualmax
and IPGear into 5.50652 shares of Series A Convertible Preferred Stock of New World, which
are convertible into approximately 16,500,000 shares of New World Common Stock, reflecting
a conversion rate of $0.09 per one share of Common Stock. Conversion of the Series A
Preferred Stock into Common Stock was to take place automatically upon effectiveness of an
amendment to the New World Brands certificate of incorporation authorizing an
increase in the number of outstanding shares of common stock. Our registration rights with
respect to the Qualmax Shares shall be applied also towards our New World Shares. Our New
World holdings as of December 31, 2006 are approximately 4.2% of New Worlds issued
and outstanding share capital. On April 27, 2007, New World Brands announced the
conversion of all of its outstanding Series A Convertible Preferred Stock into shares of
Common Stock.

In connection with the transaction,
we agreed to grant New World, contingent upon the satisfaction of certain conditions, a
three-year option to purchase up to 30% of the New World shares held by us, at prices
ranging from $0.12 to $0.24 per share of Commons Stock.

In addition, we agreed to enter into
a lock up agreement, restricting the transfer of our share holdings in Qualmax and in New
World, for up to two years.

In November 2006, Mr. Shmuel Koren
was appointed to succeed Mr. Adiv Baruch as the Companys President and CEO. Mr.
Baruch continues to serve on the Companys Board of Directors.

In addition, we appointed Mr. Eyal
Cohen as our new Chief Financial Officer, effective January 2007 to replace Mr. Nehemia
Kaufman. Mr. Cohen previously served as our controller and prior to that held the position
of Chief Financial Officer at Cellact Ltd.

Also, in January 2007, the Company
appointed Mr. Yoav Brukner as its new Internal Auditor. Mr. Brukner, a certified public
accountant, is a partner with Brukner Ingber, CPA to replace Mr. Shmuel Rozenblum.

We have recently completed the
previously announced relocation of our headquarters to the city of Rishon Lezion, in the
center of Israel, and of our manufacturing and development facilities to the city of
Yoqneam, in the north of Israel.

In April 2007 the Company completed a
rights offering in which it raised gross proceeds of approximately $4.4 million. In the
rights offering, the Company offered its shareholders rights to purchase its ordinary
shares at a subscription price of $2.50 per ordinary share. The rights were traded for one
day on both the Nasdaq Global Market and the Tel-Aviv Stock Exchange. The offering ended
on April 16, 2007.1,739,398 ordinary shares were issued pursuant to the rights
offering.

- 18 -

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

The Company manages its business in
two reportable segments, which consist of Software Solutions and the Supply-Chain
Solutions. A third segment, Communication Solutions, existed until it was sold in the
fourth quarter of 2005.

(a)    Software
Solutions Segment.

The Software Solutions segment
focuses on developing and providing software solutions that are based on middleware
architecture, enabling enterprises to extend their business application capabilities to
the Web, Mobile and RFID environments.

The table below summarizes the
current offerings of our Software Solutions segment:

|Product name         | Technology
Environment | Target Market                                                    
|-------------------- | ---------------------- | -----------------------------------------------------------------
|
|
|
|
|BOSâNOVA-Mobile      | IBM System i           | Logistics, Out door employees using                              
|                     | and UNIX               | Terminals and Mobile devices                                     
|BOSâNOVA-WEB         | IBM System i           | Customers with branches and employees that are using Laptops     
|BOSâNOVA-Spooler     | IBM System i           | Customers conducting web facing projects using Websphere and     
|                     |                        | other web applications servers.                                  
|BOSâNOVA-LAN Spooler | IBM System i           | Customers with branches who need to control and manage their     
|                     | and Microsoft          | branches' printers.                                              
|BOSâNOVA-Secure      | IBM System i           | Customers who need to secure the TCP/IP LAN network              
|e-Twin@x             | IBM System i           | Customers who are implementing the TCP/IP on their System i and  
|                     |                        | want to keep the Twinax devices.                                 
|BOSâNOVAPlus         | IBM System i           | Customers who want to use their PC as a Twinax terminal.         
|                    
|Safe-T               | Generic                | Customers that need to transfer large and/or sensitive data files
|                     |                        | in a secured and managed way.                                    

BOSâNOVA Suite
Solution The Suite solution under
BOSâNOVA brand name enables customers to extend compatibility of IBM System i
Servers to other environments by implementing a variety of technologies such as Twinax to
TCP/IP, WEB and Mobile connectivity.

- 19 -

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BOSâNOVA Mobile 
Breaking the virtual office
boundaries and truly empowering the workforce with an I Series mobility solution.
BOSâNOVA Mobile improves branch (inter-) connectivity and overall business
continuity by combining the convenience of a mobile device (3.5G ready) with the stability
and strength of BOSâNOVA capabilities in the System i environment. We are currently
developing new version of our BOSâNOVA Mobile to support the Blackberry devices and
also intend to release a new version for the UNIX environment.

BOSâNOVA Web 
The System i Gate to the WEB is designed to connect external users to the Enterprises
System i via the web. BOSâNOVA Web extends connectivity to branches and external
users at exceptionally low usage and maintenance cost. BOSâNOVA Web provides
complete security and encryption capabilities while preserving and supporting all of
iSeries capabilities.

BOSâNOVA Spooler 
The System i spool printing solution
for WEB Application Servers. System ispooled files can be printed and
managed from any web environment workstation connected to the organizations server
through the internet. It is easily integrated with existing Web application servers such
as IBM WebSphere® and Microsoft IIS®. The BOSâNOVA Spooler has an
advanced, flexible mechanism for direction of Telnet Printer Sessions, tailored to the
needs of every organization. The server and users are managed easily and economically via
the browser-based BOSâNOVA Spooler Administrator Interface.

BOSâNOVA LAN
Spooler 
A reliable and cost-effective
Enterprise print solution for combined environments that is easy to deploy and offers
complete control of all print tasks in the network. A Scalable solution that offers
centralized configuration and management of multiple LAN spoolers in the corporate
network, transgressing locations & branches.

BOSâNOVA Secure 
The comprehensive solution for
encrypted System i emulation over TCP/IP networks. Secured TN5250 emulation capabilities
are delivered to any PC Workstation connected to a TCP/IP network, implementing SSL and
SSO (Single Sign ON by Kerberos). This security emulation is an evolution of the original
BOSâNOVA TCP/IP product.BOSâNOVA TCP/IP customers can implement the
SSL and SSO features by adding BOSâNOVA Secure to their existing BOSâNOVA
TCP/IP client(s).

e-Twin@X controller 
This product provides TCP/IP over
Twinax connection to local and remote System i, 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).

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

- 20 -

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---

# BOS Generic Solutions

Recently we have begun to expand our
range of software solutions to include generic, platform independent software that is no
longer solely based on the IBM System i environment in order to diversify our Software
segment offerings.

# Safe-T

Our Safe-T product, launched in May
2007 , delivers and manages secure File transfers for enterprise customers. Safe-T is a
server based solution that provides organizations a holistic approach to their file
transfer needs. Safe-T uses revolutionary compression technology that ensures fast
transmission of the data that is secured by encrypting the transmission channel or the
data itself. The recipient has no need for client software, eliminating the need for
costly support or maintenance.

Safe-T manages recipients and the way
they are authenticated and monitors and reports on all corporate file transfer activity
allowing accountability.

# Software RFID Server

We are currently developing an RFID
server, which will be a middleware between the Enterprise Application system and the RFID
equipments (Reader and Tags). This server will enable customers to integrate their RFID
environment directly with their ERP application and receive the RFID data in Bach mode or
in an on-line mode, depending on their business needs.

(b)    Supply-Chain
Solutions Segment

Our Supply-Chain Solutions segment,
provides, through Odem, solutions in RFID (Radio Frequency Identification Devices),
semiconductors, electronic components, CCD (Charge  Coupled Devices), imaging,
networking, telecom and automation. Odem is a major solution provider and distributor of
electronic components and advance technologies in the Israeli market.

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.

Below is a description of our
Supply-Chain product line.

|(b1) | 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 a research entitled RFID Forecasts, Players
& Opportunities 2007-2017", which was released on February 2007 by IDTechEX, a
knowledge based company specializing in providing independent marketing, technical and
business advice and services on RFID smart labels, the total RFID market value (including
all hardware, systems, integration etc.) across all countries is expected to reach $4.96
Billion in 2007. We believe 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.

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In 2004, our Supply-Chain division
started to provide products and solutions in the field of RFID and successfully
implemented an RFID solution in the Maccabia sports event. On January 10, 2007, we
announced that we had entered into an agreement with Environmental Solutions Europe
Holdings B.V. (ESE) for the supply of RFID tags for tagging garbage bins and
collection containers. ESE is a major provider of waste management services in Europe.

At the beginning of year 2007 we
launched a website, www.yourfid.com for our RFID customers.

|(b2) | Electronic
Components
|---- | ---------------------

We supply and distribute electronic
components to the electronic and technology industries in Israel and globally and
represent suppliers of components in five 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.In March 20,
          2007 we announced that Odems appointment as a non-exclusive sales
          representative of Sensata Technologies Inc. (previously Texas Instruments
          Sensors & Controls) was expanded to include the territories of Turkey,
          Greece and Asia.

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

5)    
          Supply-Chain  a complete components supply chain solution offered by Odem
          to its customers. This program accommodates the preference of hi-tech customers
          to work with a limited number of suppliers that will be able to provide a
          comprehensive solution to their needs, covering the entire range of components.

A significant part of the
revenues of Odem, is from one major customer, Israel Aircraft Industries
(IAI). Sales to IAI accounted for 24% of our revenues in the year 2006
and for 14% of our revenue in 2005. The vast majority of Odems sales to the IAI was
made pursuant to individual purchase orders. In May 9, 2007, we announced that Odem
received orders of about $1.5 million from IAI for a components supply chain program. An
interruption in our business relationship with the IAI would materially adversely impact
our financial results.

|(b3) | 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, storage equipment, ATM devices, and more.

- 22 -

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|(b4) | 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.

In 2006 and 2005, 90% and 84% of our
sales were attributable to sales of the Electronic Components Solutions segment.

# 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
Software solutions 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
(Supply-Chain solutions) markets its products and services in the United States through a
wholly owned company, Ruby-Tech, Inc., located in Sherbourn, Massachusetts.

In Europe, we market our Software
solutions 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 Software solutions largest
customer is a master distributor located in Phoenix, Arizona, and Supply-chain
solutions largest customer is located in Israel.

Our Companys sales fluctuate
seasonally, with the third quarter sales 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. Revenues of our subsidiary, Odem, fluctuate in as a result of changes in
the security conditions in Israel.

- 23 -

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

|                  | 2006 | % | 2005 | %      | 2004 | %
|----------------- | ---- | - | ---- | ------ | ---- | -
|
|
|
|
|United States     |      |   |      | 2,848  |      |  
|                  |      |  
|Europe            |      |   |      | 1,173  |      |  
|                  |      |  
|Far East          |      |   |      | 2,019  |      |  
|                  |      |  
|Israel and others |      |   |      | 14,877 |      |  
|                  |      |   |      |        |      |  
|Total Revenues    |      |   |      | 20,917 |      |  
|                  |      |   |      |        |      |  

# 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.

# 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.

- 24 -

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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 1.13 million for unpaid license fees. On June 11, 2006 the
Company filed with the Haifa District Court in Israel a claim against IDEAL. On January
10, 2007, we announced that we entered into a settlement of this dispute, pursuant to
which, on December 21, 2006, we paid IDEAL an amount of 110,000, and agreed to
withdraw the claim we filed against IDEAL.

# Competition

Software Solutions:

The Software Solutions 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.

Supply-Chain 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, causing a
substantial decrease in Odems sales to the Far East.

- 25 -

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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 45 overseas
suppliers, of which 30 are electronic components suppliers, 5 are suppliers of IT
equipment, 5 are suppliers of market image-processing products and 5 are suppliers of RFID
tags.

The electronic market is
characterized by multiple agents and distributors. Three local electronic component
competitors  Telsys Ltd., Nisco Projects Ltd. and STG International Electronics
(1981) Ltd., are publicly traded on the Tel Aviv stock exchange. Other large and
influential competitors, which are active in the electronic components and data market are
Eastronics Ltd., Arrow/Rapac Ltd., Avent Components Israel Ltd., Chayon Group Ltd., and
C.M.S. Compucenter Ltd. There is an increase in the number of distributors that are owned
by international companies.

In the international market,
Odems competitors are mainly Airtechnics, Inc., Flame enterprise Inc., Norstan
electronics Inc. and Peerless Electronics Inc. Our sales in the international market are
through middle channels and not directly to the customers.

In the RFID market our main
competitors are Moba mobile automation AG, Hewlett-Packard Company and Dymex Inc.

# Strategy

The Companys vision is to
become a leading provider of integrated RFID and Software Solutions for enterprises in the
western markets.

The Companys strategy is to
develop RFID and software applications and to build sales platform, which will enable us
to sell in the western markets. In order to achieve our vision and strategy, we may
acquire technologies and sales channels.

The key elements of our strategy are
as follows:

| |  | Continue
to expand our range of software solutions to include generic, platform independent
software that is no longer solely based on the IBM System i environment, in order to
diversify our Software Solutions segment offerings.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Increase
representations: we continuously search for additional manufacturers to represent through
our Supply-Chain Solutions division.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------

| |  | Expand
our marketing network: we intend to increase our marketing presence in the Western
markets, through the use of acquisitions, the engagement of additional independent
distributors and original equipment manufacturers as well as our own sales
representatives.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Acquisition
of RFID applications to be sold through our existing and future channels.
| | - | -------------------------------------------------------------------------------------

| |  | Acquisition
of companies or businesses that will increase our sales channels in Western markets.
| | - | ------------------------------------------------------------------------------------------------

- 26 -

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# Exchange Controls

See Item 10D.

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.;

(2)    
          Odem, which we purchased on November 18, 2004 from Odems previous
          shareholders, and in which, by November 2005, our holdings increased to 100%.
          Odem, an Israeli company, is a major solution provider and distributor of RFID
          and electronics components and advance technologies in the Israeli market; and

(3)    
          Quasar Telecom, which obtained the assets BOS acquired in September 2004 from
          Quasar Communication Systems Ltd. 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.

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., a Texan corporation; and

(3)    
          BOS Delaware Inc. a Delaware corporation.

In the U.S., only Ruby-Tech is still
operational.

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.

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. in which it has been investing since 1997, and in
Qualmax Inc. and its subsidiary New World Brands Inc. in which it has been invested since
December 2005.

- 27 -

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

Our executive offices and
engineering, development, testing, shipping and service operations are currently located
in two Israeli facilities (Rishon Lezion and Yoqneam), and occupy a total of approximately
1,719 square meters. BOS occupies 537 square meters in Rishon Lezion, pursuant to a lease
which expires in January 2012. 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 three years. BOScom
occupies a total of 390 square meters in Yoqneam, pursuant to leases that expire within
one to three years. The current monthly rental fee for these lease agreements amounts to
$9,134.

Our average monthly rental fee in
2006 and 2005 amounted to $10,000 and $16,000, respectively.

The facilities in Yoqneam are 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.

|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.

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 our 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.

- 28 -

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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 for the year
ended December 31, 2006. The following accounting policies had the most significant impact
on the Financial Statements for the year ended December 31, 2006.

# 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 for the year ended
December 31, 2006).

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 2006 and 2004, 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 2006.

# 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.

- 29 -

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---

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 definite 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 did not have any
impairment losses for the years ended December 31, 2006, 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.

# 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 for the year ended December 31, 2006). 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 Supply-Chain
products mainly through direct sales and the Software Solutions 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.

- 30 -

---

---

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. 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 a corresponding provision was
recorded in this respect. For additional information see Legal Proceedings. 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.

# Stock based compensation

On January 1, 2006, the Company
adopted Statement of Financial Accounting Standards No. 123 (revised 2004),
Share-Based Payment (SFAS 123(R)) which requires the measurement
and recognition of compensation expense based on estimated fair values for all share-based
payment awards made to employees and directors. SFAS 123(R) supersedes Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees
(APB 25), for periods beginning in fiscal 2006. In March 2005, the Securities
and Exchange Commission issued Staff Accounting Bulletin No. 107 (SAB 107)
relating to SFAS 123(R). The Company has applied the provisions of SAB 107 in its adoption
of SFAS 123(R).

SFAS 123(R) requires companies to
estimate the fair value of equity-based payment awards on the date of grant using an
option-pricing model. The value of the portion of the award that is ultimately expected to
vest is recognized as an expense over the requisite service periods in the Companys
consolidated income statement. Prior to the adoption of SFAS 123(R), the Company accounted
for equity-based awards to employees and directors using the intrinsic value method in
accordance with APB 25 as allowed under Statement of Financial Accounting Standards No.
123, Accounting for Stock-Based Compensation (SFAS 123).

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The Company adopted SFAS 123(R) using
the modified prospective transition method, which requires the application of the
accounting standard starting from January 1, 2006, the first day of the Companys
fiscal year 2006. Under that transition method, compensation cost recognized in the year
ended December 31, 2006, includes: (a) compensation cost for all share-based payments
granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair
value estimated in accordance with the original provisions of Statement 123, and (b)
compensation cost for all share-based payments granted subsequent to January 1, 2006,
based on the grant-date fair value estimated in accordance with the provisions of
Statement 123(R). Results for prior periods have not been restated.

The fair value for options granted in
the year 2006 was estimated on the date of grant using a Black-Scholes Option Pricing
Model, with the following weighted average assumptions:

|Risk free interest       |  |  |  | 4.91 | %
|------------------------ |  |  |  | ---- | -
|Dividend yield           |  |  |  | 0    | %
|Volatility               |  |  |  | 78   | %
|Expected term (in years) |  |  |  | 3    |  

# 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 permanently 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 non monetary assets as of March 31, 2005, prior to the change
became the accounting basis for those assets in the periods starting April 1, 2005.

# Discontinued operations

On December 31, 2005, we sold our
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., a wholly owned subsidiary of Qualmax.

The results of operations, including
revenues, cost of revenues, operating expenses, and other income and expenses of the
discontinued operations have been reclassified in the statements of operations as
discontinued operations. The Companys balance sheet reflects the net assets and
liabilities of the discontinued operations as assets and liabilities related to
discontinued operations.

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

# Comparison of 2006 and
2005

Revenues of 2006 were $20,917,000
compared to $24,099,000 in 2005. Revenues of the Supply-Chain segment decreased from
$20,203,000 in year 2005 to $18,859,000 in year 2006 as a result of our strategic decision
to move out of the Far East market due to increased competition. As a result, 2006
revenues to the Far East were reduced by $4,100,000 as compared to year 2005.

Revenues of Software solutions
segment decreased from $3,926,009 in year 2005 to $2,058,000 in year 2006 as a result of
continued weakness in the sales of BOSâNOVA Suite Solution to IBM System i
environment. We have begun to expand our range of software solutions to include generic,
platform independent software that is no longer solely based on the IBM System i
environment. Our first product, Safe-T, was launched in May 2007. In the coming months we
intend to expand our BOSâNOVA Mobile to support Blackberry devices and UNIX
environment, as well. In addition, 2005 revenues included revenues of $864,000 attributed
to non profitable product lines that were sold during that year. Excluding the effect of
the revenues attributed to the Far East and to the sold product lines, 2006 revenues
reflect a 10% increase over the revenues of 2005.

Gross profit for 2006 was $4,717,000
(gross margin of 23%) compared to $6,245,000 (gross margin of 26%) for 2005. The decrease
in gross margin results from a decrease in the revenues of the Software Solutions segment
which has a relatively high gross margin. Software Solutions revenues decreased from
$3,926,000 (gross margin of 62%) in year 2005 to $2,058,000 (gross margin of 65%) in 2006.
Our future gross margins may be lower than what we experienced during 2006 in case the
portion of the Software segment revenues as compared to the Supply-Chain revenues
continues to decrease.

Research and development expenses for
2006 were $486,000 compared to $893,000 for 2005. The decrease in research and development
expenses results from the sale of the Software Utilities product line during 2005, with
respect to which research and development expenses in 2005 were $378,000.

Selling and marketing expenses for
2006 were $2,019,000 compared to $2,425,000 in 2005. The decrease in selling and marketing
expenses results primarily from the sale of the Software Utilities product line during
2005, with respect to which selling and marketing expenses in the year 2005 were $226,000.

General and administrative expenses
for 2006 were $3,268,000 compared to $2,667,000 in the year 2005. General and
administrative expenses for 2006 includes shares based compensation cost in the amount of
$727,000 compared to $348,000 in 2005.

As a result of the above, operating
loss in year 2006 amounted to $1,056,000 compared to operating income of $260,000 in year
2005. Operating loss of the Software Solutions segment amounted to $35,000 in year 2006
compared to an operating profit of $235,000 in year 2005. Operating loss of the
Supply-Chain segment amounted to $64,000 in year 2006 compared to an operating profit of
$727,000 in year 2005

Financial expenses for 2006 were
$626,000 compared to $448,000 in 2005. The increase is attributed mainly to the sale of an
additional convertible note in principal amount of $1,500,000 to Laurus Master Fund Ltd.
(Laurus) in August 2006.

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Tax benefit in 2006 amounted to
$89,000 compared to taxes on income of $204,000 in 2005. The tax benefit and tax on income
are related to the taxable income of our subsidiary, Odem.

Equity losses of an affiliated
company in 2005, refers to our investment in Surf. In September 2005, Surf completed a
private placement that diluted the Companys holdings to 8.7% of Surfs issued
and outstanding share capital. 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 is accounted for based on the cost accounting method.

In June 2006, as part of an
investment round, the Company invested $300,000 in Surf, following which it holds 7.8% of
Surfs issued and outstanding share capital as of December 31, 2006.

Minority interest in earnings of a
subsidiary in 2005 refers to the Companys investment in Odem, which as of November
1, 2005, became a wholly-owned subsidiary of the Company.

Loss from continuing operations in
2006 amounted to $1,593,000 compared to a loss of $2,010,000 in 2005. On a per share
basis, the basic and diluted loss per share from continuing operations in 2006 was $0.24,
compared to $0.36 in 2005.

Income (loss) from discontinued
operations is attributed to the operational results of the Communication segment that was
sold in 2005. On a per share basis, the basic and diluted earning per share from
discontinuing operations in 2006 was $0.25, compared to loss $0.28 in 2005.

Basic and diluted net earning per
share in 2006 was $0.01, compared to net loss of $0.64 in 2005.

# Comparison of 2005 and
2004

Revenues for 2005 were $24,099,000
compared with $6,919,000 in 2004, a 248% increase, which is mainly due to the
consolidation, starting from November 18, 2004, of the results of operation of Odem
(related to the Supply-Chain segment).

The Supply-Chain segment accounted
for $20,253,000 (or 84% of our consolidated revenues) in 2005, out of which the sales to
the Far East accounted for $6,083,000 (or 25% of our consolidated revenues in 2005). In
the second half of 2005 we began to implement our strategic decision to move out of the
Far East market, and focus on expanding our presence in the Western markets. This resulted
in a decrease in the sales to the Far East, which was partially offset by growth in local
sales.

The Software Solutions segment
accounted for $3,926,000 (or 16% of our consolidated revenues) in 2005. These revenues
include $864,000 related to the Software Utilities product line product line that was sold
during 2005 and Thin Client product line that was closed at the beginning of 2005. Gross
profit in 2005 totaled $6,245,000 representing 26% of revenues, compared with $3,260,000,
constituting 47% 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 19% of revenues (see also Note 18 of the
Consolidated Financial Statements).

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Net research and development costs
in 2005 amounted to $893,000 compared to $669,000 in 2004. The increase was attributed
mainly to research and development costs in 2005, related mainly to our Software
Utilities product line.

Sales and marketing expenses
increased to $2,425,000 compared to $1,015,000 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 $2,667,000 in 2005 from $1,271,000 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 income in 2005 was $260,000 compared to an operating income of $305,000 in 2004.

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 13 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 $355,000 related mainly to the sale of the Software Utilities product
line during year 2005.

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 $2,010,000 compared to loss of $198,000 in
2004. On a per share basis, the net loss from the continuing operations in 2005 was $0.36
per share compared with a -$0.04 net loss per share in 2004. (For details regarding
computation of net loss per share, see Note 17b to the Consolidated Financial Statements).

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.

# 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.

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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.

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

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

In the years ended December 31, 2006,
2005, 2004, 2003, 2002 the inflation rate in Israel as adjusted for the devaluation of the
Israeli currency in relation to the Dollar was 8.1%, (4.5)% 2.8%, 5.7%, and (0.8)%,
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 4.225, NIS 4.44, NIS 4.603, NIS
4.308, NIS 4.379, and NIS 4.737, respectively. As a result, the Company experienced
increases in the Dollar costs of operations in Israel in2006, 2004, 2003 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 35%
for the year 2004, 34% for 2005, 31% for 2006, 29% for 2007, 27% for 2008, 26% for 2009
and 25% for year 2010 and thereafter.

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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 for the year ended December 31, 2006, and Tax Benefits under the Law for the
Encouragement of Capital Investments, 1959 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.

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 Research 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 Research 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.

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The Research 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
Research 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
$27,000 in 2006, $296,000 in 2005 and $492,000 in 2004.

As
of December 31, 2006, the Company has an outstanding contingent obligation to pay
royalties in respect of OCS grants, in the amount of approximately $3,430,000, compared to
$3,500,000 as of December 31, 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, 2006, the Company
has an outstanding contingent obligation to pay royalties of $89,000 with respect to these
grants, compared to $110,000 on December 31, 2005.

# 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 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.

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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
July 2006, Israel became involved in a major military conflict with the Hizbullah
organization in Lebanon, which subjected the north of Israel to missile attacks. Certain
of our facilities are located in the north of Israel near the City of Haifa. Israels
military operations required the drafting of a substantial number of reserve soldiers.

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.

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.

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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 equity financings, short and long-term loans, and income from
operating activities.

As of December 31, 2006, the
Companys long and short term credit, net of convertible note issuance expenses,
amounted to $5,259,000, of which $2,949,000 is credit from Israeli banks and the
convertible notes issued to Laurus accounts for the remainder. In March, 2007 we converted
$1,400,000 in short term bank loans into long term bank loans. There are no restrictions
on the use of the loans proceeds, but the Company is subject to certain limitations
related mainly to financial ratios.

As of December 31, 2006 we had
$2,033,000 in cash and cash equivalents.

Net cash used in operating activities
from continuing operations in 2006 was $1,953,000 compared to $2,257,000 in 2005.

During 2006, cash provided by
investing activities from continuing operations amounted to $631,000 as compared to
$610,000 in 2005. In both periods, the cash provided by investing activities results
mainly from redemption of marketable securities.

Net cash provided by financing
activities in 2006 amounted to $1,676,000, which relates mainly to proceeds from short
term bank credit and convertible notes. Net cash provided by financing activities amounted
to $4,159,000 in 2005, mainly as a result of the issuance of a Convertible Note and short
term bank loans in the net amount of $2,179,000 and proceeds from issuance of shares in
the amount of $2,090,000.

Working capital requirements will
vary from time-to-time and will depend on numerous factors, including but not limited to,
the operating results, scope of sales, supplier credit, the level of resources devoted to
research and development, new product introductions, and marketing and acquisition
activities.

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. As of
December 31, 2006, our average trade receivables and trade payables aging days
are 74 and 51 days, respectively. 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 proceedings.

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We believe that our cash resources
are sufficient to meet our operating needs for at least the next 12 months. In April 2007,
the Company completed a rights offering in which it raised gross proceeds of approximately
$4.4 million. In the rights offering, the Company offered its shareholders rights to
purchase its ordinary shares at a subscription price of $2.50 per ordinary share. It is
our intention to seek to raise additional equity and debt financings, to fund additional
product development, establish distribution channels in new markets and for new merger and
acquisition opportunities. There is, however, no assurance that we shall be able to obtain
such financing.

Laurus Convertible Note
Financings

On June 10, 2004 the Company entered
into a Securities Purchase Agreement with Laurus, under which the Company issued and sold
to Laurus in a private placement (i) a Secured Convertible Term Note of a $2 million
principal amount, due June 10, 2007 and (ii) a Warrant to purchase 130,000 Ordinary Shares
at an exercise price of $4.04 per share. 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, Laurus 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 Laurus
elected to convert $308,000 of the principal sum of the convertible note, Laurus was
issued 100,000 ordinary shares of the Company. On July 14, 2005, Laurus 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 Laurus 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 Laurus liquidated damages until
March 11, 2005, in the amount of $92,000.

- 41 -

---

---

On September 29, 2005, the Company
entered into a Second Securities Purchase Agreement with Laurus, under which the Company
issued to Laurus in a private placement (i) a Secured Convertible Term Note of a $1.5
million principal amount, due September 2008, and (ii) a Warrant to purchase 73,052
ordinary shares at an exercise price of $4.04 per share. The Note is convertible into
ordinary shares at a price of $3.08 per share. As a result of the price per share in the
rights offering described below (that was completed on April 16, 2007), the conversion
price of the convertible note was reduced to $2.97 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, Laurus 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 Laurus, 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.

On August 16, 2006 the Company
entered into and closed an additional financing transaction with Laurus. The financing
consisted of a $1.5 million Secured Convertible Term Note with a term of three years. In
addition, BOS granted to Laurus a Warrant to purchase up to 73,052 Ordinary Shares, which
is exercisable, in whole or in part, until August 16, 2013 at an exercise price of $4.04
per share for the first 24,351 Ordinary Shares acquirable thereunder, and of $5.30 per
share for the additional 48,701 acquirable thereunder.

The Note bears interest at a
fluctuating interest rate, which begins at the Prime rate plus 1.5%.

The conversion rate under the Note is
$3.08 per share for the first $500,000 of principal amount payable thereunder and $4.08
for any additional amount payable thereunder (subject to adjustment). As a result of the
price per share in the rights offering described below (that was completed on April 16,
2007), the $3.08 conversion rate was reduced to $2.97 and the $4.08 conversion rate was
reduced to $3.78. The principal amount of the Note is repayable in monthly installments
commencing as of December 1, 2006, and may be paid in cash or, subject to certain
conditions, in Ordinary Shares. Interest on the Note is payable monthly and may be paid in
cash or, subject to certain conditions, in Ordinary Shares. The Note is secured by a
security interest in certain assets of the Company. The proceeds from the private
placement were to be used for general working capital purposes and/or mergers and
acquisitions.

- 42 -

---

---

The Company also entered into a
Registration Rights agreement with Laurus pursuant to which the Company agreed to prepare
and file with the Securities and Exchange Commission a registration statement 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 December 5, 2006, and no penalties were incurred.

In the case of both the Note issued
in September 2005 and the Note issued in August 2005, the following provisions apply:

(a)    
          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;

(b)    
          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.; and

(c)    
          Conversion of the Note and exercise of the Warrants are limited such that 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 Laurus, 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 Laurus, provided that in
          no time shall Laurus beneficial ownership of ordinary shares exceed 19.9%
          of our ordinary shares. In addition, the number of ordinary shares issuable
          under the September 2005 Note, the August 2006 Note and the related Warrants
          shall not exceed an aggregate of 1,270,720 ordinary shares.

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.

- 43 -

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---

# Rights Offering

In April 2007 the Company completed a
rights offering in which it raised gross proceeds of approximately $4.4 million. In the
rights offering, the Company offered its shareholders rights to purchase its ordinary
shares at a subscription price of $2.50 per ordinary share. The rights were traded for one
day on both the Nasdaq Global Market and the Tel-Aviv Stock Exchange. The offering ended
on April 16, 2007.

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

We believe that our future growth will
depend upon our ability to enhance our existing products and introduce new products on a
timely basis. Since we commenced operations, we have conducted extensive research and
development activities.

Our research and development efforts
have been focused on Communication Solutions (until sold in December 2005) and on Software
Solutions. We intend to finance our research and development activities with our own
resources and through funds from the Office of Chief Scientist (OCS) of
Israels Ministry of Industry,Trade and Labor.

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

Commencing the second half of year
2003 we completed the transfer of sales and marketing activities of Software solutions
from our subsidiaries abroad to distributors and resellers. This trend is continuing with
respect to the Software segment by increasing the number of distributors and resellers in
order to deepen our penetration in existing markets such as the Western markets.

In the Software Solutions segment,
the trend of customer immigration from IBM iSeries to different systems has continued. In
response we continue to expand our range of software solutions to include generic,
platform independent software that is no longer solely based on the IBM System i
environment, in order to diversify our Software Solutions segment offerings. As we execute
our strategy to diversify of Software Solutions line of products, our research and
development expenses are expected to increase.

In the second half of year 2005 and
during the first half of year 2006, Odem faced a trend of decrease in its sales 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 in the
Far East.

Our gross margin in year 2006 was
lower than what we experienced during year 2005 as a result of a decrease in the
proportion of revenues generated by Software solutions that carried a gross margin of 65%,
to revenues of the Supply-Chain solution that carried gross margins of 18% in the year
2006.

- 44 -

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|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.

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, 2006 we had no write down of write off
of inventory that related to this agreement.

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

The following table of our material
contractual obligations as of December 31, 2006, summarizes the aggregate effect that
these obligations are expected to have on our cash flows in the periods indicated:

|                                | Payment due by period
|------------------------------- | ---------------------
|
|
|
|
|Long-term loans (1)             |                      
|                                |                      
|Accrued severance pay (2)       |                      
|                                |                      
|Other long term liabilities     |                      
|                                |                      
|Other liabilities reflected on  |                      
|our Balance Sheet (3)           |                      
|                                |                      
|Operating lease - cars          |                      
|                                |                      
|Purchase obligation for service |                      
|and inventory                   |                      
|                                |                      
|Facilities lease                |                      
|                                |                      
|Total                           |                      

- 45 -

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---

|(1) | Does
not include discount of $264,000 that related to the convertible note (see
                    note 13 of the Consolidated Financial Statements).
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | This
amount reflects our accrued severance pay liability. Out of this amount,
                    $741,000 has been previously funded by our contributions to employee
plans.                     During the first quarter of year 2007, $139,655 were paid to
employees. The time                     payment of the rest of accrued severance
liability in the amount of $776,345,                     cannot be predicted and, as a
result, this amount is presented in the more than                     5 years column.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | This
amount reflects the trade payables, employees and payroll accruals,
                    deferred revenues, accrued expenses and other liabilities presented
in our                     balance sheet.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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
|--- | -------------------------------

Set
forth below is information regarding our directors and senior management.

|Name                       | Age | Position                                       
|-------------------------- | --- | -----------------------------------------------
|
|
|
|
|Mr. Edouard Cukierman1     | 42  | Chairman of the Board of Directors             
|Mr. Shmuel Koren           | 37  | President and Chief Executive Officer          
|Mr. Eyal Cohen             | 38  | Chief Financial Officer                        
|Mr. Joel Adler             | 53  | Director                                       
|Mr. Avishai Gluck          | 35  | Director                                       
|Mr. Andrea Mandel-Mantello | 48  | Director                                       
|Mr. Ronen Zavlik           | 46  | Director                                       
|Mr. Jean-Marc Bally        | 36  | Director                                       
|Dr. Yael Ilan              | 58  | External Director                              
|Prof. Adi Raveh            | 59  | External Director                              
|Mr. Avidan Zelicovsky1     | 37  | Odem's CEO, Head of RFID & Supply-Chain Segment
|Mr. Shai Sadeh             | 53  | Senior VP, Software Solutions Segment          
|Ms. Sari Ellenberg         | 49  | VP, Resources                                  

Mr.
          Edouard Cukierman 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.

---

1          Mr.
Cukierman and Mr. Zelicovsky are first cousins. There are no other family
          relationships among the officers and directors.

- 46 -

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Mr.
          Shmuel Koren has been serving as the Companys President and CEO Since
          November 2006. From 1999 to 2006 Mr. Koren served as the Chief Financial
Officer           of Visonic Ltd. (LSE: VSC.L; TASE: VSC.TA). Prior to joining Visonic,
Mr. Koren           worked at Oren and Horowitz (an Israeli CPA firm), where he served
for five           years as a senior manager specializing in public companies and Israeli
IPOs. Mr.           Koren is a certified public accountant in Israel. He holds a B.A.
degree in           Business and Accounting from the Tel Aviv College of Business, an
International           M.B.A degree from the Herriot-Watt University Business School and
a Masters           degree in Law (LL.M.) from Bar Ilan University.

Mr.
          Eyal Cohen was appointed the Companys Chief Financial Officer on
          January, 2007. From 2004 through 2006 Mr. Cohen served as the Companys
          controller, and prior to that held the position of Chief Financial Officer at
          Cellact Ltd. From 1998 to 2001, Mr. Cohen was the controller of e-SIM Ltd.
          (NASDAQ:ESIMF) and in the years 1995-1997 held an audit manager position in
          PricewaterhouseCoopers. Mr. Cohen holds a B.A. in Accounting and Business
          Administration from the College of Management in Tel-Aviv and is a certified
          public accountant in Israel and in the United States, in the state of Maine.

Mr.
          Joel Adlerhas been a director since June 2005. Mr. Adler is a partner in
          Mishcon de Reya a leading law firm in 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 Mishcon de Reya as a partner in           2006,
from the London law firm of Speechly Bircham, where he was a partner from           1999.
Previously Mr. Adler was head of the corporate department of Rakisons (now           part
of US law firm Steptoe & Johnson). He gained his experience with other
          leading law firms in London Herbert Oppenheimer Nathan & Vandyck (now
Denton           Wilde Sapte) and DJ Freeman. 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 an LLM from
London           University. He was born and educated in Vienna.

Mr.
          Avishai Glück 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.

- 47 -

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---

Mr.
          Andrea Mandel-Mantello 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 securitizations, 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 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.

Mr.
          Jean-Marc Bally 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 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.

- 48 -

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Prof.
          Adi Raveh 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.
          Avidan Zelicovskyis the head of the Companys RFID & Electronic
          Division and the CEO of the Companys subsidiary, Odem Electronic
          Technologies 1992 Ltd., which he first joined in 1996, as a sales engineer. Mr.
          Zelicovsky holds a B.A. in Business Administration from the Tel Aviv College of
          Management and an LL.M. from the Ben-Gurion University.

Mr.
          Shai Sadeh 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 is studying towards an M.B.A at
the Hebrew           University in Jerusalem.

Ms.
          Sari Ellenberg joined the Company as VP Resources in February 2007. From
          March 2005 through February 2007, Mrs. Ellenberg held the position of the
          assistant to the CFO of Visonic Ltd. (LSE:VSC.L; VSC.T). Prior to joining
          Visonic, Mrs. Ellenberg worked for two years at Elbit Medical Imaging Ltd.
          (NasdaqGM: EMITF) where she held the position of Deputy Legal Counsel. Prior to
          joining Elbit, Mrs. Ellenberg was an attorney with the Israeli law firm of
          Efrati, Galili & Co. . Mrs. Ellenberg holds a B.A. in English Linguistics
          from the Tel-Aviv University, an LL.B. from the Tel-Aviv University School of
          Law, and an MBA from the Ono Academic College.

|6B. | Board
and Executive 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. 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 $6,325, and a
participation fee in meetings of approximately $328. On February 18, 2003 the shareholders
approved compensation for all directors who are not employees or
consultants1, including directors appointed in the future, at the same rate
the external directors of the Company are paid. 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.

---

|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).
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

- 49 -

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---

The
following tables present 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, 2006:

|                                                        | Salaries, Directors' fees, Service
fees, Commissions and Bonus | 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.

In
2005 and in 2006, we received CFO services from Mocha Global Managerial Services Ltd.,
with the services provided by Mr. Nehemia Kaufman. Commencing January 2007, these services
are no longer provided and the Company has appointed Mr. Eyal Cohen as its CFO. In 2005
and through October 31, 2006 we received managerial/CEO services from Signum Ltd., with
the services provided by Mr. Adiv Baruch. Mr. Baruch was replaced by Mr. Shmuel Koren on
November 1, 2006. On May 30, 2007, Mr. Baruch resigned from the Companys Board of
Directors. 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.

|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.

- 50 -

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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.

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.

- 51 -

---

---

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.

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.

- 52 -

---

---

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).

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, 2006, we employed 53 employees (including employees of our subsidiaries).
All of our employees are employed in Israel. Of the 53 employees, 16 employees are in
administration and finance, 18 employees in marketing and sales, 5 employees in research
and development, 3 employees in technical support, and 11 employees in manufacturing and
related activities. As of December 31, 2005, we employed 98 employees (the decrease in the
number of employees in 2006 compared to 2005, is mainly due to the sale of the
Communication segment in December 31, 2005). As of December 31, 2004, we employed 93
employees. We believe that our relations with our employees are satisfactory. We have not
experienced a collective labor dispute or a 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.

- 53 -

---

---

All
Israeli employers, 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 30, 2007, out of our directors and officers, then consisting of 14 persons, shares
held by our officers and directors are as follow:

|Name                   | Position | Shares | Options                                        
|---------------------- | -------- | ------ | -----------------------------------------------
|
|
|
|
|Mr. Edouard Cukierman2 |          |        | Chairman of the Board of Directors             
|Mr. Joel Adler3        |          |        | Director                                       
|Mr. Avidan Zelicovsky  |          |        | Odem's CEO, Head of RFID & Supply-Chain Segment

As
of May 30, 2007, we have granted our officers and directors options to acquire an
aggregate of 1,085,637 ordinary shares under our Stock Option Plans.3 The
average exercise price of these options is $2.404 per option. Of these options, none have
been exercised until now and 81,666 had vested as of May 30, 2007.

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. Due to following share fluctuation, 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 Global 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.

---

|2              Mr.
Edouard Cukierman held 21,666 ordinary shares directly and an additional           6,424
ordinary shares through a wholly owned company, E.D.I European Development           and
Investments Ltd.
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|3    
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. Does not include 85,000 options
          granted to Mocha Global Managerial Services Ltd., which in 2006 provided the
          Company with CFO services through Mr. Nehemia Kaufman.
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

- 54 -

---

---

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
May 18, 2006 the shareholders approved to grant Mr. Edouard Cukierman, the Chairman of the
Board of Directors, a bonus of 21,666 ordinary shares (for no consideration), and 233,876
options 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 Global 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.

In
May 2007 our Audit Committee and Board of Directors approved an Active Chairman Agreement
with Mr. Edouard Cukierman. Pursuant to this Agreement, in consideration for Mr.
Cukiermans services as the Companys Active Chairman, he shall receive a grant
of 400,000 options in four equal annual tranches. The Agreement is subject to shareholder
approval. The Options exercise price shall be equal to the weighted average of the
closing prices of the Companys Ordinary Shares on the Nasdaq Global Market, during a
thirty-day period preceding the date of approval of the Agreement by the Companys
shareholders.

# 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.

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.

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.

- 55 -

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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 April 30, 2007 we had 1,393,694 options outstanding under this plan (of which 226,474
are vested) with the exercise prices as set forth below:

|Exercise Price Per Share $ | Outstanding
|-------------------------- | -----------
|
|
|
|
|Less than $0.01            |            
|$                    1.84  |            
|$                    2.00  |            
|$                    2.28  |            
|$                  2.4795  |            
|$                    2.52  |            
|$                   2.554  |            
|$                    2.58  |            
|$                   2.631  |            
|$                    2.68  |            
|$                   2.695  |            
|$                    3.00  |            
|$                    3.08  |            
|Total                      |            

- 56 -

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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 April 30, 2007, we had
84,937 options outstanding under this plan, 75,000 at an exercise price of $4.00 per share
and 9,937 at an exercise price of $6.80 per share. All of the outstanding options had
vested as of April 30, 2007.

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 April 30, 2007,
we had 10,235 options outstanding under this plan at an exercise price of $28.00 per
share. All of the outstanding options had vested as of April 30, 2007.

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 April 30, 2007, there were no options outstanding
under this plan.

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. April 30, 2007, we had 600 options outstanding under this plan at
an exercise price of $18.00. All of the outstanding options had vested as of April 30,
2007.

|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 sets forth, as of
April 30, 2007, information to the best of the Companys knowledge, as to each person
known to the Company to be the beneficial owner of more than five percent (5%) of the
Companys outstanding Ordinary Shares. Except where indicated, to the best of the
Companys knowledge based on information provided by the owners, 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 8,492,213 shares outstanding as of April 30, 2007.

- 57 -

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The voting rights of our major
shareholders do not differ from the voting rights of other holders of our ordinary shares.

Catalyst Fund may be deemed to be a
Controlling Shareholder of the Company, as defined under the Israeli
Companies Law. Cukierman & Co. Investment House Ltd. may be deemed a controlling
person of Catalyst, and is (indirectly) controlled by Mr. Edouard Cukierman, the Companys
Chairman of the Board, and the Chief Executive Officer of the general managing partner of
Catalyst.

|                        | Shares Beneficially Owned
|----------------------- | -------------------------
|
|
|
|
|Catalyst Fund, LP(1)(2) |                          
|3 Daniel Frisch Street, |                          
|Tel-Aviv 64731, Israel  |                          
|                        |                          
|D.S Apex Holdings Ltd.  |                          
|2 Kaufman St.           |                          
|Tel-Aviv 68012 Israel   |                          

(1)    
          Catalyst Fund refers collectively to Catalyst Fund L.P., Catalyst
          Fund II L.P. and Catalyst Fund III, L.P., all of which are limited partnerships
          organized and existing under the laws of the State of Israel, and which share
          the same general partner, Catalyst Investments L.P. Mr. Edouard Cukierman may be
          deemed to have sole voting and dispositive power with respect to the shares held
          by Catalyst. Mr. Cukierman disclaims beneficial ownership in such shares, except
          to the extent of his proportionate interest in them as an indirect shareholder
          in the general partner of Catalyst Fund.

(2)    
          Does not include 207,000 warrants to purchase Ordinary Shares of the Company.

(3)    
          Refers to the holdings of D.S Apex Holdings Ltd. and its subsidiaries.

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, 2004 | December 31, 2005 | December 31, 2006 | April 30, 2007
|----------------------- | ----------------- | ----------------- | ----------------- | --------------
|
|
|
|
|Catalyst Fund, LP       |                   |                   |                   | 947,275       
|                        |                   |                  
|Jacob and Sara Neuhof   |                   |                   |                   | 217,532       
|                        |                   |                  
|Touareg Consulting Ltd. |                   |                   |                   |               
|                        |                   |                  
|D.S Apex Holdings Ltd.  |                   |                   |                   |               

- 58 -

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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 April 30, 2007, there were 37
record holders of ordinary shares, of which 9 were registered with addresses in the United
States, representing approximately 41.2% 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
|--- | --------------------------

# Grant of Shares and
Options and to Mr. Cukierman

The shareholders approved on August
5, 2004, that Edouard Cukierman, Chairman of the Board, will be granted 7,500 options at
an exercise price of $1.84 under the same terms as all other first time directors (See
Share Ownership). The shareholders also approved, on June 29, 2005, to grant
all directors of the Company, an additional 7,500 options to purchase ordinary shares of
the Company on the third anniversary of their service as directors. Following this
decision Edouard Cukierman was granted 7,500 options at an exercise price of $2.695 (See
Share Ownership).

On May 18, 2006 the shareholders
approved a grant to Mr. Edouard Cukierman of 21,666 ordinary shares (for no
consideration), and 233,876 options to purchase ordinary shares of the Company, pursuant
to the Companys 2003 Israeli Share Option Plan, at an exercise price of $2.68. The
options exercise price was equal to the average closing price of the Companys
shares on the Nasdaq Global Market on the 20 trading days preceding the shareholders
meeting date at which the grant was approved (the Grant Date). The options
vest in three equal parts on the first, second and third anniversary of the Grant Date,
and expire from May 2010 through May 2012 (see Share Ownership).

In May 2007 our Audit Committee and
Board of Directors approved an Active Chairman Agreement with Mr. Edouard Cukierman.
Pursuant to this Agreement, in consideration for Mr. Cukiermans services as the
Companys Active Chairman, he shall receive a grant of 400,000 options in four equal
annual tranches. The Agreement is subject to shareholder approval. The Options
exercise price shall be equal to the weighted average of the closing prices of the
Companys Ordinary Shares on the Nasdaq Global Market, during a thirty-day period
preceding the date of approval of the Agreement by the Companys shareholders.

In 2003, the Companys audit
committee and Board 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, he serves as Chairman of
the Companys Board, 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 Service 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.

- 59 -

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---

The payments the Company paid
pursuant to the Service Agreement in year 2006 are:

|Business development                                                                    |  |  | $ | 120 | 
|--------------------------------------------------------------------------------------- |  |  | - | --- | 
|Success fee in respect of issuance of convertible loan,  investment in Odem and private |  | 
|placements                                                                              |  |  |   | 75  | 
|                                                                                        |  | 
|                                                                                        |  | 
|                                                                                        |  |  | $ | 195 | 
|                                                                                        |  | 

# Management Agreement
with Signum Ltd.

The Companys audit committee,
Board of Directors and shareholders have approved an agreement with Signum Ltd. to provide
management services to the Company (exclusively through Adiv Baruch who served in the
capacity of President and Chief Executive Officer of the Company), effective January 1,
2004. Mr. Adiv Baruch is one of the controlling shareholders of Signum.

Signum was entitled to a monthly
gross management fee of NIS 79,698, (approximately $18,000) plus Value Added Tax, based on
a NIS  US Dollar exchange rate of NIS 4.4 to 1 US Dollar, that shall be adjusted at
the beginning of every calendar quarter in accordance with the NIS  US Dollar
exchange rate on the last day of the previous quarter.

Additionally, Signum was granted
options to purchase 216,282 ordinary shares of the Company (equal to five percent (5%) of
the Companys issued and outstanding share capital, on a fully diluted and as
converted basis, on November 23, 2003). The options vest and become exercisable in 36
equal monthly installments (fractions shall be rounded up) at the end of each month
following the date of grant and shall be exercisable at any time during a period of ten
years from the date of adoption of the Companys stock option plan (i.e. until
22.5.2013). The exercise price is $3 per ordinary share. Notwithstanding the foregoing,
all options shall immediately vest and become exercisable upon (a) the occurrence of a
merger, reorganization, or sale of the Company or a sale all or substantially all of the
Companys shares or assets or (b) upon the termination by the Company of the
management agreement other than for Cause (as defined in the agreement), provided however
that no such immediate vesting shall occur in the event of termination due to failure of
Adiv Baruch to reach annual goals set by the Companys Board of Directors.

Furthermore, pursuant to the
agreement, Signum had pro rata preemptive rights (taking into account all of the ordinary
shares as if the options had vested and Signum had exercised all such options) with regard
to future issuance of securities of the Company, under certain terms and conditions.

- 60 -

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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, as a bonus for year 2004, at an exercise price
of $3.08 per share, vesting over 24 months from the date of grant in 24 equal parts, 1/24
per month, exercisable until June 2010.

On May 18, 2006, the shareholders
approved (i) the grant to Mr. Adiv Baruch of 65,000 ordinary shares (for no consideration)
and (ii) the grant to Signum of options to purchase 187,100 ordinary shares of the
Company, pursuant to the Companys 2003 Israeli Share Option Plan, at an exercise
price of $2.68. The options exercise price was equal to the average closing price of
the Companys shares on the Nasdaq Global Market on the 20 trading days preceding the
shareholders meeting date at which the grant was approved (the Grant
Date).

On September 27, 2006, Mr. Baruch
notified the Board that he shall be leaving the Company at the end of 2006 at which time
the Management Agreement expired. The abovementioned options granted to Signum expired as
well. On May 30, 2007 Mr. Baruch resigned from the Company's Board of Directors.

# 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 Companies Law.

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

Not applicable.

|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
| | ---- | --------------- | -----------------
|
|
|
|
| | 2006 |                 |                  
| |      |                 |                  
| | 2005 |                 |                  
| |      |                 |                  
| | 2004 |                 |                  

- 61 -

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Legal Proceedings

In March 2005, 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. 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 assesses the prospect of
the claimant to prevail and recover a significant amount as remote. The Companys
financial statements include a provision in this respect.

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 it for unpaid license fees. On June 11, 2006 the
Company filed with the Haifa District Court in Israel a claim against IDEAL. Recently, we
announced that we entered into a settlement of this dispute with IDEAL, pursuant to which,
on December 21, 2006, we paid IDEAL an amount of 110,000 Euros, and we agreed to withdraw
the claim we filed in Israel.

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, and quoted on what is now called the NASDAQ
Capital Market under the symbol BOSC and BOSCW, respectively. In
September 2000, our shares started to be traded on what is now called the NASDAQ Global
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.

In April 2007 we concluded a rights
offering in which we raised gross proceeds of approximately $4.4 million. The rights were
traded for one day, April 12, 2007, on both the Nasdaq Global Market and the Tel-Aviv
Stock Exchange.

Exemption from Nasdaq Marketplace
Rules Nasdaq Marketplace Rule 4350(a)(1) allows foreign private issuers an exemption
from certain Nasdaq requirements, if the foreign private issuer follows home country
practice.

- 62 -

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Under the Israeli Companies Law 1999,
there is no requirement to send shareholders of a public company a copy of the
Companys annual financial statements. The Companys annual financial statements
are available through to the Companys public filings both in the United States and
in Israel. In reliance on this home country practice, the Company does not distribute it
annual financial statements to its shareholder by mail.

In addition, under the Israeli
Companies Law 1999 the Company was not required to seek shareholder approval for the
rights offering. The Company has relied on this home country practice for an exemption
from Nasdaq Marketplace Rule 4350(i)(1).

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

|Period |  | NASDAQ | TASE                
|------ |  | ------ | --------------------
|
|
|
|
|2002   |  |        | Annual              
|2003   |  |        | Annual              
|2004   |  |        | Annual              
|2005   |  |        | Annual              
|       |  |        | First Quarter       
|       |  |        | Second Quarter      
|       |  |        | Third Quarter       
|       |  |        | Fourth Quarter      
|       |  |       
|2006   |  |        | Annual              
|       |  |        | First Quarter       
|       |  |        | Second Quarter      
|       |  |        | Third Quarter       
|       |  |        | Fourth Quarter      
|       |  |        | December            
|       |  |       
|2007   |  |        | January             
|       |  |        | February            
|       |  |        | March               
|       |  |        | April               
|       |  |        | May (until May 31st)

|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.

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|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 then, certain
articles of the Article of Association have been amended.

Set forth below is a summary of
certain provisions of our Memorandum and Articles of Association. This summary is not
complete and should be read together with our Memorandum and Articles of Association,
previously filed.

|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.

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

The Board of Directors may issue
shares and other securities, which are convertible or exercisable into shares, up to the
limit of the Companys authorized share capital.

(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.

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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.

(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.

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

(a)    
          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). Such voting rights may
be affected in the future by the grant of any special voting rights to the holders of a
class of shares with preferential rights. 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).

(c)    
          Election of Directors.

The Companys directors are
elected by the shareholders at a shareholders meeting. The Ordinary Shares do not
have cumulative voting rights in the election of directors. The holders of Ordinary Shares
conferring more than 50% of the voting power present by person or by proxy at the
shareholders meeting, have the power to elect the directors. The directors elected
shall hold office until the next annual meeting, or sooner if they cease to hold office
pursuant to the provisions of the Companys Articles. In addition, the Board of
Directors may appoint a director (to fill a vacancy or otherwise) between shareholder
meetings, and such appointment shall be valid until the next annual meeting or until such
appointee ceases to hold office pursuant to the provisions of the Companys Articles.
In compliance with the Companies Law, the Company has two external directors. The external
directors are also appointed by the shareholders and their term of office is three years.
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.

- 66 -

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(d)     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).

(e)     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).

(f)     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).

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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).

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 33?%
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.

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|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.

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.

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|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
previously 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.

At this time, due to the removal of
the restrictions, 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. 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.

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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.

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, subject
to certain limitations, up to ten taxable years. 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.

- 71 -

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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.

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.

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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.

# 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.

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.

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# 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).

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
listed securities, unless such companies were not subject to the Adjustments Law (or
certain regulations under Section 130A of the Tax Ordinance) 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.

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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.

# 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.

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# 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.

# 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.

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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 2006. 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.

# 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.

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|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.

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

For information relating to the
Companys subsidiaries, see Item 4.C  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 balance of monetary assets in
comparison to liabilities in non-dollar currencies in the Balance Sheet as of December 31,
2006 and December 31, 2005 (Balance Sheet Exposure) is presented in the table
below.

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The data is presented in US Dollars
(in thousands):

|                                                                     | December 31, 2006 | December 31, 2005
|-------------------------------------------------------------------- | ----------------- | -----------------
|
|
|
|
|Current assets:                                                      |                   |                  
|Cash and cash equivalents                                            |                   |                  
|Trade receivables                                                    |                   |                  
|Other accounts receivable                                            |                   |                  
|                                                                     |                   |                  
|                                                                     |                   |                  
|                                                                     |                   |                  
|Long term assets                                                     |                   |                  
|                                                                     |                   |                  
|Total assets                                                         |                   |                  
|                                                                     |                   |                  
|                                                                     |                   |                  
|Current liabilities:                                                 |                   |                  
|Short term loans from banks andcurrent maturities of long term loans |                   |                  
|Trade payables                                                       |                   |                  
|Other accounts payable                                               |                   |                  
|                                                                     |                   |                  
|                                                                     |                   |                  
|                                                                     |                   |                  
|                                                                     |                   |                  
|                                                                     |                   |                  
|Long term liabilities                                                |                   |                  
|                                                                     |                   |                  
|Total liabilities                                                    |                   |                  
|                                                                     |                   |                  
|Net assets (liabilities)                                             |                   |                  
|                                                                     |                   |                  

| | (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.

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 Israel, the United States, the
Far East 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.

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 account
receivables balance by geographical market as of December 31, 2006 and December 31, 2005:

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

- 80 -

---

---

# 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 three banks, which are among the five largest in Israel.

|Item 12: | Description
of Securities Other than Equity Securities.
|-------- | -------------------------------------------------------

Not applicable.

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.

This Annual Report does not include
an attestation report of our registered public accounting firm regarding internal control
over financial reporting. Managements report was not subject to attestation by our
registered public accounting firm pursuant to temporary rules of the Securities and
Exchange Commission that permit us to provide only managements report in this Annual
Report.

- 81 -

---

---

(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, 2006, 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]
|-------- | ----------

|Item16A: | 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.

|Item 16C: | Principal
Accountant Fees and Services
|--------- | --------------------------------------

The Companys principal
accountants for the years 2005 and 2006 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 2005 and 2006:

|                       | Year Ended December 31, 2006 | Year Ended December 31, 2005
|---------------------- | ---------------------------- | ----------------------------
|
|
|
|
|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.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

- 82 -

---

---

|(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 2006.

- 83 -

---

---

# 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       
|-------------------------------------------- | -----------
|
|
|
|
|Reports of Independent Auditors              | F-2 - F-3  
|Consolidated Balance Sheets                  | F-4 - F-5  
|Consolidated Statements of Operations        | F-6        
|Statement of Changes in Shareholders' Equity | F-7 - F-8  
|Consolidated Statements of Cash Flows        | F-9 - F-10 
|Notes to Consolidated Financial Statements   | F-11 - F-50

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 2, 2007, except for
a correction of certain typographical errors.

|Item 19: | Exhibits
|-------- | --------

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

|1.1 |  | Memorandum
of Association, as amended (incorporated by reference to Exhibit 1.1 of the Companys
Annual Report on Form 20-F filed with the SEC on June 28, 2006).
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

|1.2 |  | Articles
of Association, as amended (incorporated by reference to Exhibit 1.2 of the Companys
Annual Report on Form 20-F filed with the SEC on June 28, 2006).
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.1 |  | Form
of Indemnification Agreement between the Company and its officers and directors, as
amended (incorporated by reference to Exhibit 4.1 of the Companys Annual Report on
Form 20-F filed with the SEC on June 28, 2006).
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|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 |  | 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).
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

- 84 -

---

---

|4.6 |  | Securities
Purchase Agreement and Master Security Agreement, dated as of September 29, 2005, by and
between Laurus Master Fund Ltd. and the Registrant (incorporated by reference to Exhibit
4.1 of the Companys Annual Report on Form 20-F filed with the SEC on June 28, 2006;
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).
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.7 |  | Securities
Purchase Agreement and Master Security Agreement, dated as of August 16, 2006, 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. 333-137153)
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|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 (incorporated by reference to Exhibit 4.1 of the Companys
Annual Report on Form 20-F filed with the SEC on June 28, 2006).
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.12 |  | 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).
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.13 |  | 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 (incorporated by reference to Exhibit 4.1 of the Companys Annual
Report on Form 20-F filed with the SEC on June 28, 2006).
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.14 |  | 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 (incorporated by reference to Exhibit 4.1 of the Companys
Annual Report on Form 20-F filed with the SEC on June 28, 2006).
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

- 85 -

---

---

|4.15 |  | Letter
 agreement among New World Brands,  Inc.,  Qualmax,  Inc., IP Gear,  Ltd., P&S Spirit,
         LLC and B.O.S  Better  Online  Solutions  Ltd.,  dated  December 31, 2006
 (incorporated  by          reference to Exhibit 10.17 to the Company's  Registration
Statement on Form F-1/A filed with          the SEC on February 12, 2007).
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.16 |  | 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).
|--- |  | ------------------------------------------------------------------------------------------------------------

|11 |  | Statement
of Computation of Earnings Per Share
|-- |  | ----------------------------------------------

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

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

|23.1 |  | Consent
of Kost Forer Gabbay & Kasierer, a member of Ernst & Young Global.
|---- |  | --------------------------------------------------------------------------

|23.2 |  | Consent
of Kesselman & Kesselman, a member of PricewaterhouseCoopers International Limited.
|---- |  | -------------------------------------------------------------------------------------------

- 86 -

---

---

# 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/ Shmuel Koren
Shmuel KorenPresident and Chief Executive Officer | By: /s/ Eyal Cohen
Eyal CohenChief Financial Officer

Date: June 5, 2007

- 87 -

---

---

B.O.S. BETTER ONLINE SOLUTIONS LTD.

AND ITS
SUBSIDIARIES

CONSOLIDATED
FINANCIAL STATEMENTS

AS OF
DECEMBER 31, 2006

U.S. DOLLARSIN THOUSANDS

INDEX

|                                                             |              
|------------------------------------------------------------ | -------------
|                                                             | Page         
|                                                             |              
|                                                             |              
|Reports of Independent
   Registered Public Accounting Firms | F-2  F-3    
|                                                             |              
|Consolidated Balance
  Sheets                                | F-4  F-5    
|                                                             |              
|Consolidated Statements
  of Operations                      | F-6          
|                                                             |              
|Statements of Changes in
  Shareholders Equity              | F-7 - F-8    
|                                                             |              
|Consolidated Statements
  of Cash Flows                      | F-9  F-10   
|                                                             |              
|Notes to Consolidated
  Financial Statements                 | F-11 
  F-50

---

---



|                     |                        |                                |                    |                     
|-------------------- | ---------------------- | ------------------------------ | ------------------ | --------------------
|(ERNST & YOUNG LOGO) | n                      | Kost Forer Gabbay
  & Kasierer | n                  | Phone: 972-3-6232525
|                     | 3 Aminadav St.         |                                | Fax: 972-3-5622555
|                     | Tel-Aviv 67067, Israel |                                |                   

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, 2006 and
2005, 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, 2006. 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 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,
2006 and 2005, and the consolidated results of their operations and their cash
flows for each of the three years in the period ended December 31, 2006,
in conformity with U.S. generally accepted accounting principles.

As
discussed in Note 2t to the consolidated financial statements, effective
January 1, 2006, the Company adopted the provision of Statement of Financial
Accounting Standard No. 123(R), Shared-Based Payment.

|                 |                                 
|---------------- | --------------------------------
|Tel-Aviv, Israel | KOST FORER GABBAY & KASIERER    
|March 26,
  2007 | A Member of Ernst & Young Global

F-2

---

---



# REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholders of

# ODEM ELECTRONIC
TECHNOLOGIES 1992 LTD.

We have audited the consolidated balance
sheets of Odem Electronic Technologies 1992 Ltd. (the Company) and its
subsidiaries as of December 31, 2003 and 2004 and the related consolidated statements
of operations, changes in shareholders equity and cash flows for each of the years
ended on those dates. These financial statements are the responsibility of the
Companys Board of Directors and management. Our responsibility is to express an
opinion on these financial statements based on our audits.

We conducted our audits in accordance
with auditing standards generally accepted in Israel and the standards of the Public
Company Accounting Oversight Board (United States), including those prescribed by the
Israeli Auditors (Mode of Performance) Regulations, 1973. Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant estimates
made by the Companys Board of Directors and management, as well as evaluating the
overall financial statement presentation. We believe that our audit provide a reasonable
basis for our opinion.

In our opinion, the consolidated
financial statements referred to above, present fairly, in all material respects, the
consolidated financial position of the Company and its subsidiaries as of
December 31, 2003 and 2004 and the consolidated results of operations, changes in
shareholders equity and cash flows for each of the years ended on those dates, in
conformity with accounting principles generally accepted in the United States of America.

|Jerusalem, Israel 
    March 25, 2005 | Kesselman & Kesselman
Certified Public Accountants (Israel)
A member of PricewaterhouseCoopers International Limited
|------------------------------------- | --------------------------------------------------------------------------------------------------------------------

F-3

---

---

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

|                                                                                                                         |  |                |        |      |   |        | 
|------------------------------------------------------------------------------------------------------------------------ |  | -------------- | ------ | ---- | - | ------ | 
|                                                                                                                         |  | December
  31, |       
|                                                                                                                         |  |                |       
|                                                                                                                         |  | 2006           |        | 2005 |  
|                                                                                                                         |  |                |        |      |  
|ASSETS                                                                                                                   |  |                |        |      |   |        | 
|                                                                                                                         |  |                |        |      |   |        | 
|CURRENT ASSETS:                                                                                                          |  |                |        |      |   |        | 
|Cash and cash
equivalents                                                                                                |  | $              | 2,033  |      | $ | 2,232  | 
|Marketable securities (Note
5)                                                                                           |  |                | -      |      |   | 1,333  | 
|Trade receivables (net of
  allowance for doubtful accounts of $23 and $3 at December 31, 2006 and 2005,
  respectively) |  |                | 5,632  |      |   | 4,844  | 
|Other accounts receivable and
  prepaid expenses (Note 3)                                                                |  |                | 858    |      |   | 504    | 
|Inventories (Note 4)                                                                                                     |  |                | 4,017  |      |   | 3,320  | 
|                                                                                                                         |  |                |        |      |   |        | 
|                                                                                                                         |  |                |        |      |   |        | 
|Total
  current assets                                                                                                   |  |                | 12,540 |      |   | 12,233 | 
|                                                                                                                         |  |                |        |      |   |        | 
|                                                                                                                         |  |                |        |      |   |        | 
|LONG-TERM ASSETS:                                                                                                        |  |                |        |      |   |        | 
|Severance pay fund                                                                                                       |  |                | 741    |      |   | 907    | 
|Investment in other companies
  (Note 6)                                                                                 |  |                | 8,082  |      |   | 5,412  | 
|                                                                                                                         |  |                |        |      |   |        | 
|                                                                                                                         |  |                |        |      |   |        | 
|Total long-term
assets                                                                                                   |  |                | 8,823  |      |   | 6,319  | 
|                                                                                                                         |  |                |        |      |   |        | 
|                                                                                                                         |  |                |        |      |   |        | 
|OTHER ASSETS                                                                                                             |  |                | 65     |      |   | 49     | 
|                                                                                                                         |  |                |        |      |   |        | 
|                                                                                                                         |  |                |        |      |   |        | 
|PROPERTY, PLANT AND EQUIPMENT,
NET (Note 7)                                                                              |  |                | 520    |      |   | 667    | 
|                                                                                                                         |  |                |        |      |   |        | 
|                                                                                                                         |  |                |        |      |   |        | 
|GOODWILL (Note 9)                                                                                                        |  |                | 952    |      |   | 952    | 
|                                                                                                                         |  |                |        |      |   |        | 
|                                                                                                                         |  |                |        |      |   |        | 
|CUSTOMER LIST, NET (Note
8)                                                                                              |  |                | 1,629  |      |   | 1,836  | 
|                                                                                                                         |  |                |        |      |   |        | 
|                                                                                                                         |  |                |        |      |   |        | 
|ASSETS RELATED TO DISCONTINUED
OPERATIONS
  (Note 1d)                                                                    |  |                | -      |      |   | 590    | 
|                                                                                                                         |  |                |        |      |   |        | 
|                                                                                                                         |  |                |        |      |   |        | 
|                                                                                                                         |  | $              | 24,529 |      | $ | 22,646 | 
|                                                                                                                         |  |                |        |      |   |        | 

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 BALANCE SHEETS                                 
|                                                            
|U.S. dollars in thousands, except share and
  per share data

|                                                                                                                                                                                                         |  |                |         |      |   |         |  
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------- | ------- | ---- | - | ------- | -
|                                                                                                                                                                                                         |  | December
  31, |        
|                                                                                                                                                                                                         |  |                |        
|                                                                                                                                                                                                         |  | 2006           |         | 2005 |  
|                                                                                                                                                                                                         |  |                |         |      |  
|LIABILITIES AND
SHAREHOLDERS EQUITY                                                                                                                                                                     |  |                |         |      |   |         |  
|                                                                                                                                                                                                         |  |                |         |      |   |         |  
|CURRENT LIABILITIES:                                                                                                                                                                                     |  |                |         |      |   |         |  
|Short-term bank loans (Note
10)                                                                                                                                                                          |  | $              | 2,931   |      | $ | 2,271   |  
|Current maturities of
  long-term bank loans and convertible note                                                                                                                                        |  |                | 1,157   |      |   | 354     |  
|Trade payables                                                                                                                                                                                           |  |                | 3,844   |      |   | 3,073   |  
|Employees and payroll
accruals                                                                                                                                                                           |  |                | 460     |      |   | 709     |  
|Deferred revenues                                                                                                                                                                                        |  |                | 103     |      |   | 258     |  
|Accrued expenses and other
  liabilities (Note 11)                                                                                                                                                       |  |                | 999     |      |   | 1,406   |  
|                                                                                                                                                                                                         |  |                |         |      |   |         |  
|                                                                                                                                                                                                         |  |                |         |      |   |         |  
|Total
  current liabilities                                                                                                                                                                              |  |                | 9,494   |      |   | 8,071   |  
|                                                                                                                                                                                                         |  |                |         |      |   |         |  
|                                                                                                                                                                                                         |  |                |         |      |   |         |  
|LONG-TERM
LIABILITIES:                                                                                                                                                                                   |  |                |         |      |   |         |  
|Long-term bank loans (net of
  current maturities) (Note 12)                                                                                                                                             |  |                | -       |      |   | 17      |  
|Convertible note (net of
  current maturities) (Note 13)                                                                                                                                                 |  |                | 1,171   |      |   | 921     |  
|Deferred taxes                                                                                                                                                                                           |  |                | 362     |      |   | 422     |  
|Accrued severance pay                                                                                                                                                                                    |  |                | 916     |      |   | 1,157   |  
|Other long-term
liabilities                                                                                                                                                                              |  |                | 237     |      |   | -       |  
|                                                                                                                                                                                                         |  |                |         |      |   |         |  
|                                                                                                                                                                                                         |  |                |         |      |   |         |  
|Total long-term
liabilities                                                                                                                                                                              |  |                | 2,686   |      |   | 2,517   |  
|                                                                                                                                                                                                         |  |                |         |      |   |         |  
|                                                                                                                                                                                                         |  |                |         |      |   |         |  
|LIABILITIES RELATED TO
  DISCONTINUED OPERATIONS (Note 1d)                                                                                                                                               |  |                | -       |      |   | 792     |  
|                                                                                                                                                                                                         |  |                |         |      |   |         |  
|                                                                                                                                                                                                         |  |                |         |      |   |         |  
|COMMITMENTS AND CONTINGENT
  LIABILITIES (Note 14)                                                                                                                                                       |  |                |         |      |   |         |  
|                                                                                                                                                                                                         |  |                |         |      |   |         |  
|SHAREHOLDERS EQUITY (Note
  15):                                                                                                                                                                        |  |                |         |      |   |         |  
|Share capital                                                                                                                                                                                            |  |                |         |      |   |         |  
|Ordinary shares of NIS 4.00 parvalue:  Authorized: 35,000,000 shares at December 31, 2006 and 2005; Issued and outstanding: 6,744,798 and  6,589,385 shares at December 31, 2006 and 2005, respectively; |  |                | 6,571   |      |   | 6,432   |  
|Additional paid-in
capital                                                                                                                                                                               |  |                | 48,330  |      |   | 47,588  |  
|Deferred share-based
compensation                                                                                                                                                                        |  |                | -       |      |   | (112    | )
|Accumulated other comprehensive
income                                                                                                                                                                   |  |                | 19      |      |   | 21      |  
|Accumulated deficit                                                                                                                                                                                      |  |                | (42,571 | )    |   | (42,663 | )
|                                                                                                                                                                                                         |  |                |         |      |   |         |  
|                                                                                                                                                                                                         |  |                |         |      |   |         |  
|Total
  shareholders equity                                                                                                                                                                             |  |                | 12,349  |      |   | 11,266  |  
|                                                                                                                                                                                                         |  |                |         |      |   |         |  
|                                                                                                                                                                                                         |  |                |         |      |   |         |  
|Total liabilities
  and shareholders equity                                                                                                                                                             |  | $              | 24,529  |      | $ | 22,646  |  
|                                                                                                                                                                                                         |  |                |         |      |   |         |  

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

|                                             |  |                                                       |  |                                     
|-------------------------------------------- |  | ----------------------------------------------------- |  | ------------------------------------
|March 26, 2007                               |  |                                                       |  |                                     
|                                             |  |                                                       |  |                                     
|Date of approval of the financial statements |  | Shmuel Koren
  Presidentand Chief
  Executive Officer |  | Eyal Cohen
  Chief Financial Officer

F-5

---

---



|                                                  
|--------------------------------------------------
|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, |       
|                                                                                                                                        |  |                         |       
|                                                                                                                                        |  | 2006                    |        | 2005 |   | 2004   |  
|                                                                                                                                        |  |                         |        |      |   |        |  
|                                                                                                                                        |  |                         |        |      |   |        |   |   |        |  
|Revenues                                                                                                                                |  | $                       | 20,917 |      | $ | 24,099 |   | $ | 6,919  |  
|Cost of revenues                                                                                                                        |  |                         | 16,200 |      |   | 17,854 |   |   | 3,659  |  
|                                                                                                                                        |  |                         |        |      |   |        |   |   |        |  
|                                                                                                                                        |  |                         |        |      |   |        |   |   |        |  
|Gross profit                                                                                                                            |  |                         | 4,717  |      |   | 6,245  |   |   | 3,260  |  
|                                                                                                                                        |  |                         |        |      |   |        |   |   |        |  
|                                                                                                                                        |  |                         |        |      |   |        |   |   |        |  
|Operating costs and
expenses:                                                                                                           |  |                         |        |      |   |        |   |   |        |  
|Research and
development                                                                                                                |  |                         | 486    |      |   | 893    |   |   | 669    |  
|Sales and marketing                                                                                                                     |  |                         | 2,019  |      |   | 2,425  |   |   | 1,015  |  
|General and administrative
(including
  share-based compensation expense of $727, $348 and $117 in 2006, 2005 and
  2004, respectively) |  |                         | 3,268  |      |   | 2,667  |   |   | 1,271  |  
|                                                                                                                                        |  |                         |        |      |   |        |   |   |        |  
|                                                                                                                                        |  |                         |        |      |   |        |   |   |        |  
|Total
  operating costs and expenses                                                                                                    |  |                         | 5,773  |      |   | 5,985  |   |   | 2,955  |  
|                                                                                                                                        |  |                         |        |      |   |        |   |   |        |  
|                                                                                                                                        |  |                         |        |      |   |        |   |   |        |  
|Operating income
(loss)                                                                                                                 |  |                         | (1,056 | )    |   | 260    |   |   | 305    |  
|Financial expenses, net (Note
  17a)                                                                                                    |  |                         | (626   | )    |   | (448   | ) |   | (158   | )
|Other income, net (Note
1d)                                                                                                             |  |                         | -      |      |   | 355    |   |   | -      |  
|                                                                                                                                        |  |                         |        |      |   |        |   |   |        |  
|                                                                                                                                        |  |                         |        |      |   |        |   |   |        |  
|Income (loss) before taxes on
  income                                                                                                  |  |                         | (1,682 | )    |   | 167    |   |   | 147    |  
|Tax benefit (taxes on income)
(Note
  16)                                                                                               |  |                         | 89     |      |   | (204   | ) |   | (20    | )
|                                                                                                                                        |  |                         |        |      |   |        |   |   |        |  
|                                                                                                                                        |  |                         |        |      |   |        |   |   |        |  
|Net income (loss) after taxes
  on income                                                                                               |  |                         | (1,593 | )    |   | (37    | ) |   | 127    |  
|Equity in losses of an
  affiliate                                                                                                      |  |                         | -      |      |   | (1,750 | ) |   | (308   | )
|Minority interest in earnings
  of a subsidiary                                                                                         |  |                         | -      |      |   | (223   | ) |   | (17    | )
|                                                                                                                                        |  |                         |        |      |   |        |   |   |        |  
|                                                                                                                                        |  |                         |        |      |   |        |   |   |        |  
|Loss from continuing
  operations                                                                                                       |  |                         | (1,593 | )    |   | (2,010 | ) |   | (198   | )
|Income (loss) from to
  discontinued operations (Note 1d)                                                                               |  |                         | 1,685  |      |   | (1,595 | ) |   | (1,855 | )
|                                                                                                                                        |  |                         |        |      |   |        |   |   |        |  
|                                                                                                                                        |  |                         |        |      |   |        |   |   |        |  
|Net income (loss)                                                                                                                       |  | $                       | 92     |      | $ | (3,605 | ) | $ | (2,053 | )
|                                                                                                                                        |  |                         |        |      |   |        |   |   |        |  
|                                                                                                                                        |  |                         |        |      |   |        |   |   |        |  
|Basic and diluted loss per share
  from continuing operations (Note 17b)                                                                |  | $                       | (0.24  | )    | $ | (0.36  | ) | $ | (0.04  | )
|                                                                                                                                        |  |                         |        |      |   |        |   |   |        |  
|                                                                                                                                        |  |                         |        |      |   |        |   |   |        |  
|Basic and diluted net earnings
(loss) per share from discontinued operations (Note 17b)                                                 |  | $                       | 0.25   |      | $ | (0.28  | ) | $ | (0.40  | )
|                                                                                                                                        |  |                         |        |      |   |        |   |   |        |  
|                                                                                                                                        |  |                         |        |      |   |        |   |   |        |  
|Basic and diluted net earnings
  (loss) per share (Note 17b)                                                                            |  | $                       | 0.01   |      | $ | (0.64  | ) | $ | (0.44  | )
|                                                                                                                                        |  |                         |        |      |   |        |   |   |        |  

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  |                                                        

|                                                                           |  |                   |           |                 |   |                                |  |                                       |        |                                              |   |                   |   |                       |    |                              |   |                                |   |   |         |   |   |        |   |   |        |  
|-------------------------------------------------------------------------- |  | ----------------- | --------- | --------------- | - | ------------------------------ |  | ------------------------------------- | ------ | -------------------------------------------- | - | ----------------- | - | --------------------- | -- | ---------------------------- | - | ------------------------------ | - | - | ------- | - | - | ------ | - | - | ------ | -
|                                                                           |  | Ordinary
  shares |           | Share
  capital |   | Additional
  paid in
  capital |  | Deferred
  share-based
  compensation |        | Accumulated
  other
  comprehensive
  income |   | Treasury
  shares |   | Accumulated
  deficit |    | Total
  comprehensive
  loss |   | Total
  shareholders
  equity |  
|                                                                           |  |                   |           |                 |   |                                |  |                                       |        |                                              |   |                   |   |                       |    |                              |   |                                |  
|                                                                           |  |                   |           |                 |   |                                |  |                                       |        |                                              |   |                   |   |                       |    |                              |   |                                |   |   |         |   |   |        |   |   |        |  
|Balance at January 1, 2004                                                 |  |                   | 4,167,509 |                 | $ | 4,309                          |  | $                                     | 43,247 |                                              | $ | -                 |   | $                     | -  |                              | $ | (150                           | ) | $ | (36,865 | ) |   |        |   | $ | 10,541 |  
|Deferred share-based compensation                                          |  |                   | -         |                 |   | -                              |  |                                       | 179    |                                              |   | (179              | ) |                       | -  |                              |   | -                              |   |   | -       |   |   |        |   |   | -      |  
|Amortization of deferred share-based
  compensation                        |  |                   | -         |                 |   | -                              |  |                                       | -      |                                              |   | 5                 |   |                       | -  |                              |   | -                              |   |   | -       |   |   |        |   |   | 5      |  
|Issuance of shares related to the
  acquisitions of Quasar and Odem, net   |  |                   | 570,149   |                 |   | 514                            |  |                                       | 784    |                                              |   | -                 |   |                       | -  |                              |   | 150                            |   |   | (140    | ) |   |        |   |   | 1,308  |  
|Share-based compensation related to warrants
  issued to service providers |  |                   | -         |                 |   | -                              |  |                                       | 117    |                                              |   | -                 |   |                       | -  |                              |   | -                              |   |   | -       |   |   |        |   |   | 117    |  
|Warrants related to a convertible note
  issued to lenders                 |  |                   | -         |                 |   | -                              |  |                                       | 99     |                                              |   | -                 |   |                       | -  |                              |   | -                              |   |   | -       |   |   |        |   |   | 99     |  
|Other comprehensive loss:                                                  |  |                   |           |                 |   |                                |  |                                       |        |                                              |   |                   |   |                       |    |                              |   |                                |   |   |         |   |   |        |   |   |        |  
|Net loss                                                                   |  |                   | -         |                 |   | -                              |  |                                       | -      |                                              |   | -                 |   |                       | -  |                              |   | -                              |   |   | (2,053  | ) | $ | (2,053 | ) |   | (2,053 | )
|Unrealized gain on available-for-sale
  marketable securities              |  |                   | -         |                 |   | -                              |  |                                       | -      |                                              |   | -                 |   |                       | 5  |                              |   | -                              |   |   | -       |   |   | 5      |   |   | 5      |  
|Foreign currency translation adjustments                                   |  |                   | -         |                 |   | -                              |  |                                       | -      |                                              |   | -                 |   |                       | 26 |                              |   | -                              |   |   | -       |   |   | 26     |   |   | 26     |  
|                                                                           |  |                   |           |                 |   |                                |  |                                       |        |                                              |   |                   |   |                       |    |                              |   |                                |   |   |         |   |   |        |   |   |        |  
|Total comprehensive loss                                                   |  |                   |           |                 |   |                                |  |                                       |        |                                              |   |                   |   |                       |    |                              |   |                                |   |   |         |   | $ | (2,022 | ) |   |        |  
|                                                                           |  |                   |           |                 |   |                                |  |                                       |        |                                              |   |                   |   |                       |    |                              |   |                                |   |   |         |   |   |        |   |   |        |  
|                                                                           |  |                   |           |                 |   |                                |  |                                       |        |                                              |   |                   |   |                       |    |                              |   |                                |   |   |         |   |   |        |   |   |        |  
|Balance at December 31, 2004                                               |  |                   | 4,737,658 |                 |   | 4,823                          |  |                                       | 44,426 |                                              |   | (174              | ) |                       | 31 |                              |   | -                              |   |   | (39,058 | ) |   |        |   |   | 10,048 |  
|Amortization of deferred share-based
  compensation                        |  |                   | -         |                 |   | -                              |  |                                       | -      |                                              |   | 62                |   |                       | -  |                              |   | -                              |   |   | -       |   |   |        |   |   | 62     |  
|Conversion of convertible note                                             |  |                   | 640,293   |                 |   | 570                            |  |                                       | 1,046  |                                              |   | -                 |   |                       | -  |                              |   | -                              |   |   | -       |   |   |        |   |   | 1,616  |  
|Issuance of shares related to acquisition of
  Odem, net                   |  |                   | 232,603   |                 |   | 202                            |  |                                       | 330    |                                              |   | -                 |   |                       | -  |                              |   | -                              |   |   | -       |   |   |        |   |   | 532    |  
|Issuance of shares related to the private
  placement, net                 |  |                   | 953,743   |                 |   | 815                            |  |                                       | 1,225  |                                              |   | -                 |   |                       | -  |                              |   | -                              |   |   | -       |   |   |        |   |   | 2,040  |  
|Issuance of Ordinary shares for options
  exercised                        |  |                   | 25,088    |                 |   | 22                             |  |                                       | 28     |                                              |   | -                 |   |                       | -  |                              |   | -                              |   |   | -       |   |   |        |   |   | 50     |  
|Share-based compensation related to warrants
  issued to service providers |  |                   | -         |                 |   | -                              |  |                                       | 348    |                                              |   | -                 |   |                       | -  |                              |   | -                              |   |   | -       |   |   |        |   |   | 348    |  
|Warrants related to a convertible note
  issued to lenders                 |  |                   | -         |                 |   | -                              |  |                                       | 185    |                                              |   | -                 |   |                       | -  |                              |   | -                              |   |   | -       |   |   |        |   |   | 185    |  
|Other comprehensive loss:                                                  |  |                   |           |                 |   |                                |  |                                       |        |                                              |   |                   |   |                       |    |                              |   |                                |   |   |         |   |   |        |   |   |        |  
|Net loss                                                                   |  |                   | -         |                 |   | -                              |  |                                       | -      |                                              |   | -                 |   |                       | -  |                              |   | -                              |   |   | (3,605  | ) | $ | (3,605 | ) |   | (3,605 | )
|Loss on available-for-sale marketable
  securities                         |  |                   | -         |                 |   | -                              |  |                                       | -      |                                              |   | -                 |   |                       | (4 | )                            |   | -                              |   |   | -       |   |   | (4     | ) |   | (4     | )
|Foreign currency translation adjustments                                   |  |                   | -         |                 |   | -                              |  |                                       | -      |                                              |   | -                 |   |                       | (6 | )                            |   | -                              |   |   | -       |   |   | (6     | ) |   | (6     | )
|                                                                           |  |                   |           |                 |   |                                |  |                                       |        |                                              |   |                   |   |                       |    |                              |   |                                |   |   |         |   |   |        |   |   |        |  
|Total comprehensive loss                                                   |  |                   |           |                 |   |                                |  |                                       |        |                                              |   |                   |   |                       |    |                              |   |                                |   |   |         |   | $ | (3,615 | ) |   |        |  
|                                                                           |  |                   |           |                 |   |                                |  |                                       |        |                                              |   |                   |   |                       |    |                              |   |                                |   |   |         |   |   |        |   |   |        |  
|                                                                          
|Balance at December 31, 2005                                               |  |                   | 6,589,385 |                 |   | 6,432                          |  |                                       | 47,588 |                                              |   | (112              | ) |                       | 21 |                              |   | -                              |   |   | (42,663 | ) |   |        |   |   | 11,266 |  
|                                                                           |  |                   |           |                 |   |                                |  |                                       |        |                                              |   |                   |   |                       |    |                              |   |                                |   |   |         |   |   |        |   |   |        |  

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

F-7

---

---



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

|                                                                           |  |                   |           |                 |   |                                |  |                                       |        |                                              |   |                   |   |                       |    |                                |   |                                |  |   |         |   |   |    |   |   |        |  
|-------------------------------------------------------------------------- |  | ----------------- | --------- | --------------- | - | ------------------------------ |  | ------------------------------------- | ------ | -------------------------------------------- | - | ----------------- | - | --------------------- | -- | ------------------------------ | - | ------------------------------ |  | - | ------- | - | - | -- | - | - | ------ | -
|                                                                           |  | Ordinary
  shares |           | Share
  capital |   | Additional
  paid in
  capital |  | Deferred
  share-based
  compensation |        | Accumulated
  other
  comprehensive
  income |   | Treasury
  shares |   | Accumulated
  deficit |    | Total
  comprehensive
  income |   | Total
  shareholders
  equity | 
|                                                                           |  |                   |           |                 |   |                                |  |                                       |        |                                              |   |                   |   |                       |    |                                |   |                                | 
|                                                                           |  |                   |           |                 |   |                                |  |                                       |        |                                              |   |                   |   |                       |    |                                |   |                                |  |   |         |   |   |    |   |   |        |  
|Balance at January 1, 2006                                                 |  |                   | 6,589,385 |                 |   | 6,432                          |  |                                       | 47,588 |                                              |   | (112              | ) |                       | 21 |                                |   | -                              |  |   | (42,663 | ) |   |    |   |   | 11,266 |  
|Reversal of deferred share-based
compensation                              |  |                   | -         |                 |   | -                              |  |                                       | (112   | )                                            |   | 112               |   |                       | -  |                                |   | -                              |  |   | -       |   |   |    |   |   | -      |  
|Issuance of Ordinary shares for options
exercised                          |  |                   | 68,747    |                 |   | 61                             |  |                                       | 74     |                                              |   | -                 |   |                       | -  |                                |   | -                              |  |   | -       |   |   |    |   |   | 135    |  
|Share-based compensation expense                                           |  |                   | 21,666    |                 |   | 20                             |  |                                       | 411    |                                              |   | -                 |   |                       | -  |                                |   | -                              |  |   | -       |   |   |    |   |   | 431    |  
|Share-based compensation related to warrants issued
to service
  providers |  |                   | 65,000    |                 |   | 58                             |  |                                       | 238    |                                              |   | -                 |   |                       | -  |                                |   | -                              |  |   | -       |   |   |    |   |   | 296    |  
|Warrants related to a convertible note issued to
lenders                   |  |                   | -         |                 |   | -                              |  |                                       | 131    |                                              |   | -                 |   |                       | -  |                                |   | -                              |  |   | -       |   |   |    |   |   | 131    |  
|Other comprehensive income:                                                |  |                   |           |                 |   |                                |  |                                       |        |                                              |   |                   |   |                       |    |                                |   |                                |  |   |         |   |   |    |   |   |        |  
|Net income                                                                 |  |                   | -         |                 |   | -                              |  |                                       | -      |                                              |   | -                 |   |                       | -  |                                |   | -                              |  |   | 92      |   | $ | 92 |   |   | 92     |  
|Loss on available-for-sale marketable
securities                           |  |                   | -         |                 |   | -                              |  |                                       | -      |                                              |   | -                 |   |                       | (2 | )                              |   | -                              |  |   | -       |   |   | (2 | ) |   | (2     | )
|                                                                           |  |                   |           |                 |   |                                |  |                                       |        |                                              |   |                   |   |                       |    |                                |   |                                |  |   |         |   |   |    |   |   |        |  
|Total comprehensive income                                                 |  |                   |           |                 |   |                                |  |                                       |        |                                              |   |                   |   |                       |    |                                |   |                                |  |   |         |   | $ | 90 |   |   |        |  
|                                                                           |  |                   |           |                 |   |                                |  |                                       |        |                                              |   |                   |   |                       |    |                                |   |                                |  |   |         |   |   |    |   |   |        |  
|                                                                           |  |                   |           |                 |   |                                |  |                                       |        |                                              |   |                   |   |                       |    |                                |   |                                |  |   |         |   |   |    |   |   |        |  
|Balance at December 31, 2006                                               |  |                   | 6,744,798 |                 | $ | 6,571                          |  | $                                     | 48,330 |                                              | $ | -                 |   | $                     | 19 |                                | $ | -                              |  | $ | (42,571 | ) |   |    |   | $ | 12,349 |  
|                                                                           |  |                   |           |                 |   |                                |  |                                       |        |                                              |   |                   |   |                       |    |                                |   |                                |  |   |         |   |   |    |   |   |        |  

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, |       
|                                                                                                        |  |                         |       
|                                                                                                        |  | 2006                    |        | 2005 |   | 2004   |  
|                                                                                                        |  |                         |        |      |   |        |  
|Cash flows fromoperatingactivities:                                                                     |  |                         |        |      |   |        |   |   |        |  
|Net income (loss)                                                                                       |  | $                       | 92     |      | $ | (3,605 | ) | $ | (2,053 | )
|Adjustments to reconcile net income (loss)
  to net cash used in operating activities:                  |  |                         |        |      |   |        |   |   |        |  
|Loss (income) from discontinued
operations                                                              |  |                         | (1,685 | )    |   | 1,595  |   |   | 1,855  |  
|Depreciation and amortization                                                                           |  |                         | 378    |      |   | 474    |   |   | 311    |  
|Amortization of premium and accretion of
  accrued interest on available-for-sale marketable securities |  |                         | -      |      |   | 35     |   |   | 47     |  
|Impairment of investment                                                                                |  |                         | 39     |      |   | -      |   |   | -      |  
|Severance pay, net                                                                                      |  |                         | (75    | )    |   | (75    | ) |   | 8      |  
|Equity in losses of an affiliate                                                                        |  |                         | -      |      |   | 1,750  |   |   | 308    |  
|Minority interest in earnings of a
  subsidiary                                                         |  |                         | -      |      |   | 223    |   |   | 17     |  
|Share-based compensation related to
  warrants issued to service providers                              |  |                         | 296    |      |   | 59     |   |   | 5      |  
|Capital gain from sale of product line                                                                  |  |                         | -      |      |   | (273   | ) |   | -      |  
|Net loss from decrease in value of Put
  options                                                        |  |                         | -      |      |   | 8      |   |   | -      |  
|Capital loss from sale of property and
  equipment                                                      |  |                         | -      |      |   | 3      |   |   | 5      |  
|Share-based compensation related to
  employees                                                         |  |                         | 431    |      |   | 244    |   |   | 121    |  
|Financial expenses related to warrants
  issued in connection with long-term convertible note           |  |                         | 162    |      |   | 120    |   |   | 78     |  
|Increase in trade receivables                                                                           |  |                         | (788   | )    |   | (547   | ) |   | (118   | )
|Decrease in deferred taxes                                                                              |  |                         | (70    | )    |   | (88    | ) |   | (47    | )
|Decrease (increase) in other accounts
  receivable and prepaid expenses                                 |  |                         | (595   | )    |   | 86     |   |   | 160    |  
|Increase in inventories                                                                                 |  |                         | (697   | )    |   | (1,971 | ) |   | 357    |  
|Increase (decrease) in trade payables                                                                   |  |                         | 790    |      |   | (172   | ) |   | 531    |  
|Decrease in employees and payroll accruals,
  deferred revenues, accrued expenses and other liabilities |  |                         | (231   | )    |   | (123   | ) |   | (111   | )
|                                                                                                        |  |                         |        |      |   |        |   |   |        |  
|                                                                                                        |  |                         |        |      |   |        |   |   |        |  
|Net cash provided by (used in) operating activities from continuing
  operations                        |  |                         | (1,953 | )    |   | (2,257 | ) |   | 1,474  |  
|Net cash used in operating activities from discontinued
operations                                      |  |                         | (446   | )    |   | (1,647 | ) |   | (2,593 | )
|                                                                                                        |  |                         |        |      |   |        |   |   |        |  
|                                                                                                        |  |                         |        |      |   |        |   |   |        |  
|Net cash used in operating activities                                                                   |  |                         | (2,399 | )    |   | (3,904 | ) |   | (1,119 | )
|                                                                                                        |  |                         |        |      |   |        |   |   |        |  
|                                                                                                        |  |                         |        |      |   |        |   |   |        |  
|Cash flows from investing activities:                                                                   |  |                         |        |      |   |        |   |   |        |  
|Purchase of property and equipment                                                                      |  |                         | (24    | )    |   | (245   | ) |   | (214   | )
|Proceeds from sale of property and
  equipment                                                          |  |                         | -      |      |   | 13     |   |   | 38     |  
|Proceeds from sale of product line                                                                      |  |                         | -      |      |   | 257    |   |   | -      |  
|Investment in long-term marketable
  securities                                                         |  |                         | -      |      |   | (607   | ) |   | (1,247 | )
|Proceeds from redemption of marketable
  securities                                                     |  |                         | 1,331  |      |   | 2,316  |   |   | 1,000  |  
|Investment in other companies                                                                           |  |                         | (676   | )    |   | -      |   |   | -      |  
|Acquisitions, net of cash acquired (a)                                                                  |  |                         | -      |      |   | (1,124 | ) |   | (1,385 | )
|                                                                                                        |  |                         |        |      |   |        |   |   |        |  
|                                                                                                        |  |                         |        |      |   |        |   |   |        |  
|Net cash provided by (used in) investing
  activities from
  continuing operations                      |  |                         | 631    |      |   | 610    |   |   | (1,808 | )
|Net cash used in investing activities from
  discontinued operations                                    |  |                         | (221   | )    |   | (1,087 | ) |   | (58    | )
|                                                                                                        |  |                         |        |      |   |        |   |   |        |  
|                                                                                                        |  |                         |        |      |   |        |   |   |        |  
|Net cash provided by (used in) investing activities                                                     |  |                         | 410    |      |   | (477   | ) |   | (1,866 | )
|                                                                                                        |  |                         |        |      |   |        |   |   |        |  
|                                                                                                        |  |                         |        |      |   |        |   |   |        |  
|Cash flows from financing activities:                                                                   |  |                         |        |      |   |        |   |   |        |  
|Repayment of short-term and long-term bank
  loans                                                      |  |                         | (26    | )    |   | (55    | ) |   | (93    | )
|Proceeds from short-term bank loans                                                                     |  |                         | 686    |      |   | 933    |   |   | -      |  
|Proceeds from long-term convertible note
  and warrants, net of issuance expenses                       |  |                         | 1,319  |      |   | 1,246  |   |   | 1,787  |  
|Payment of long-term convertible note                                                                   |  |                         | (438   | )    |   | (55    | ) |   | (80    | )
|Proceeds from exercise of options                                                                       |  |                         | 135    |      |   | 2,090  |   |   | -      |  
|                                                                                                        |  |                         |        |      |   |        |   |   |        |  
|                                                                                                        |  |                         |        |      |   |        |   |   |        |  
|Net cash provided by financing activities                                                               |  |                         | 1,676  |      |   | 4,159  |   |   | 1,614  |  
|                                                                                                        |  |                         |        |      |   |        |   |   |        |  
|                                                                                                        |  |                         |        |      |   |        |   |   |        |  
|Decrease in cash and cash equivalents                                                                   |  |                         | (313   | )    |   | (222   | ) |   | (1,371 | )
|Increase (decrease) in cash and cash equivalents from discontinued
  operations                         |  |                         | 114    |      |   | 163    |   |   | (208   | )
|Effect of exchange rate changes on cash and
  cash equivalents                                          |  |                         | -      |      |   | (13    | ) |   | 11     |  
|Cash and cash equivalents at the beginning
  of the year                                                |  |                         | 2,232  |      |   | 2,304  |   |   | 3,872  |  
|                                                                                                        |  |                         |        |      |   |        |   |   |        |  
|                                                                                                        |  |                         |        |      |   |        |   |   |        |  
|Cash and cash equivalents at the end of the
  year                                                      |  | $                       | 2,033  |      | $ | 2,232  |   | $ | 2,304  |  
|                                                                                                        |  |                         |        |      |   |        |   |   |        |  

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

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, |      
|                                                 |  |  |                                                                                                                                  |  |                         |      
|                                                 |  |  |                                                                                                                                  |  | 2006                    |       | 2005 |   | 2004   |  
|                                                 |  |  |                                                                                                                                  |  |                         |       |      |   |        |  
|Supplemental disclosure of cash flow activities: |  |  |                                                                                                                                  |  |                         |       |      |   |        |  
|                                                 |  |  |                                                                                                                                  |  |                         |       |      |   |        |   |   |       | 
|(i)                                              |  |  | Net cash paid during the year for:                                                                                               |  |                         |       |      |   |        |   |   |       | 
|                                                 |  |  | Interest                                                                                                                         |  | $                       | 532   |      | $ | 126    |   | $ | 129   | 
|                                                 |  |  |                                                                                                                                  |  |                         |       |      |   |        |   |   |       | 
|                                                 |  |  | Income tax                                                                                                                       |  | $                       | 180   |      | $ | 309    |   | $ | -     | 
|                                                 |  |  |                                                                                                                                  |  |                         |       |      |   |        |   |   |       | 
|                                                 |  |  |                                                                                                                                  |  |                         |       |      |   |        |   |   |       | 
|(ii)                                             |  |  | Non-cash activities:                                                                                                             |  |                         |       |      |   |        |   |   |       | 
|                                                 |  |  |                                                                                                                                  |  |                         |       |      |   |        |   |   |       | 
|                                                 |  |  | Conversion of convertible note into shares                                                                                       |  | $                       | -     |      | $ | 1,614  |   | $ | -     | 
|                                                 |  |  |                                                                                                                                  |  |                         |       |      |   |        |   |   |       | 
|                                                 |  |  | Sale of the communication segment in consideration for shares in Qualmax                                                         |  | $                       | 958   |      | $ | 4,690  |   | $ | -     | 
|                                                 |  |  |                                                                                                                                  |  |                         |       |      |   |        |   |   |       | 
|                                                 |  |  | Conversion of Qualmaxs debt into New World Brands shares                                                                       |  | $                       | 1,480 |      | $ | -      |   | $ | -     | 
|                                                 |  |  |                                                                                                                                  |  |                         |       |      |   |        |   |   |       | 
|                                                 |  |  |                                                                                                                                  |  |                         |       |      |   |        |   |   |       | 
|                                                 |  |  | Sale of PrintBOS:                                                                                                                |  |                         |       |      |   |        |   |   |       | 
|                                                 |  |  |                                                                                                                                  |  |                         |       |      |   |        |   |   |       | 
|                                                 |  |  | Consideration, net                                                                                                               |  | $                       | -     |      | $ | 275    |   | $ | -     | 
|                                                 |  |  | Disposal of fixed assets                                                                                                         |  |                         | -     |      |   | (28    | ) |   | -     | 
|                                                 |  |  | Disposal of liability                                                                                                            |  |                         | -     |      |   | 100    |   |   | -     | 
|                                                 |  |  | Related expenses                                                                                                                 |  |                         | -     |      |   | (74    | ) |   | -     | 
|                                                 |  |  |                                                                                                                                  |  |                         |       |      |   |        |   |   |       | 
|                                                 |  |  |                                                                                                                                  |  |                         |       |      |   |        |   |   |       | 
|                                                 |  |  | Capital gain                                                                                                                     |  | $                       | -     |      | $ | 273    |   | $ | -     | 
|                                                 |  |  |                                                                                                                                  |  |                         |       |      |   |        |   |   |       | 
|                                                 |  |  |                                                                                                                                  |  |                         |       |      |   |        |   |   |       | 
|                                                 |  |  | Sale of the communication segment:                                                                                               |  |                         |       |      |   |        |   |   |       | 
|                                                 |  |  |                                                                                                                                  |  |                         |       |      |   |        |   |   |       | 
|                                                 |  |  | Consideration, net                                                                                                               |  | $                       | 2,437 |      | $ | 3,690  |   | $ | -     | 
|                                                 |  |  | Disposal of tangible and intangible assets                                                                                       |  |                         | (752  | )    |   | (2,425 | ) |   | -     | 
|                                                 |  |  | Related expenses                                                                                                                 |  |                         | -     |      |   | (486   | ) |   | -     | 
|                                                 |  |  |                                                                                                                                  |  |                         |       |      |   |        |   |   |       | 
|                                                 |  |  |                                                                                                                                  |  |                         |       |      |   |        |   |   |       | 
|                                                 |  |  | Capital gain                                                                                                                     |  | $                       | 1,685 |      | $ | 779    |   | $ | -     | 
|                                                 |  |  |                                                                                                                                  |  |                         |       |      |   |        |   |   |       | 
|                                                 |  |  |                                                                                                                                  |  |                         |       |      |   |        |   |   |       | 
|(a)                                              |  |  | Acquisition of Odem:                                                                                                             |  |                         |       |      |   |        |   |   |       | 
|                                                 |  |  |                                                                                                                                  |  |                         |       |      |   |        |   |   |       | 
|                                                 |  |  | Fair value of net tangible
  assets acquired (excluding cash and cash equivalents) and liabilities assumed
  at acquisition date |  | $                       | -     |      | $ | 1,020  |   | $ | 1,366 | 
|                                                 |  |  | Fair value of net intangible
  assets acquired at acquisition date                                                               |  |                         | -     |      |   | 718    |   |   | 927   | 
|                                                 |  |  | Less -                                                                                                                           |  |                         | -     |      |   |        |   |   |       | 
|                                                 |  |  | Amount acquired by issuance of
  shares                                                                                          |  |                         | -     |      |   | 532    |   |   | 769   | 
|                                                 |  |  | Payables                                                                                                                         |  |                         | -     |      |   | 219    |   |   | 139   | 
|                                                 |  |  | Add-                                                                                                                             |  |                         | -     |      |   |        |   |   |       | 
|                                                 |  |  | Cancellation of Put and Call
  options                                                                                           |  |                         | -     |      |   | 137    |   |   | -     | 
|                                                 |  |  |                                                                                                                                  |  |                         |       |      |   |        |   |   |       | 
|                                                 |  |  |                                                                                                                                  |  |                         |       |      |   |        |   |   |       | 
|                                                 |  |  |                                                                                                                                  |  | $                       | -     |      | $ | 1,124  |   | $ | 1,385 | 
|                                                 |  |  |                                                                                                                                  |  |                         |       |      |   |        |   |   |       | 

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
  manages its operations through two wholly-owned subsidiaries:                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|            |         | -                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               | BOScom Ltd.
  (BOScom) is engaged in the software solutions segment of the Companys
  business. BOScom was involved in cross platform printing solutions answering
  a demand for central printing and output management solutions in
  organizations which were sold during 2005 (see c); and                                                                                                                                                                                                                                                                                                                                  
|            |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |         | -                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               | Odem
  Electronic Technologies 1992 Ltd. (Odem) is engaged in the supply chain
  solutions segment of the Companys business. In September and November 2005,
  the Company purchased an additional 23.9% and 12.3%, respectively, of the
  outstanding shares of Odem. Following these purchases, the Company owns 100%
  of Odem. Odem is a solutions supplier of electronic components and systems to
  the technologies sector (see b).                                                                                                                                                                                      
|            |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |         | BOS
  communication segment (the communication 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 this segment have
  been sold as part of the disposal of the communication segment in December
  2005 (see d).
|            |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|            |         | In addition, the Company
  holds shares in two other companies:                                                                                                                                                                                                                                                                                                                                                                                                                                
|            |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|            |         | 1.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              | Surf Communication Systems
  Ltd. (Surf), a developer and supplier of access and network convergence
  software solutions to the wire line and wireless telecommunications and data
  communications industries. In
  June 2006, the Company invested $300, following which, the Company
  holds 7.8% of Surfs issued and outstanding shares (see Note 6).                                                                                                                                                                                                                                                                      
|            |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |         | 2.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              | Qualmax Inc. (Qualmax),
  a U.S. public corporation listed on the Pink Sheets (QMXI.PK), and
  its subsidiaries New World Brands Inc. (OTC: NWBD.OB) and IPGear. Qualmax and its subsidiaries are developers and
  suppliers of voiceover IP technology products and services. The
  Company holds 18% of the issued and outstanding shares of Qualmax Inc. and
  Preferred shares in New World Brands Inc. that can be converted into 4.2% of
  New World Brands Inc. issued and outstanding shares. The Companys holdings in Qualmax were received as the consideration
  for the sale of the communication segment (see d).

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.)
|            |                
|            | b.              | Business combination:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|            |                 |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                 | 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
  financial 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 in November 2005 the
  Company paid $554, in cash and for the 23.9% of Odems shares purchase 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 (ii) an amount of
  $716 to be paid in cash.                                                                                                                                                                                                                                                                                                                 
|            |                 |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                 | The
  Companys consolidated financial statements reflect the purchase price
  determined as follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            

| |                                      |  |                  |     |                   |   |                  |   |       |       |  |   |       |  
| | ------------------------------------ |  | ---------------- | --- | ----------------- | - | ---------------- | - | ----- | ----- |  | - | ----- | -
| |                                      |  | Odem             |    
| |                                      |  |                  |    
| |                                      |  | November 1, 2005 |     | September 29,2005 |   | November 18,2004 |   | Total |      
| |                                      |  |                  |     |                   |   |                  |   |       |      
| |                                      |  |                  |     |                   |   |                  |   |       |       |  |   |       |  
| | Issuance of shares (1)               |  | $                | -   |                   | $ | 532              |   | $     | 769   |  | $ | 1,301 |  
| | Cash consideration                   |  |                  | 554 |                   |   | 716              |   |       | 1,971 |  |   | 3,241 |  
| | Transaction costs                    |  |                  | 19  |                   |   | 54               |   |       | 139   |  |   | 212   |  
| | Cancellation of Put and Call options |  |                  | (33 | )                 |   | (104             | ) |       | -     |  |   | (137  | )
| |                                      |  |                  |     |                   |   |                  |   |       |       |  |   |       |  
| |                                      |  |                  |     |                   |   |                  |   |       |       |  |   |       |  
| | Total purchase price                 |  | $                | 540 |                   | $ | 1,198            |   | $     | 2,879 |  | $ | 4,617 |  
| |                                      |  |                  |     |                   |   |                  |   |       |       |  |   |       |  

| |     |                                                                                                                                                                                                                                        
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (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-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.)

| |                                                                         
| | ------------------------------------------------------------------------
| | The Company
  has allocated the total purchase price in 2004 as follows:

| |                                            |  |      |       |                         |  |          | 
| | ------------------------------------------ |  | ---- | ----- | ----------------------- |  | -------- | 
| | Allocation of purchase price               |  | Odem |       | Estimated
  useful life | 
| |                                            |  |      |       |                         | 
| |                                            |  |      |       |                         |  |          | 
| | Cash                                       |  | $    | 586   |                         |  |          | 
| | Tangible
  assets                          |  |      | 780   |                         |  |          | 
| | Put option
  to minority shareholders (2)  |  |      | (359  | )                       |  |          | 
| | Call option
  to minority shareholders (2) |  |      | 230   |                         |  |          | 
| | Customer
  list (1)                        |  |      | 1,406 |                         |  | 10 years | 
| | Deferred tax
  liability                   |  |      | (430  | )                       |  |          | 
| | Goodwill                                   |  |      | 666   |                         |  | 10 years | 
| |                                            |  |      |       |                         |  |          | 
|
| | Total
  purchase price                     |  | $    | 2,879 |                         |  |          | 
| |                                            |  |      |       |                         |  |          | 

| |     |                                                                                                                                                                       
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (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
  options pricing model.                                                                          

| |                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The
  acquisitions have been treated using the purchase method of accounting in
  accordance with SFAS 141 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 Odem acquisition in 2005 as follows.                                                                                                                                                                                                                                                                                                                                                           

| |                              |  |                   |     |                     |   |       |   |                         |       |   |  |           | 
| | ---------------------------- |  | ----------------- | --- | ------------------- | - | ----- | - | ----------------------- | ----- | - |  | --------- | 
| | Allocation of purchase price |  | November
  1,2005 |     | September
  29,2005 |   | Total |   | Estimated
  useful life |      
| |                              |  |                   |     |                     |   |       |   |                         |      
| |                              |  |                   |     |                     |   |       |   |                         |       |   |  |           | 
| | Tangible assets              |  | $                 | 340 |                     | $ | 681   |   | $                       | 1,021 |   |  |           | 
| | Customer list (1)            |  |                   | 85  |                     |   | 509   |   |                         | 594   |   |  | 9
  years | 
| | Deferred tax liability       |  |                   | (23 | )                   |   | (136  | ) |                         | (159  | ) |  |           | 
| | Goodwill                     |  |                   | 138 |                     |   | 144   |   |                         | 282   |   |  | 9
  years | 
| |                              |  |                   |     |                     |   |       |   |                         |       |   |  |           | 
| |                              |  |                   |     |                     |   |       |   |                         |       |   |  |           | 
| | Total purchase price         |  | $                 | 540 |                     | $ | 1,198 |   | $                       | 1,738 |   |  |           | 
| |                              |  |                   |     |                     |   |       |   |                         |       |   |  |           | 

| |     |                                                                                                                                                                       
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (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.

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.)

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | c. | 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, Consist will generate from the PrintBOS product
  line. The Company has recognized a gain of $273 in 2005 with respect of this
  sale. As of December 31, 2005, the Company has received $375 and the
  remaining $125 has been placed in an escrow for a period of three years,
  pending repayment of royalties to the Office of the Chief Scientist (OCS)
  on sales of PrintBOS products. For the year ended December 31, 2006, total
  revenues generated by Consist from the PrintBOS products were less than
  $1,000 and, therefore, the Company did not receive any royalties in 2006.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | d. | Discontinued
  operations:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    | 1.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         | Sale of
  communication segment:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            | On December
  31, 2005, the Company sold its communication segment, 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 segment (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 segment
  (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. In June 2006, the Company
  received 250,000 of Qualmax shares, valued at $1.43 per share, as part of the
  Earn Out Shares consideration.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            | 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 Qualmax.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

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.)

| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | In addition,
  the Company and IP Gear entered into an Outsourcing Agreement, pursuant to
  which the Company provided IP Gear with certain operating services relating
  to the sold communication segment through December 31, 2006. In accordance
  with the Outsourcing Agreement, the first three months of services were
  provided for no charge. For services rendered from April 2006 through
  December 2006, the Company charged IP Gear $240, which was paid by issuing
  the Company Qualmax subsidiarys shares in December 2006, as part of an
  agreement signed by the parties (see below).                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | 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 a
  major financial institution in the event such charge is recorded. In
  addition, repayment is guaranteed by Qualmax Inc.                                                                                                                                                                                                                                                                                                                                                                                                                
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | The loan
  agreement provides that if the disposed segment 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. Pursuant to
  this provision, in May 2006, Qualmax issued to the Company 244,755 shares, at
  a price of $1.43 per share, resulting in an amount of $350. In June 2006,
  Qualmax issued BOS an additional 174,825 shares, reducing the principal
  amount of the loan to $400 following which, the Company holds approximately
  17.8% of Qualmaxs total issued and outstanding Common stock. As part of the agreement
  signed between the parties in December 2006, the loan was fully repaid by
  issuance of additional shares of Qualmax (see below).                                                                                   
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | 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 warrants.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | The Company
  signed in December 2006 an agreement with Qualmax and its subsidiaries, New
  World Brands Inc. (NWB) and IP Gear, pursuant to which, the outstanding
  debt of Qualmax to the Company, in the amount of $1,480 (which included
  long-term debt, outsourcing fees, royalties and other debts), was repaid to
  the Company through the issuance of 5.506652 shares of series A Convertible
  Preferred stock of NWB which are convertible into approximately 16,450,000
  shares of NWB Common stock, reflecting a conversion rate of $0.09 per one
  share of Common stock. Conversion of the series A Preferred stock into Common
  stock will take place automatically upon effectiveness of an amendment to the
  NWBs certificate of incorporation authorizing an increase in the number of
  outstanding shares of Common stock. Following the conversion, the Company
  holds 18% in Qualmax and 4.2% in NWB. The Companys registration rights with
  respect to the Qualmax shares shall also apply to NWB shares.

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.)

| |                                                                                                                                                                                                                                                                                                    
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | In
  connection with the transaction, the Company agreed to grant NWB, contingent
  upon the satisfaction of certain conditions, a three-year option to purchase
  up to 30% of the NWBs shares held by the Company, at prices ranging from
  $0.12 to $0.24 per share of Common stock.           
| |                                                                                                                                                                                                                                                                                                    
| | In addition,
  the Company agreed to enter into a lock up agreement, restricting the
  transfer of the share holdings in Qualmax and in NWB, for up to two years.                                                                                                                                  
| |                                                                                                                                                                                                                                                                                                    
| | The Company
  accounts for its holdings in Qualmax shares on the cost basis since it is
  unable to exercise significant influence over Qualmax financial policies and
  since the shares held in Qualmax are restricted stock which do not meet the
  fair value availability criteria of FAS 115.
| |                                                                                                                                                                                                                                                                                                    
| | For the
  years ended December 31, 2006 and 2005, the Companys consolidated financial
  statements reflected a capital gain from the sale of the communication segment,
  which was determined as follows:                                                                                        

| |                                                                         |  |                           |       |      |   |        |  
| | ----------------------------------------------------------------------- |  | ------------------------- | ----- | ---- | - | ------ | -
| |                                                                         |  | Year ended
  December 31, |      
| |                                                                         |  |                           |      
| |                                                                         |  | 2006                      |       | 2005 |  
| |                                                                         |  |                           |       |      |  
| | Consideration:                                                          |  |                           |       |      |   |        |  
| | Ordinary shares of Qualmax (1)                                          |  | $                         | 957   |      | $ | 4,586  |  
| | 107,143 warrants (2)                                                    |  |                           | -     |      |   | 104    |  
| | 5.50652 series A Preferred stock of NWB
(3)                             |  |                           | 1,480 |      |   |        |  
| | Debt conversion (loan granted to IP Gear)                               |  |                           | -     |      |   | (1,000 | )
| |                                                                         |  |                           |       |      |   |        |  
|
| | Total consideration                                                     |  |                           | 2,437 |      |   | 3,690  |  
| |                                                                         |  |                           |       |      |   |        |  
| | Cost:                                                                   |  |                           |       |      |   |        |  
| | Disposal of assets (liabilities) related to
  the communication segment |  |                           | 752   |      |   | 2,425  |  
| | Transactions related costs                                              |  |                           | -     |      |   | 486    |  
| |                                                                         |  |                           |       |      |   |        |  
|
| | Total cost                                                              |  |                           | 752   |      |   | 2,911  |  
| |                                                                         |  |                           |       |      |   |        |  
|
| | Capital gain                                                            |  | $                         | 1,685 |      | $ | 779    |  
| |                                                                         |  |                           |       |      |   |        |  

| |     |                                                                                                                                        
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------
| | (1) | Valuated at $1.43 per share.                                                                                                           
| |     |                                                                                                                                        
| | (2) | Valuated at $0.97 per warrant.                                                                                                         
| |     |                                                                                                                                        
| | (3) | 5.50652 series A Preferred stock convertible into 16.5 million Common
  stock of NWB. Each Common stock is valuated at $0.09 per share.

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.)

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    | Following
  the agreement, signed in December 2006, under which the Company has accounted
  for the communication segment as a discontinued operation, in accordance
  with EITF 03-13 Applying the Conditions in Paragraph 42 of FASB Statement
  144 in Determining Whether to Report Discontinued Operations. As such, the
  results of operations, including revenues, cost of revenues, operating
  expenses, and other income and expenses of the communication segment for 2005
  and 2004, have been reclassified in the accompanying statements of operations
  as discontinued operations. The Companys balance sheet as of December 31,
  2005 reflects the net assets and liabilities of the communication segment as
  assets and liabilities related to discontinued operations.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | 2. | Discontinued
  product line:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    | 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, operating expenses and other income and expenses of
  PacInfo for 2004, have been reclassified in the accompanying statement of
  operations as discontinued operations. The Companys balance sheet at
  December 31, 2005 reflects the net assets and liabilities of PacInfo as
  assets and liabilities related to discontinued operations.                                                                                                                                                                                                                                                                                                                                                                                                             
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | 3. | The carrying
  amounts of the major classes of assets and liabilities included as part of
  the discontinued operations are:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       

| |                                                      |  |                     |      |  
| | ---------------------------------------------------- |  | ------------------- | ---- | -
| |                                                      |  | December
  31, 2005 |     
| |                                                      |  |                     |     
| |                                                      |  |                     |      |  
| | Cash
  and cash equivalents                          |  | $                   | 114  |  
| | Trade
  receivables, net                             |  |                     | 355  |  
| | Other
  accounts receivable and prepaid expenses     |  |                     | 88   |  
| | Inventories                                          |  |                     | 3    |  
| | Severance
  pay fund                                 |  |                     | 30   |  
| | Trade
  payables                                     |  |                     | (488 | )
| | Accrued
  expenses and other liabilities             |  |                     | (271 | )
| | Accrued
  severance pay                              |  |                     | (33  | )
| |                                                      |  |                     |      |  
| |                                                      |  |                     |      |  
| | Net
  liabilities related to discontinued operations |  | $                   | (202 | )
| |                                                      |  |                     |      |  

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 1:    | GENERAL (Cont.)
|            |                 |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|            |                 |  | The results
  of operations, including revenues, cost of revenues, operating expenses and
  other income and expenses of the communication segment and PacInfos
  operations for 2006, 2005 and 2004, 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 and cash flows of the
  discontinued operations is as follows:

| |                                                               |  |                           |        |      |   |        |   |   |        |  
| | ------------------------------------------------------------- |  | ------------------------- | ------ | ---- | - | ------ | - | - | ------ | -
| |                                                               |  | Year ended
  December 31, |       
| |                                                               |  |                           |       
| |                                                               |  | 2006                      |        | 2005 |   | 2004   |  
| |                                                               |  |                           |        |      |   |        |  
| |                                                               |  |                           |        |      |   |        |   |   |        |  
| | Revenues                                                      |  | $                         | -      |      | $ | 2,954  |   | $ | 1,363  |  
| | Cost of revenues                                              |  |                           | -      |      |   | 2,171  |   |   | 949    |  
| | Operating expenses                                            |  |                           | 752    |      |   | 3,157  |   |   | 2,269  |  
| |                                                               |  |                           |        |      |   |        |   |   |        |  
| |                                                               |  |                           |        |      |   |        |   |   |        |  
| | Operating loss                                                |  |                           | (752   | )    |   | (2,374 | ) |   | (1,855 | )
| | Gain derived from sale of the discontinued
  operation        |  |                           | 2,437  |      |   | 779    |   |   | -      |  
| |                                                               |  |                           |        |      |   |        |   |   |        |  
| |                                                               |  |                           |        |      |   |        |   |   |        |  
| | Net income (loss)                                             |  | $                         | 1,685  |      | $ | (1,595 | ) | $ | (1,855 | )
| |                                                               |  |                           |        |      |   |        |   |   |        |  
| |                                                               |  |                           |        |      |   |        |   |   |        |  
| |                                                               |  | Year ended December 31,   |       
| |                                                               |  |                           |       
| |                                                               |  | 2006                      |        | 2005 |   | 2004   |  
| |                                                               |  |                           |        |      |   |        |  
| |                                                               |  |                           |        |      |   |        |   |   |        |  
| | Cash flows from operating activities                          |  |                           |        |      |   |        |   |   |        |  
| | Gain (loss) from discontinue                                  |  | $                         | 1,685  |      | $ | (1,595 | ) | $ | (1,846 | )
| | Depreciation and amortization of equipment
  and intangibles  |  |                           | -      |      |   | 107    |   |   | 40     |  
| | Capital gain                                                  |  |                           | (2,052 | )    |   | (779   | ) |   | -      |  
| | Adjustments due to changes in working
  capital               |  |                           | (79    | )    |   | 620    |   |   | (787   | )
| |                                                               |  |                           |        |      |   |        |   |   |        |  
| |                                                               |  |                           |        |      |   |        |   |   |        |  
| | Net cash flows used in operating activities                   |  | $                         | (446   | )    | $ | (1,647 | ) | $ | (2,593 | )
| |                                                               |  |                           |        |      |   |        |   |   |        |  
| |                                                               |  |                           |        |      |   |        |   |   |        |  
| | Cash flows from investing activities                          |  |                           |        |      |   |        |   |   |        |  
| | Communication sales costs                                     |  | $                         | (221   | )    | $ | -      |   | $ | -      |  
| | Purchase of property and equipment                            |  |                           | -      |      |   | (27    | ) |   | -      |  
| | Payment on account of sale of Communication
  Segment         |  |                           | -      |      |   | (1,060 | ) |   | -      |  
| | Investment in Company                                         |  |                           | -      |      |   | -      |   |   | (58    | )
| |                                                               |  |                           |        |      |   |        |   |   |        |  
| |                                                               |  |                           |        |      |   |        |   |   |        |  
| | Net cash flows provided from (used in)
  investing activities |  | $                         | (221   | )    | $ | (1,087 | ) | $ | (58    | )
| |                                                               |  |                           |        |      |   |        |   |   |        |  

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                                                                                                          
|            |                                                                                                                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            | 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:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                                                                                                                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            |                                                                                                                                           | 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 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 statement of operations as financial income or expenses as
  appropriate.                                                                                                                                                                                                                                                           
|            |                                                                                                                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            |                                                                                                                                           | The
  financial statements of Odem, a subsidiary, whose functional currency as of
  December 31, 2004, was other than dollar have been translated into dollars,
  but on April 1, 2005, due to significant changes in circumstances initiated
  by management, like transition of Odems majority of sales, expenses and
  budget from New Israeli Shekels (NIS) to dollars, indicate a functional
  currency change. Since the functional currency changed from a foreign
  currency to the reporting currency, dollars, as of March 31, 2005, the
  translation adjustments for non-monetary assets prior to the change, became
  the accounting basis for the periods starting April 1, 2005.
|            |                                                                                                                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            | c.                                                                                                                                        | Principles
  of consolidation:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                                                                                                                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            |                                                                                                                                           | The
  consolidated financial statements include the accounts of the Company and its
  subsidiaries. Intercompany transactions and balances including profits from
  intercompany 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-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.)
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            | e.                                      | Marketable
  securities:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                                         | The Company
  accounts for investments in debt securities in accordance with Statement of
  Financial Accounting Standard 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, 2006 and 2005, inventory is
  presented net of $100 and $100, 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 - moving average cost method.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            | 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 and development
  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 affiliate:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                                         | An affiliate
  is a company in which the Company is able to exercise significant influence,
  but that is not a 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 affiliate until
  September 30, 2005 (see Note 6).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              

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.)
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|            |                                         | The
  investment in an affiliate 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 affiliate are recognized based on the ownership level of the particular
  security of the affiliate 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 18 The Equity Method of Accounting for Investments in Common
  Stock (APB 18). During 2005, an impairment of $1,385 has been recorded in
  equity in losses of an affiliate in the statement of operations. In 2004,
  based on managements analysis, no impairment losses were identified.
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|            | i                                       | Investment
  in other companies:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|            |                                         | Investment
  in other companies are investments in which the Company is unable 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 or changes in circumstances indicate that the carrying amount of the
  investment may not be recoverable in accordance with APB 18. During 2006, an
  impairment loss of $39 has been recorded. During 2005 and 2004, no impairment
  losses have been identified.                                                                                                                                                                                                
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|            | 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%)                                                              
| | Leasehold
  improvements         | 10      | (over the shorter of the period 
  of the lease or the life of the assets)
| | Vehicles                         | 15      |                                                                           
| | Plant                            | 4       |                                                                           

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.)
|            |                                        
|            | k.                                      | Impairment
  of long-lived assets:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                                         | The
  Companys long-lived assets are reviewed for impairment in accordance with
  Statement of Financial Accounting Standard 144 Accounting for the Impairment
  or Disposal of Long-Lived Assets (SFAS 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.
  During 2006, 2005 and 2004, no impairment losses have been identified.                                                         
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            | l.                                      | Goodwill:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                                         | Goodwill
  represents excess of the costs over the net assets of businesses acquired.
  SFAS 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 2006, 2005 and 2004, no impairment losses have been identified.                                                         
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            | m.                                      | Research and
  development costs:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                                         | Statement of
  Financial Accounting Standards 86 Accounting for the Costs of Computer
  Software to be Sold, Leased or Otherwise Marketed, (SFAS 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.                                                                                                                                                                                                                                                      

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.)
|            |                                        
|            |                                         | 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 2006, 2005 and 2004 amounted to $298, $256 and $214,
  respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            | 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 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 is 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.

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.)
|            |                                        
|            | 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.
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|            | 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. 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 trade
  receivables of the Company are derived from sales to customers located
  primarily in Israel, United States, Europe and the Far East. 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.                                                                                                                                                                                                                                                                                                                                                  
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|            |                                         | The loan
  granted to IP Gear is secured by a first priority floating charge, which may
  be subordinated to a charge in favor of a major financial institution in the
  event such charge is recorded. In addition, repayment is guaranteed by
  Qualmax Inc. (see Note 1d).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|            |                                         | The Company
  has no off-balance-sheet concentrations of credit risk such as foreign
  exchange contracts, option contracts or other foreign hedging arrangements.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         

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.)
|            |                                        
|            | s.                                      | Basic and
  diluted net earnings (loss) per share:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                         | Basic net
  earnings (loss) per share are calculated based on the weighted average number
  of Ordinary shares outstanding during each year. Diluted net earnings (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 128,
  Earnings Per Share.                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                         | The total
  number of shares related to the outstanding options and warrants excluded
  from the calculations of diluted net earnings (loss) per share, since they
  would have an anti-dilutive effect, were 1,386,424, 1,506,803 and 855,783 for
  the years ended December 31, 2006, 2005 and 2004, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            | t.                                      | Accounting
  for share-based compensation:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                         | On January
  1, 2006, the Company adopted Statement of Financial Accounting Standards 123
  (revised 2004), Share-Based Payment (SFAS 123(R)) which requires the
  measurement and recognition of compensation expense based on estimated fair
  values for all share-based payment awards made to employees and directors.
  SFAS 123(R) supersedes Accounting Principles Board Opinion 25, Accounting
  for Stock Issued to Employees (APB 25), for periods beginning in fiscal
  2006. In March 2005, the Securities and Exchange Commission issued Staff
  Accounting Bulletin 107 (SAB 107) relating to SFAS 123(R). The Company has
  applied the provisions of SAB 107 in its adoption of SFAS 123(R).                                                                                                            
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                         | SFAS 123(R)
  requires companies to estimate the fair value of equity-based payment awards
  on the date of grant using an option pricing model. The value of the portion
  of the award that is ultimately expected to vest is recognized as an expense
  over the requisite service periods in the Companys consolidated statement of
  operations. Prior to the adoption of SFAS 123(R), the Company accounted for
  equity-based awards to employees and directors using the intrinsic value
  method in accordance with APB 25 as allowed under Statement of Financial
  Accounting Standards 123, Accounting for Share-based Compensation (SFAS
  123).                                                                                                                                                                 
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                         | The Company
  adopted SFAS 123(R) using the modified prospective transition method, which
  requires the application of the Accounting Standard starting from January 1,
  2006, the first day of the Companys fiscal year 2006. Under that transition
  method, compensation cost recognized in the year ended December 31, 2006
  includes: (a) compensation cost for all share-based payments granted prior
  to, but not yet vested as of January 1, 2006, based on the date of grant fair
  value estimated in accordance with the original provisions of SFAS 123, and
  (b) compensation cost for all share-based payments granted subsequent to
  January 1, 2006, based on the date of grant fair value estimated in
  accordance with the provisions of SFAS 123(R). Results for prior periods have
  not been restated.

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.)
|                                                    |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                                                    |  | Prior to
  January 1, 2006, the Company applied the intrinsic value method of accounting
  for stock options as prescribed by APB 25, whereby compensation expense is
  equal to the excess, if any, of the quoted market price of the stock over the
  exercise price on the date of grant of the award.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|                                                    |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                                                    |  | The Company
  recognizes compensation expenses for the value of its awards granted
  subsequent to January 1, 2006 based on the straight line method over the
  requisite service period of each of the awards, net of estimated forfeitures.
  SFAS 123(R) requires forfeitures to be estimated at the time of grant and
  revised, if necessary, in subsequent periods if actual forfeitures differ
  from those estimates. Estimated forfeitures are based on actual historical
  pre-vesting forfeitures. For awards granted prior to January 1, 2006, the
  Company recognizes compensation expenses based on the accelerated attribution
  method over the requisite service period of each of the awards. Forfeitures
  were previously accounted for as they occurred, but have been estimated with
  the adoption of SFAS 123(R) for those awards not yet vested. The compensation
  expenses related to the stock options granted to employees, for the year
  ended December 31, 2006, was $360.
|                                                    |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                                                    |  | As a result
  of adopting SFAS 123(R) on January 1, 2006, the Companys income before
  income taxes and net income for the year ended December 31, 2006, is $370
  lower than if it had continued to account for share-based compensation under
  APB 25. Basic and diluted net earnings per share for the year ended December
  31, 2006, are $0.06 and $0.05, respectively, lower than if the Company had
  continued to account for share-based compensation under APB 25.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|                                                    |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                                                    |  | The Company
  estimates the fair value of stock options granted using the Black-Scholes
  options pricing model. The option-pricing model requires a number of
  assumptions, of which the most significant are expected stock price
  volatility and the expected option term. Expected volatility was calculated
  based upon actual historical stock price movements over the most recent
  periods ending on the date of grant, equal to the expected option term. The
  expected option term represents the average of the options contractual life
  and the vesting period in accordance with SAB 107 guidance. The risk-free
  interest rate is based on the yield from U.S. Treasury zero-coupon bonds with
  an equivalent term. The Company has historically not paid dividends and has
  no foreseeable plans to pay dividends.                                                                                                                                                                
|                                                    |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                                                    |  | The fair
  value for options granted in 2006 and 2005 is estimated on the date of grant
  using a Black-Scholes
  options pricing model with the following weighted average assumptions:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   

| |  |                          |  |              |      |      |  |      |  
| |  | ------------------------ |  | ------------ | ---- | ---- |  | ---- | -
| |  |                          |  | December 31, |     
| |  |                          |  |              |     
| |  |                          |  | 2006         |      | 2005 | 
| |  |                          |  |              |      |      | 
| |  |                          |  |              |      |      |  |      |  
| |  | Risk free interest       |  |              | 4.91 | %    |  | 4.00 | %
| |  | Dividend yields          |  |              | 0    | %    |  | 0    | %
| |  | Volatility               |  |              | 78   | %    |  | 120  | %
| |  | Expected term (in years) |  |              | 3    |      |  | 3    |  

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 2:    SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|                                                    |  |                                                                                                                                                                                                                                                                                    
|                                                    |  | The
  pro-forma table below reflects the Companys stock based compensation
  expense, net loss and basic and diluted net loss per share for the years
  ended December 31, 2005 and 2004, had the Company applied the fair value
  recognition provisions of SFAS 123, as follows:

| |  |                                                                                                                                                        |  |              |        |      |   |        |  
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ------------ | ------ | ---- | - | ------ | -
| |  |                                                                                                                                                        |  | December 31, |       
| |  |                                                                                                                                                        |  |              |       
| |  |                                                                                                                                                        |  | 2005         |        | 2004 |  
| |  |                                                                                                                                                        |  |              |        |      |  
| |  |                                                                                                                                                        |  |              |        |      |   |        |  
| |  | Net loss from continuing
  operations, as reported                                                                                                     |  | $            | (2,010 | )    | $ | (198   | )
| |  | Add: share-based compensation expenses
  related to employee stock options determined under intrinsic value method included in the
  reported net loss |  |              | 62     |      |   | 5      |  
| |  | Deduct: share-based compensation expense
  related to employee stock options determined under fair value method for all awards                         |  |              | (246   | )    |   | (96    | )
| |  |                                                                                                                                                        |  |              |        |      |   |        |  
| |  |                                                                                                                                                        |  |              |        |      |   |        |  
| |  | Pro forma net loss from
  continuing operations                                                                                                        |  |              | (2,194 | )    |   | (289   | )
| |  | Pro forma net loss from
  discontinued operations                                                                                                      |  |              | (1,595 | )    |   | (1,855 | )
| |  |                                                                                                                                                        |  |              |        |      |   |        |  
| |  |                                                                                                                                                        |  |              |        |      |   |        |  
| |  | Pro forma net loss                                                                                                                                     |  | $            | (3,789 | )    | $ | (2,144 | )
| |  |                                                                                                                                                        |  |              |        |      |   |        |  
| |  |                                                                                                                                                        |  |              |        |      |   |        |  
| |  | Basic and diluted net loss
  per share from continuing operations, as reported                                                                         |  | $            | (0.36  | )    | $ | (0.04  | )
| |  |                                                                                                                                                        |  |              |        |      |   |        |  
| |  |                                                                                                                                                        |  |              |        |      |   |        |  
| |  | Basic and diluted net loss
  per share from discontinued operations, as reported                                                                       |  | $            | (0.28  | )    | $ | (0.40  | )
| |  |                                                                                                                                                        |  |              |        |      |   |        |  
| |  |                                                                                                                                                        |  |              |        |      |   |        |  
| |  | Basic and diluted net loss
  per share, as reported                                                                                                    |  | $            | (0.64  | )    | $ | (0.44  | )
| |  |                                                                                                                                                        |  |              |        |      |   |        |  
| |  |                                                                                                                                                        |  |              |        |      |   |        |  
| |  | Basic and diluted net loss
  per share, including the effect of share-based compensation expense                                                       |  | $            | (0.67  | )    | $ | (0.46  | )
| |  |                                                                                                                                                        |  |              |        |      |   |        |  

| |  |                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The Company
  applies SFAS 123 Accounting for stock Based Compensation (SFAS 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 123 requires the use
  of option valuation models to measure the fair value of the warrants at the
  date of grant.

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 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.                                      | Impact of
  recently issued accounting pronouncements:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|            |                                         | In June
  2006, the FASB issued Interpretation 48 (FIN 48), Accounting for
  Uncertainty in Income Taxes (FIN 48), an interpretation of FASB Statement
  109, Accounting for Income Taxes. The Interpretation addresses the
  determination of whether tax benefits claimed or expected to be claimed on a
  tax return should be recorded in the financial statements. Under FIN 48, the
  Company may recognize the tax benefit from an uncertain tax position only if
  it is more likely than not that the tax position will be sustained on
  examination by the tax authorities, based on the technical merits of the
  position. The tax benefits recognized in the financial statements from such a
  position should be measured based on the largest benefit that has a greater
  than fifty percent likelihood of being realized upon ultimate settlement. FIN
  48 also provides guidance on de-recognition, classification, interest and
  penalties on income taxes, accounting in interim periods and requires
  increased disclosures. FIN 48 applies to all tax positions related to income
  taxes subject to SFAS 109. This includes tax positions considered to be
  routine as well as those with a high degree of uncertainty. FIN 48 specifically
  prohibits the use of a valuation allowance as a substitute for de-recognition
  of tax positions. The provisions of FIN 48 are effective beginning January 1,
  2007. The Company is currently assessing the impact that FIN 48 will have on
  its consolidated financial statements.
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|            |                                         | In September
  2006, the Financial Accounting Standards Board (FASB) issued SFAS 157,
  Fair Value Measurements (SFAS 157). This Standard defines fair value,
  establishes a framework for measuring fair value in generally accepted
  accounting principles and expands disclosures about fair value measurements.
  SFAS 157 is effective for financial statements issued for fiscal years
  beginning after November 15, 2007 and interim periods within those fiscal
  years. The Company is currently assessing the impact that SFAS 157 will have
  on its consolidated financial statements.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               

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 2:    | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|            |                                         | In February
  2007, the FASB issued SFAS 159, The Fair Value Option for Financial Assets
  and Financial Liabilities (SFAS 159). SFAS 159 permits companies to choose
  to measure certain financial instruments and certain other items at fair
  value. The Standard requires that unrealized gains and losses on items for
  which the fair value option has been elected be reported in earnings. SFAS
  159 is effective for financial statements issued for fiscal years beginning
  after November 15, 2007 and interim periods within those fiscal years,
  although earlier adoption is permitted. The Company is currently assessing
  the impact that SFAS 159 will have on its consolidated financial statements

|            |                                                          |  |                |     |      |   |     | 
|----------- | -------------------------------------------------------- |  | -------------- | --- | ---- | - | --- | 
|NOTE 3:    | OTHER ACCOUNTS RECEIVABLE AND PREPAID EXPENSES          
|            |                                                          |  | December
  31, |    
|            |                                                          |  |                |    
|            |                                                          |  | 2006           |     | 2005 |  
|            |                                                          |  |                |     |      |  
|            |                                                          |  |                |     |      |   |     | 
|            | Government
  authorities  Income tax advances and V.A.T |  | $              | 279 |      | $ | 295 | 
|            | Advances to
  suppliers                                  |  |                | 296 |      |   | -   | 
|            | Other                                                    |  |                | 283 |      |   | 209 | 
|            |                                                          |  |                |     |      |   |     | 
|            |                                                          |  |                |     |      |   |     | 
|            |                                                          |  | $              | 858 |      | $ | 504 | 
|            |                                                          |  |                |     |      |   |     | 

|            |                                                 |  |   |       |  |   |       | 
|----------- | ----------------------------------------------- |  | - | ----- |  | - | ----- | 
|NOTE 4:    | INVENTORIES                                    
|            | Raw
  materials (including packaging materials) |  | $ | 117   |  | $ | 107   | 
|            | Products in
  progress                          |  |   | 3     |  |   | 56    | 
|            | Finished
  products                             |  |   | 3,897 |  |   | 3,157 | 
|            |                                                 |  |   |       |  |   |       | 
|            |                                                 |  |   |       |  |   |       | 
|            |                                                 |  | $ | 4,017 |  | $ | 3,320 | 
|            |                                                 |  |   |       |  |   |       | 

| |                                                                                                                                                                           
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The
  inventories are presented net of provision for technological obsolescence and
  slow moving items of $100 and $100 as of December 31, 2006 and 2005,
  respectively.

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 5:    | MARKETABLE SECURITIES

The following
is a summary of securities:

|                     |  |                  |   |                            |   |                             |  |                                   |   |                  |   |                            |  |                             |       |                                   |   |   |  |   |   |  |   |       | 
|-------------------- |  | ---------------- | - | -------------------------- | - | --------------------------- |  | --------------------------------- | - | ---------------- | - | -------------------------- |  | --------------------------- | ----- | --------------------------------- | - | - |  | - | - |  | - | ----- | 
|                     |  | December
  31,   |  
|                     |  |                  |  
|                     |  | 2006             |   | 2005                       |  
|                     |  |                  |   |                            |  
|                     |  | Amortized
  cost |   | Gross
  unrealized
  gains |   | Gross
  unrealized
  losses |  | Estimated
  fair
  market
  value |   | Amortized
  cost |   | Gross
  unrealized
  gains |  | Gross
  unrealized
  losses |       | Estimated
  fair
  market
  value |  
|                     |  |                  |   |                            |   |                             |  |                                   |   |                  |   |                            |  |                             |       |                                   |  
|Available-for-sale:  |  |                  |   |                            |   |                             |  |                                   |   |                  |   |                            |  |                             |       |                                   |   |   |  |   |   |  |   |       | 
|                     |  |                  |   |                            |   |                             |  |                                   |   |                  |   |                            |  |                             |       |                                   |   |   |  |   |   |  |   |       | 
|Corporate debentures |  | $                | - |                            | $ | -                           |  | $                                 | - |                  | $ | -                          |  | $                           | 1,332 |                                   | $ | 1 |  | $ | - |  | $ | 1,333 | 
|                     |  |                  |   |                            |   |                             |  |                                   |   |                  |   |                            |  |                             |       |                                   |   |   |  |   |   |  |   |       | 

|            |                              
|----------- | -----------------------------
|NOTE 6:    | INVESTMENT IN OTHER COMPANIES

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a. | Investment
  in Surf Communication Systems Ltd.:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |    | In November
  2001, the Company invested $1,000 as part of a private placement in Surf
  Communication Systems 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 of Surf at an exercise price equal to Surfs fair value
  as determined in the investment agreement. As a result of this private
  placement, the Companys holding in Surf was diluted to 17%. Accordingly, the
  investment was accounted based on the cost accounting method.                                                       
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |    | In March
  2003, the Company engaged with Catalyst Investors L.P. (Catalyst), in order
  to purchase additional 191,548 series C Preferred shares of Surf. In
  consideration, the Company issued to Catalyst 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.                               
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |    | 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 entered into a private placement that is considered an event of
  change in circumstances having 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 affiliate in the statement of
  operations for the year December 31, 2005.

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 6:    | INVESTMENT IN OTHER COMPANIES (Cont.)

| |  |                                                                                                                                                                                                                                                                                                                                                                                      
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | In June
  2006, as part of the investment round, the Company invested $300 in Surf,
  following which, the Company holds 7.8% of Surfs issued and outstanding
  shares.                                                                                                                                                                                                             
| |  |                                                                                                                                                                                                                                                                                                                                                                                      
| |  | 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.
| |  |                                                                                                                                                                                                                                                                                                                                                                                      
| |  | Summarized
  combined financial information of Surf for the years in which the investment
  was accounted using the equity method was as follows:                                                                                                                                                                                                                                    

|                                                |  |                           |       |      |   |       | 
|----------------------------------------------- |  | ------------------------- | ----- | ---- | - | ----- | 
|                                                |  | Year ended
  December 31, |      
|                                                |  |                           |      
|                                                |  | 2005                      |       | 2004 |  
|                                                |  |                           |       |      |  
|                                                |  |                           |       |      |   |       | 
|Revenues                                        |  | $                         | 2,055 |      | $ | 2,762 | 
|                                                |  |                           |       |      |   |       | 
|                                                |  |                           |       |      |   |       | 
|Cost of sales                                   |  | $                         | 660   |      | $ | 700   | 
|                                                |  |                           |       |      |   |       | 
|                                                |  |                           |       |      |   |       | 
|Operating expenses from continuing
  operations |  | $                         | 3,694 |      | $ | 4,037 | 
|                                                |  |                           |       |      |   |       | 
|                                                |  |                           |       |      |   |       | 
|Net loss                                        |  | $                         | 2,334 |      | $ | 1,971 | 
|                                                |  |                           |       |      |   |       | 

| |    |                                                      
| | -- | -----------------------------------------------------
| | b. | The
  Companys investments in companies comprise of:

|                                |  |                |       |      |   |       | 
|------------------------------- |  | -------------- | ----- | ---- | - | ----- | 
|                                |  | December
  31, |      
|                                |  |                |      
|                                |  | 2006           |       | 2005 |  
|                                |  |                |       |      |  
|                                |  |                |       |      |   |       | 
|Surf Communication Systems Ltd. |  | $              | 983   |      | $ | 722   | 
|                                |  |                |       |      |   |       | 
|Qualmax Inc. (1)                |  |                | 5,619 |      |   | 4,690 | 
|                                |  |                |       |      |   |       | 
|New World Brands Inc. (1)       |  |                | 1,480 |      |   | -     | 
|                                |  |                |       |      |   |       | 
|                                |  |                |       |      |   |       | 
|                                |  | $              | 8,082 |      | $ | 5,412 | 
|                                |  |                |       |      |   |       | 
|                                |  |                |       |      |   |       | 
|(1)     See
  Note 1d.         

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 7:    | PROPERTY, PLANT AND EQUIPMENT

|                                 |  |                |       |      |   |       | 
|-------------------------------- |  | -------------- | ----- | ---- | - | ----- | 
|                                 |  | December
  31, |      
|                                 |  |                |      
|                                 |  | 2006           |       | 2005 |  
|                                 |  |                |       |      |  
|Cost:                            |  |                |       |      |   |       | 
|Computers and software           |  | $              | 1,697 |      | $ | 1,683 | 
|Office furniture and equipment   |  |                | 458   |      |   | 448   | 
|Leasehold improvements and plant |  |                | 1,116 |      |   | 1,116 | 
|Vehicles                         |  |                | 89    |      |   | 89    | 
|                                 |  |                |       |      |   |       | 
|                                 |  |                |       |      |   |       | 
|                                 |  |                | 3,360 |      |   | 3,336 | 
|                                 |  |                |       |      |   |       | 
|Accumulated depreciation:        |  |                |       |      |   |       | 
|Computers and software           |  |                | 1,569 |      |   | 1,511 | 
|Office furniture and equipment   |  |                | 301   |      |   | 288   | 
|Leasehold improvements and plant |  |                | 906   |      |   | 816   | 
|Vehicles                         |  |                | 64    |      |   | 54    | 
|                                 |  |                |       |      |   |       | 
|                                 |  |                |       |      |   |       | 
|                                 |  |                | 2,840 |      |   | 2,669 | 
|                                 |  |                |       |      |   |       | 
|                                 |  |                |       |      |   |       | 
|Depreciated cost                 |  | $              | 520   |      | $ | 667   | 
|                                 |  |                |       |      |   |       | 

Depreciation
expenses amounted to $171, $317 and $294 for the years ended December 31, 2006,
2005 and 2004, respectively.

|            |                   
|----------- | ------------------
|NOTE 8:    | CUSTOMER LIST, NET

|                          |  |                |       |      |   |       | 
|------------------------- |  | -------------- | ----- | ---- | - | ----- | 
|                          |  | December
  31, |      
|                          |  |                |      
|                          |  | 2006           |       | 2005 |  
|                          |  |                |       |      |  
|Cost:                     |  |                |       |      |   |       | 
|Customer list             |  | $              | 2,010 |      | $ | 2,010 | 
|                          |  |                |       |      |   |       | 
|                          |  |                |       |      |   |       | 
|Accumulated amortization: |  |                |       |      |   |       | 
|Customer list             |  |                | 381   |      |   | 174   | 
|                          |  |                |       |      |   |       | 
|                          |  |                |       |      |   |       | 
|Amortized cost            |  | $              | 1,629 |      | $ | 1,836 | 
|                          |  |                |       |      |   |       | 

Amortization
expenses amounted to $207, $157 and $17 for the years ended December 31, 2006,
2005 and 2004, respectively.

Estimated
amortization expenses for the years ended:

|            |  |                |       | 
|----------- |  | -------------- | ----- | 
|            |  | December
  31, |      
|            |  |                |      
|            |  |                |       | 
|2007        |  | $              | 207   | 
|2008        |  |                | 207   | 
|2009        |  |                | 207   | 
|2010        |  |                | 207   | 
|2011 - 2014 |  |                | 801   | 
|            |  |                |       | 
|            |  |                |       | 
|            |  | $              | 1,629 | 
|            |  |                |       | 

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 9:    | GOODWILL                                                                                                   
|            |                                                                                                            
|            | Goodwill
  attributed to operating segments for the years ended December 31, 2006 and
  2005 is as follows:

| |                                            |  |                       |      |                      |   |       |  |   |       |  
| | ------------------------------------------ |  | --------------------- | ---- | -------------------- | - | ----- |  | - | ----- | -
| |                                            |  | Software 
  solutions |      | Supplychainsolutions |   | Total | 
| |                                            |  |                       |      |                      |   |       | 
| |                                            |  |                       |      |                      |   |       |  |   |       |  
| | Balance as of January 1, 2005              |  | $                     | 903  |                      | $ | 666   |  | $ | 1,569 |  
| |                                            |  |                       |      |                      |   |       |  |   |       |  
| | Foreign currency translation
  adjustments |  |                       | -    |                      |   | 4     |  |   | 4     |  
| | Exercise of options in Odem                |  |                       | -    |                      |   | 282   |  |   | 282   |  
| | Disposal of the communication
  segment    |  |                       | (903 | )                    |   | -     |  |   | (903  | )
| |                                            |  |                       |      |                      |   |       |  |   |       |  
| |                                            |  |                       |      |                      |   |       |  |   |       |  
| | Balance as of December 31, 2005            |  | $                     | -    |                      | $ | 952   |  | $ | 952   |  
| |                                            |  |                       |      |                      |   |       |  |   |       |  
| |                                            |  |                       |      |                      |   |       |  |   |       |  
| | Balance as of December 31, 2006            |  | $                     | -    |                      | $ | 952   |  | $ | 952   |  
| |                                            |  |                       |      |                      |   |       |  |   |       |  

|            |                      
|----------- | ---------------------
|NOTE 10:   | SHORT-TERM BANK LOANS

|            |                                                                                   |  |                              |      |                |   |       |  |   |       | 
|----------- | --------------------------------------------------------------------------------- |  | ---------------------------- | ---- | -------------- | - | ----- |  | - | ----- | 
|            |                                                                                   |  | Weighted 
  interest 
  rate |      | December
  31, |  
|            |                                                                                   |  |                              |      |                |  
|            |                                                                                   |  | %                            |      | 2006           |   | 2005  | 
|            |                                                                                   |  |                              |      |                |   |       | 
|            |                                                                                   |  |                              |      |                |   |       |  |   |       | 
|            | NIS                                                                               |  |                              | 7.42 |                | $ | 2,931 |  | $ | 2,271 | 
|            |                                                                                   |  |                              |      |                |   |       |  |   |       | 
|            |                                                                                   |  |                              |      |                |   |       |  |   |       | 
|            | Regarding collateral given to insure short-term credit and loans, see
  Note 12c. | 
|            |                                                                                   |  |                              |      |                |   |       |  |   |       | 
|NOTE 11:   | ACCRUED EXPENSES AND OTHER LIABILITIES                                            | 

| |                                              |  |                |     |      |   |       | 
| | -------------------------------------------- |  | -------------- | --- | ---- | - | ----- | 
| |                                              |  | December
  31, |    
| |                                              |  |                |    
| |                                              |  | 2006           |     | 2005 |  
| |                                              |  |                |     |      |  
| |                                              |  |                |     |      |   |       | 
| | Government of Israel  royalties
  and V.A.T |  | $              | 319 |      | $ | 306   | 
| | Provision for warranty                       |  |                | 73  |      |   | 73    | 
| | Professional
  services                      |  |                | 255 |      |   | 84    | 
| | Accrued expenses                             |  |                | -   |      |   | 738   | 
| | Other                                        |  |                | 352 |      |   | 205   | 
| |                                              |  |                |     |      |   |       | 
| |                                              |  |                |     |      |   |       | 
| |                                              |  | $              | 999 |      | $ | 1,406 | 
| |                                              |  |                |     |      |   |       | 

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 12:   | 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, |  
| |                               |  |                              |      |                |  
| |                               |  | %                            |      | 2006           |   | 2005 | 
| |                               |  |                              |      |                |   |      | 
| |                               |  |                              |      |                |   |      |  |   |    | 
| | NIS linked to the Israeli CPI |  |                              | 7.95 |                | $ | 18   |  | $ | 33 | 
| | NIS                           |  |                              | 6.95 |                |   | -    |  |   | 12 | 
| |                               |  |                              |      |                |   |      |  |   |    | 
| |                               |  |                              |      |                |   |      |  |   |    | 
| |                               |  |                              |      |                |   | 18   |  |   | 45 | 
| | Less  current maturities     |  |                              |      |                |   | 18   |  |   | 28 | 
| |                               |  |                              |      |                |   |      |  |   |    | 
| |                               |  |                              |      |                |   |      |  |   |    | 
| |                               |  |                              |      |                | $ | -    |  | $ | 17 | 
| |                               |  |                              |      |                |   |      |  |   |    | 

| |    |                                                                                 
| | -- | --------------------------------------------------------------------------------
| | b. | The loans
  mature in the following years subsequent to the balance sheet dates:

| |                                 |  |                |    | 
| | ------------------------------- |  | -------------- | -- | 
| |                                 |  | December
  31, |   
| |                                 |  |                |    | 
| |                                 |  |                |    | 
| | First year (current maturities) |  | $              | 18 | 
| |                                 |  |                |    | 

|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |                                                                                       
|----------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------
|            | c.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      | Odem has
  registered fixed pledges on its real estate, plant, equipment and vehicles.
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |                                                                                       
|NOTE 13:   | 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.

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 13:   | LONG-TERM CONVERTIBLE NOTE (Cont.)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|            | 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-Scholes
  options 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|            | In September
  2005, the Company entered into a Second Securities Purchase Agreement (the
  Second 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 Second 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  

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 13:   | LONG-TERM CONVERTIBLE NOTE (Cont.)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            | The fair
  value of the warrants was calculated using the Black-Scholes options
  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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            | On August
  17, 2006 the Company entered into a Third Securities Purchase Agreement (the
  Third Agreement) with the investor under which the Company issued to the
  Investor in a private placement (i) a third Convertible Term Note of a $1,500
  principal amount, due August 2009 (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 for the first 500,000 and $4.08 for any additional amount payable
  thereunder. The principal amount of the Note is repayable in monthly
  installments, commencing as of December 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 August 16, 2013 at an exercise price
  of $4.04 for the first 24,351 Ordinary shares acquirable thereunder, and of
  $5.30 per share for the additional 48,701 acquirable thereunder. 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 December 5, 2006.
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            | The fair
  value of the warrants was calculated using the Black-Scholes
  options pricing model with the following assumptions: a risk-free
  interest rate of 4.83%, a dividend yield of 0%, a volatility of the expected
  market price of the Companys Ordinary shares of 80% and a weighted-average
  contractual life of seven years. The fair value of the warrants in the amount
  of $131 is offset against the note, amortized over the period of the note and
  presented as a component in shareholders equity.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            | The maturity
  of the loans is as follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      

| |                                 |  |              |       |      |   |       | 
| | ------------------------------- |  | ------------ | ----- | ---- | - | ----- | 
| |                                 |  | December 31, |      
| |                                 |  |              |      
| |                                 |  | 2006         |       | 2005 |  
| |                                 |  |              |       |      |  
| |                                 |  |              |       |      |   |       | 
| | First year (current maturities) |  | $            | 1,139 |      | $ | 326   | 
| | Second year                     |  |              | 1,104 |      |   | 663   | 
| | Third year                      |  |              | 331   |      |   | 496   | 
| |                                 |  |              |       |      |   |       | 
| |                                 |  |              |       |      |   |       | 
| |                                 |  |              | 2,574 |      |   | 1,485 | 
| | Less  discount                 |  |              | 264   |      |   | 238   | 
| |                                 |  |              |       |      |   |       | 
| |                                 |  |              |       |      |   |       | 
| |                                 |  | $            | 2,310 |      | $ | 1,247 | 
| |                                 |  |              |       |      |   |       | 

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 14:   | 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, 2006, the Company has an outstanding contingent obligation to
  pay royalties in the amount of approximately $3,430, 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.                                                                                                                                                                                                                                                                                                                                                                        
|            |                                        |              |                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|            |                                        |              |                                                                                                                                                                                                                                               | As of
  December 31, 2006, the Company has an outstanding contingent obligation to
  pay royalties of $89 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
  2007, 2008 and 2009 are $39, 14 and $14 respectively.                        
|            |                                        |             
|            |                                        |              | 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 amount to $40.
|            |                                        |             
|            |                                        |              | Lease
  payments for the facilities occupied by the Company and the Companys motor
  vehicles in 2006, 2005 and 2004 amounted to $343, $408 and $385,
  respectively.                                                                       

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 14:   | 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 legal 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 1998, as
  part of PacInfo Share Purchase Agreement between the Company and Mr. Lee and
  Ms. Lee (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. 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 counsel opinion and management estimation, no provision was recorded.
|            |                                                |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|            |                                                | 3. | 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. The
  claim is in the amount of  1.4 million and it alleges breach of exclusive
  distributor rights in France. This claim follows a previous motion for
  temporary injunctive relief that was filed against the Companys new French
  distributor, said motion was ultimately denied by French Trade Tribunal. The
  Company assesses the prospects of the claimant to prevail and recover a significant
  amount, as remote. The financial statements include a provision in
  the respect.                                                                                                                                                                                                                                                                                                                                                                                                 

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 15:   | 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 953,743 Ordinary shares at a
  purchase price of $2.30 per share, for a consideration of approximately $2,040
  (net of $154 of issuance expenses).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|            |                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                      | 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, 2006 are as
  follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   

| |                 |  |                                  |  |                              |  |                        |   |                       |   |  |  |  |         |  |  |             |  |  | 
| | --------------- |  | -------------------------------- |  | ---------------------------- |  | ---------------------- | - | --------------------- | - |  |  |  | ------- |  |  | ----------- |  |  | 
| | Issuance
  date |  | Warrants
  for
  Ordinary shares |  | Exercise
  price
  per share |  | Warrants
  exercisable |   | Exercisable
  through |  
| |                 |  |                                  |  |                              |  |                        |   |                       |  
| |                 |  |                                  |  |                              |  |                        |   |                       |   |  |  |  |         |  |  |             |  |  | 
| | June 2005       |  |                                  |  | 441,785                      |  |                        | $ | (*                    | ) |  |  |  | 441,785 |  |  | June
  2008 | 
| | July 2005       |  |                                  |  | 130,434                      |  |                        | $ | (*                    | ) |  |  |  | 130,434 |  |  | June
  2008 | 
| |                 |  |                                  |  |                              |  |                        |   |                       |   |  |  |  |         |  |  |             |  |  | 
| |                 |  |                                  |  |                              |  |                        |   |                       |   |  |  |  |         |  |  |             |  |  | 
| |                 |  |                                  |  | 572,219                      |  |                        |   |                       |   |  |  |  | 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:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |                                                                                                                                                                                                                                                    
| |    | 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. In
  June 2005, the Companys shareholders approved an increase of the number of
  Ordinary shares reserved for issuance under the 2003 Stock Option Plan, to
  1,000,000. In May 2006, the Companys shareholders approved an increase of
  the number of Ordinary shares reserved for issuance under the 2003 Stock
  Option Plan, to 1,500,000. Any option which is canceled or forfeited before
  expiration, will become available for future grants.

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 15:   | SHAREHOLDERS EQUITY (Cont.)
|            |                              |                                                                                                                                                                                                                                                                                                                                                               
|            |                              | As of
  December 31, 2006, an aggregate 200,073 of these options are still available
  for future grants. Each option granted under the Plans expires between 3-10
  years from the date of the grant. The options vest gradually over a period of
  up to up to four years.                                                                                  
|            |                              |                                                                                                                                                                                                                                                                                                                                                               
|            |                              | During 1994,
  1995, 1999, 2000, 2001, the Companys Board 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 has resolved that no further grants shall
  be made from these Plans.
|            |                              |                                                                                                                                                                                                                                                                                                                                                               
|            |                              | A summary of
  employee option activity under the Companys stock option plans as of
  December 31, 2006, 2005 and 2004 and changes for the years then ended are as
  follows:                                                                                                                                                                                

|                                         |  |                         |         |                                       |   |                     |  |                                       |          |                     |   |                                       |  |  |         |   |   |       | 
|---------------------------------------- |  | ----------------------- | ------- | ------------------------------------- | - | ------------------- |  | ------------------------------------- | -------- | ------------------- | - | ------------------------------------- |  |  | ------- | - | - | ----- | 
|                                         |  | Year ended December 31, |        
|                                         |  |                         |        
|                                         |  | 2006                    |         | 2005                                  |   | 2004                | 
|                                         |  |                         |         |                                       |   |                     | 
|                                         |  | Number
  of options     |         | Weighted
  average
  exercise
  price |   | Number
  of options |  | Weighted
  average
  exercise
  price |          | Number
  of options |   | Weighted
  average
  exercise
  price | 
|                                         |  |                         |         |                                       |   |                     |  |                                       |          |                     |   |                                       | 
|                                        
|Options outstanding at beginning of year |  |                         | 400,250 |                                       | $ | 4.77                |  |                                       | 430,576  |                     | $ | 9.47                                  |  |  | 426,252 |   | $ | 11.93 | 
|Changes during the year:                 |  |                         |         |                                       |   |                     |  |                                       |          |                     |   |                                       |  |  |         |   |   |       | 
|Granted                                  |  |                         | 535,237 |                                       | $ | 2.67                |  |                                       | 107,000  |                     | $ | 2.91                                  |  |  | 92,500  |   | $ | 0.54  | 
|Exercised                                |  |                         | (68,747 | )                                     | $ | 1.98                |  |                                       | (25,088  | )                   | $ | 2.00                                  |  |  | -       |   | $ | -     | 
|Forfeited or cancelled                   |  |                         | (44,080 | )                                     | $ | 10.68               |  |                                       | (112,238 | )                   | $ | 21.66                                 |  |  | (88,176 | ) | $ | 11.97 | 
|                                         |  |                         |         |                                       |   |                     |  |                                       |          |                     |   |                                       |  |  |         |   |   |       | 
|                                         |  |                         |         |                                       |   |                     |  |                                       |          |                     |   |                                       |  |  |         |   |   |       | 
|Options outstanding at end of year       |  |                         | 822,660 |                                       | $ | 3.36                |  |                                       | 400,250  |                     | $ | 4.77                                  |  |  | 430,576 |   | $ | 9.47  | 
|                                         |  |                         |         |                                       |   |                     |  |                                       |          |                     |   |                                       |  |  |         |   |   |       | 
|                                         |  |                         |         |                                       |   |                     |  |                                       |          |                     |   |                                       |  |  |         |   |   |       | 
|Options exercisable at end of year       |  |                         | 162,423 |                                       | $ | 7.29                |  |                                       | 217,750  |                     | $ | 7.40                                  |  |  | 248,790 |   | $ | 5.49  | 
|                                         |  |                         |         |                                       |   |                     |  |                                       |          |                     |   |                                       |  |  |         |   |   |       | 

| |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The
  weighted-average date of grant fair value of options granted during the years
  ended December 31, 2006, 2005 and 2004 were $1.45, $2.13 and $2.58,
  respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |  | As of
  December 31, 2006, there was $611 of total unrecognized compensation cost
  related to non-vested share-based compensation arrangements granted to
  employees and directors under the Companys Plans. That cost is expected to
  be recognized over a weighted-average period of 1.5 years.                                                                                                                                                                                                                                                                                                         
| |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |  | 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 date of grant 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-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 15:   | SHAREHOLDERS EQUITY (Cont.)
|            |                              |                                                                                                                                                                                                                                                                                                                                                                      
|            |                              | As part of
  the disposition of the communication segment and the PrintBOS product line,
  the Company extended the options contractual life of employees who became the
  buyers employees. As a result, the Company recorded an expense of $104 in
  2005 which was offset from the capital gain derived from the sale of this
  segment and product line in 2005.
|            |                              |                                                                                                                                                                                                                                                                                                                                                                      
|            |                              | On May 18,
  2006, the shareholders approved to grant a bonus of 21,666 Ordinary shares to
  the Chairman of the Companys Board at no consideration. The fair value of
  the shares granted was $60 at the date of grant.                                                                                                                                           
|            |                              |                                                                                                                                                                                                                                                                                                                                                                      
|            |                              | Except for
  these options, all other options granted to employees in 2006, 2005 and 2004,
  have an exercise price equal to or higher than the market value of the
  Ordinary shares at the date of grant.                                                                                                                                                          
|            |                              |                                                                                                                                                                                                                                                                                                                                                                      
|            |                              | The options
  granted to employees outstanding as of December 31, 2006 have been separated
  into ranges of exercise prices, as follows:                                                                                                                                                                                                                             

| |                             |  |                                                     |         |                                       |   |                                                             |  |                                                     |      |                                                                  |  |         |  |   |       | 
| | --------------------------- |  | --------------------------------------------------- | ------- | ------------------------------------- | - | ----------------------------------------------------------- |  | --------------------------------------------------- | ---- | ---------------------------------------------------------------- |  | ------- |  | - | ----- | 
| | Range of
  exercise
  price |  | Options
  outstanding
  as of
  December 31,
  2006 |         | Weighted
  average
  exercise
  price |   | Weighted
  average
  remaining
  contractual
  life (years) |  | Options
  exercisable
  as of
  December 31,
  2006 |      | Weighted
  average
  exercise
  price of
  options
  exercisable | 
| |                             |  |                                                     |         |                                       |   |                                                             |  |                                                     |      |                                                                  | 
| |                             |  |                                                     |         |                                       |   |                                                             |  |                                                     |      |                                                                  |  |         |  |   |       | 
| | $ 0                         |  |                                                     | 73,000  |                                       | $ | 0.00                                                        |  |                                                     | 7.99 |                                                                  |  | -       |  | $ | 0.00  | 
| | $ 1.84-2.00                 |  |                                                     | 67,961  |                                       | $ | 1.89                                                        |  |                                                     | 3.00 |                                                                  |  | 67,961  |  | $ | 1.89  | 
| | $ 2.28-3.08                 |  |                                                     | 628,237 |                                       | $ | 2.70                                                        |  |                                                     | 5.18 |                                                                  |  | 41,000  |  | $ | 2.46  | 
| | $ 6.8                       |  |                                                     | 26,137  |                                       | $ | 6.80                                                        |  |                                                     | 1.34 |                                                                  |  | 26,137  |  | $ | 6.80  | 
| | $ 18.00                     |  |                                                     | 750     |                                       | $ | 18.00                                                       |  |                                                     | 2.36 |                                                                  |  | 750     |  | $ | 18.00 | 
| | $ 28.00                     |  |                                                     | 26,575  |                                       | $ | 28.00                                                       |  |                                                     | 1.35 |                                                                  |  | 26,575  |  | $ | 28.00 | 
| |                             |  |                                                     |         |                                       |   |                                                             |  |                                                     |      |                                                                  |  |         |  |   |       | 
| |                             |  |                                                     |         |                                       |   |                                                             |  |                                                     |      |                                                                  |  |         |  |   |       | 
| |                             |  |                                                     | 822,660 |                                       | $ | 3.36                                                        |  |                                                     | 5.01 |                                                                  |  | 162,423 |  | $ | 7.29  | 
| |                             |  |                                                     |         |                                       |   |                                                             |  |                                                     |      |                                                                  |  |         |  |   |       | 

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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 options pricing model with the following
  assumptions for the years ended December 31, 2006 and 2005: risk-free
  interest rate of 4.9% and 1.5%, respectively, dividend yields of 0% and 0%,
  respectively, volatility of 77% and 70%, respectively, and an expected life
  of 4.2 years and 2.5 years, respectively.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    | The
  compensation expenses that have been recorded in the consolidated financial
  statements regarding these stock options for the years ended December 31,
  2006, 2005 and 2004 were $116, $348 and $117 respectively.                                                                                                                                                                                                                                                                                                 
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    | On May 18,
  2006, the shareholders approved to grant a bonus of 65,000 Ordinary shares to
  the Companys former President and CEO at no consideration. The fair value of
  the shares granted was $180 at the date of grant.                                                                                                                                                                                                                                                                                             

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 15:   | SHAREHOLDERS EQUITY (Cont.)
|            |                              |                                                                                                   
|            |                              | The
  Companys outstanding options to service providers as of December 31, 2006
  are as follows:

| |                |  |                                 |         |                            |   |                       |  |                     |         |  |                               | 
| | -------------- |  | ------------------------------- | ------- | -------------------------- | - | --------------------- |  | ------------------- | ------- |  | ----------------------------- | 
| | Issuance date  |  | Options for
  Ordinary
  shares |         | Exercise price
  per share |   | Options
  exercisable |  | Exercisable through |        
| |                |  |                                 |         |                            |   |                       |  |                     |        
| |                |  |                                 |         |                            |   |                       |  |                     |         |  |                               | 
| | October 2002   |  |                                 | 75,000  |                            | $ | 4.00                  |  |                     | 75,000  |  | June 2011                     | 
| | January 2004   |  |                                 | 216,282 |                            | $ | 3.00                  |  |                     | 216,282 |  | May 2013                      | 
| | June 2004      |  |                                 | 130,000 |                            | $ | 4.04                  |  |                     | 130,000 |  | June 2011                     | 
| | March 2005     |  |                                 | 10,000  |                            | $ | 3.08                  |  |                     | 10,000  |  | March 2007                    | 
| | March 2005     |  |                                 | 10,000  |                            | $ | 3.08                  |  |                     | 3,334   |  | March 2010                    | 
| | June 2005      |  |                                 | 20,000  |                            | $ | 3.08                  |  |                     | 15,002  |  | June 2010                     | 
| | September 2005 |  |                                 | 73,052  |                            | $ | 4.04                  |  |                     | 73,052  |  | September 2012                | 
| | March 2006     |  |                                 | 10,000  |                            | $ | 2.30                  |  |                     | 10,000  |  | December 2010                 | 
| | May 2006       |  |                                 | 187,100 |                            | $ | 2.68                  |  |                     | -       |  | May 2010 - through
  May 2012 | 
| | August 2006    |  |                                 | 48,701  |                            | $ | 5.30                  |  |                     | 48,701  |  | August 2013                   | 
| | August 2006    |  |                                 | 24,351  |                            | $ | 4.04                  |  |                     | 24,351  |  | August 2013                   | 
| |                |  |                                 |         |                            |   |                       |  |                     |         |  |                               | 
| |                |  |                                 |         |                            |   |                       |  |                     |         |  |                               | 
| |                |  |                                 | 804,486 |                            |   |                       |  |                     | 605,722 |  |                               | 
| |                |  |                                 |         |                            |   |                       |  |                     |         |  |                               | 

|            |                 |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|----------- | --------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 16:   | TAXES ON INCOME
|            |                 |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            | a.              | Reduction in
  corporate tax rate:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                 |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                 | In June
  2004, an amendment to the Income Tax Ordinance (No. 140 and Temporary
  Provision), 2004 was passed by the Knesset (Israeli parliament) and on July
  25, 2005, another law was passed, the amendment to the Income Tax Ordinance
  (No. 147) 2005, according to which the corporate tax rate is to be
  progressively reduced to the following tax rates: 2004 - 35%, 2005 - 34%,
  2006 - 31%, 2007 - 29%, 2008 - 27%, 2009 - 26%, 2010 and thereafter - 25%.                                                                                         
|            |                 |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                 | The Odem
  operation is 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-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 16:   | TAXES ON INCOME (Cont.)
|            |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|            |                         | The Company
  is also a Foreign Investors Company, as defined by the above mentioned 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, may be 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 according
  to the assets ratio method into a taxable income that is entitled to the
  benefits of the Approved Enterprise and into an income that will be taxed
  at the regular 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, may be 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 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 management believes that the companies are meeting the
  aforementioned conditions.                                                                                                                                                                                                                                                                                  
|            |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|            |                         | 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 (based on the percentage of foreign ownership in each taxable
  year). In addition, these dividends will be subject to 15% withholding tax.                                                                                                                                                                                                                                              
|            |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|            |                         | As of
  December 31, 2006, the Company and BOScom have not yet utilized any tax
  benefit since they have not generated any taxable income.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

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 16:   | TAXES ON INCOME (Cont.)
|            |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|            |                         | 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 a above.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|            |                         | 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 Investment 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, 2006, 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, 2006, in the amount of approximately $30,985.
  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, 2006, the U.S. subsidiaries which were classified as
  discontinued operations had U.S. Federal and State net operating loss
  carryforward of approximately $10,265, 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, 2006, BOS UK had net operating loss carryforward of
  approximately $3,500. In February 2006, the Company filed with the UK
  Companies House an application to dissolve BOS UK.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     

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 16:   | TAXES ON INCOME (Cont.)
|            |                         |                                                                                                                                                                                                                                                                                                                    
|            | 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:

| |                                                      |  |                |         |      |   |         |  
| | ---------------------------------------------------- |  | -------------- | ------- | ---- | - | ------- | -
| |                                                      |  | December
  31, |        
| |                                                      |  |                |        
| |                                                      |  | 2006           |         | 2005 |  
| |                                                      |  |                |         |      |  
| | Assets in respect of:                                |  |                |         |      |   |         |  
| |                                                      |  |                |         |      |   |         |  
| | Property, plant and equipment                        |  | $              | 3       |      | $ | 3       |  
| | Allowances and provisions                            |  |                | 296     |      |   | 865     |  
| | Net operating loss carryforward                      |  |                | 10,674  |      |   | 9,350   |  
| |                                                      |  |                |         |      |   |         |  
| |                                                      |  |                |         |      |   |         |  
| |                                                      |  |                | 10,973  |      |   | 10,218  |  
| | Liabilities in respect of
  intangible assets        |  |                | (422    | )    |   | (486    | )
| |                                                      |  |                |         |      |   |         |  
| |                                                      |  |                |         |      |   |         |  
| | Net deferred tax assets before
  valuation allowance |  |                | 10,551  |      |   | 9,732   |  
| | Valuation allowance (1)                              |  |                | (10,936 | )    |   | (10,187 | )
| |                                                      |  |                |         |      |   |         |  
| |                                                      |  |                |         |      |   |         |  
| | Net deferred tax liability                           |  | $              | (385    | )    | $ | (455    | )
| |                                                      |  |                |         |      |   |         |  

| |     |                                                                                                                                                                                                                                                                                                                                          
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (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 their history of operating losses and current
  uncertainty concerning their ability to realize these deferred tax assets in
  the future.

| |                             |  |                |      |      |   |      |  
| | --------------------------- |  | -------------- | ---- | ---- | - | ---- | -
| |                             |  | December
  31, |     
| |                             |  |                |     
| |                             |  | 2006           |      | 2005 |  
| |                             |  |                |      |      |  
| | Presented in balance sheet: |  |                |      |      |   |      |  
| |                             |  |                |      |      |   |      |  
| | Current assets              |  | $              | 14   |      | $ | 13   |  
| | Long-term assets            |  |                | 23   |      |   | 18   |  
| | Current liabilities         |  |                | (60  | )    |   | (64  | )
| | Long-term liabilities       |  |                | (362 | )    |   | (422 | )
| |                             |  |                |      |      |   |      |  
| |                             |  |                |      |      |   |      |  
| | Net deferred tax liability  |  | $              | (385 | )    | $ | (455 | )
| |                             |  |                |      |      |   |      |  
| |                             |  |                |      |      |   |      |  
| | Net deferred tax  domestic |  | $              | (385 | )    | $ | (455 | )
| |                             |  |                |      |      |   |      |  

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 16:   | TAXES ON INCOME (Cont.)
|            |                         |                                                           
|            | e.                      | Tax benefits (taxes on income) are comprised as
  follows:

| |          |  |                           |     |      |   |      |   |   |     |  
| | -------- |  | ------------------------- | --- | ---- | - | ---- | - | - | --- | -
| |          |  | Year ended
  December 31, |    
| |          |  |                           |    
| |          |  | 2006                      |     | 2005 |   | 2004 |  
| |          |  |                           |     |      |   |      |  
| |          |  |                           |     |      |   |      |   |   |     |  
| | Current  |  | $                         | (17 | )    | $ | (259 | ) | $ | (63 | )
| | Deferred |  |                           | 106 |      |   | 55   |   |   | 43  |  
| |          |  |                           |     |      |   |      |   |   |     |  
| |          |  |                           |     |      |   |      |   |   |     |  
| |          |  | $                         | 89  |      | $ | (204 | ) | $ | (20 | )
| |          |  |                           |     |      |   |      |   |   |     |  
| |          |  |                           |     |      |   |      |   |   |     |  
| | Domestic |  | $                         | 106 |      | $ | (74  | ) | $ | (20 | )
| | Foreign  |  |                           | (17 | )    |   | (130 | ) |   | -   |  
| |          |  |                           |     |      |   |      |   |   |     |  
| |          |  |                           |     |      |   |      |   |   |     |  
| |          |  | $                         | 89  |      | $ | (204 | ) | $ | (20 | )
| |          |  |                           |     |      |   |      |   |   |     |  

| |    |              
| | -- | -------------
| | f. | Effective tax

| |                                                                                                     |  |   |        |   |   |     |   |   |     |  
| | --------------------------------------------------------------------------------------------------- |  | - | ------ | - | - | --- | - | - | --- | -
| | Income
  (loss) before taxes on income from operating activities related to continuing
  operations |  | $ | (1,682 | ) | $ | 167 |   | $ | 147 |  
| |                                                                                                     |  |   |        |   |   |     |   |   |     |  
| |                                                                                                     |  |   |        |   |   |     |   |   |     |  
| | Statutory
  tax rate                                                                                |  |   | 31     | % |   | 34  | % |   | 35  | %
| |                                                                                                     |  |   |        |   |   |     |   |   |     |  
| |                                                                                                     |  |   |        |   |   |     |   |   |     |  
| | Provision
  at statutory tax rate                                                                   |  |   | (521   | ) |   | 57  |   |   | 51  |  
| | Non-deductible
  expenses                                                                           |  |   | 21     |   |   | 219 |   |   | 16  |  
| | Deferred
  taxes on losses reserves and allowances for which a valuation allowance was
  provided   |  |   | 411    |   |   | (72 | ) |   | (47 | )
| |                                                                                                     |  |   |        |   |   |     |   |   |     |  
| |                                                                                                     |  |   |        |   |   |     |   |   |     |  
| | Taxes
  on income (tax benefit)                                                                     |  | $ | (89    | ) | $ | 204 |   | $ | 20  |  
| |                                                                                                     |  |   |        |   |   |     |   |   |     |  

| |    |                                                                                                
| | -- | -----------------------------------------------------------------------------------------------
| | g. | Tax
  assessments:                                                                             
| |    |                                                                                                
| |    | BOS and
  BOScom have final assessments through 2000. Odem has final assessment through
  2004.

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 17:   | SUPPLEMENTARY INFORMATION TO STATEMENTS OF OPERATIONS
|            |                                                       |                                  
|            | a.                                                    | Financial income (expenses), net:

| |                                                           |  |                           |      |      |   |      |   |   |      |  
| | --------------------------------------------------------- |  | ------------------------- | ---- | ---- | - | ---- | - | - | ---- | -
| |                                                           |  | Year ended
  December 31, |     
| |                                                           |  |                           |     
| |                                                           |  | 2006                      |      | 2005 |   | 2004 |  
| |                                                           |  |                           |      |      |   |      |  
| | Financial
  income:                                       |  |                           |      |      |   |      |   |   |      |  
| | Interest
  on bank deposits and marketable securities     |  | $                         | 73   |      | $ | 57   |   | $ | 98   |  
| | Other
  (mainly foreign currency translation income)      |  |                           | 65   |      |   | -    |   |   | 100  |  
| |                                                           |  |                           |      |      |   |      |   |   |      |  
| |                                                           |  |                           |      |      |   |      |   |   |      |  
| |                                                           |  |                           | 138  |      |   | 57   |   |   | 198  |  
| |                                                           |  |                           |      |      |   |      |   |   |      |  
| | Financial
  expenses:                                     |  |                           |      |      |   |      |   |   |      |  
| | In
  respect of long-term bank loans and convertible note |  |                           | (694 | )    |   | (427 | ) |   | (324 | )
| | Other
  (mainly foreign currency translation losses)      |  |                           | (70  | )    |   | (78  | ) |   | (32  | )
| |                                                           |  |                           |      |      |   |      |   |   |      |  
| |                                                           |  |                           |      |      |   |      |   |   |      |  
| |                                                           |  |                           | (764 | )    |   | (505 | ) |   | (356 | )
| |                                                           |  |                           |      |      |   |      |   |   |      |  
| |                                                           |  |                           |      |      |   |      |   |   |      |  
| |                                                           |  | $                         | (626 | )    | $ | (448 | ) | $ | (158 | )
| |                                                           |  |                           |      |      |   |      |   |   |      |  

| |    |                           
| | -- | --------------------------
| | b. | Earnings (loss) per share:
| |    |                           
| |    | 1.       Numerator:       

| |                                                                  |  |   |        |   |   |        |   |   |        |  
| | ---------------------------------------------------------------- |  | - | ------ | - | - | ------ | - | - | ------ | -
| | Numerator for basic and
  diluted net earnings (loss) per share: |  |   |        |   |   |        |   |   |        |  
| | Loss from continuing
  operations                                |  | $ | (1,593 | ) | $ | (2,010 | ) | $ | (198   | )
| | Income (loss) from
  discontinued operations                     |  |   | 1,685  |   |   | (1,595 | ) |   | (1,855 | )
| |                                                                  |  |   |        |   |   |        |   |   |        |  
| |                                                                  |  |   |        |   |   |        |   |   |        |  
| | Net earnings (loss) available
  to Ordinary shareholders         |  | $ | 92     |   | $ | (3,605 | ) | $ | (2,053 | )
| |                                                                  |  |   |        |   |   |        |   |   |        |  

| |    |                            
| | -- | ---------------------------
| | 2. | Denominator (in thousands):

| |                                                                                |  |   |       |   |   |       |   |   |       |  
| | ------------------------------------------------------------------------------ |  | - | ----- | - | - | ----- | - | - | ----- | -
| | Weighted average Ordinary
  shares outstanding (in thousands)                  |  |   | 6,675 |   |   | 5,616 |   |   | 4,631 |  
| |                                                                                |  |   |       |   |   |       |   |   |       |  
| | Diluted weighted average
  shares outstanding (in thousands)                   |  |   | 6,793 |   |   | 5,616 |   |   | 4,631 |  
| |                                                                                |  |   |       |   |   |       |   |   |       |  
| | Basic and diluted net loss
  per share from continuing operations              |  | $ | (0.24 | ) | $ | (0.36 | ) | $ | (0.04 | )
| |                                                                                |  |   |       |   |   |       |   |   |       |  
| | Basic and diluted net
  earnings (loss) per share from discontinued operations |  | $ | 0.25  |   | $ | (0.28 | ) | $ | (0.40 | )
| |                                                                                |  |   |       |   |   |       |   |   |       |  
| | Basic and diluted net
  earnings (loss) per share                              |  | $ | 0.01  |   | $ | (0.64 | ) | $ | (0.44 | )
| |                                                                                |  |   |       |   |   |       |   |   |       |  

F-47

---

---



|                                                           
|-----------------------------------------------------------
|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:   | SEGMENTS AND GEOGRAPHICAL INFORMATION

| |                                                                                                                                                                                                                                                                                                                                                                                             |                                                                                                                                    
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -----------------------------------------------------------------------------------------------------------------------------------
| | Commencing
  2006 and subsequent to the disposal of the communication segment in 2006 and
  the acquisitions of Odem and Quasar, the Company manages its business with
  two reportable segments, consisting of the software solutions segment
  (previously named the connectivity segment) and the supply chain solutions
  segment (previously named the electronic components segment).
| |                                                                                                                                                                                                                                                                                                                                                                                            
| | 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.                                  
| |                                                                                                                                                                                                                                                                                                                                                                                            
| | a.                                                                                                                                                                                                                                                                                                                                                                                          | Revenues,
  gross profit and operating income (loss) for the operating segments for the
  years 2006, 2005 and 2004 were as follow:

| |                           |  |                   |       |                            |   |                 |   |              |        |   |  |   |       
| | ------------------------- |  | ----------------- | ----- | -------------------------- | - | --------------- | - | ------------ | ------ | - |  | - | ------
| |                           |  | Softwaresolutions |       | Supply
  chain
  solutions |   | Not
  allocated |   | Consolidated |       
| |                           |  |                   |       |                            |   |                 |   |              |       
| | 2006                      |  |                   |       |                            |   |                 |   |              |        |   |  |   |       
| |                           |  |                   |       |                            |   |                 |   |              |        |   |  |   |       
| | Revenues                  |  | $                 | 2,058 |                            | $ | 18,859          |   | $            | -      |   |  | $ | 20,917
| |                           |  |                   |       |                            |   |                 |   |              |        |   |  |   |       
| | Gross profit              |  | $                 | 1,341 |                            | $ | 3,376           |   | $            | -      |   |  | $ | 4,717 
| |                           |  |                   |       |                            |   |                 |   |              |        |   |  |   |       
| | Operating loss            |  | $                 | (35   | )                          | $ | (64             | ) | $            | (957   | ) |  | $ | (1,056
| |                           |  |                   |       |                            |   |                 |   |              |        |   |  |   |       
| | Assets related to segment |  | $                 | 243   |                            | $ | 13,700          |   | $            | 10,586 |   |  | $ | 24,529
| |                           |  |                   |       |                            |   |                 |   |              |        |   |  |   |       
| | 2005                      |  |                   |       |                            |   |                 |   |              |        |   |  |   |       
| |                           |  |                   |       |                            |   |                 |   |              |        |   |  |   |       
| | Revenues                  |  | $                 | 3,926 |                            | $ | 20,253          |   | $            | (80    | ) |  | $ | 24,099
| |                           |  |                   |       |                            |   |                 |   |              |        |   |  |   |       
| | Gross profit              |  | $                 | 2,425 |                            | $ | 3,820           |   | $            | -      |   |  | $ | 6,245 
| |                           |  |                   |       |                            |   |                 |   |              |        |   |  |   |       
| | Operating income (loss)   |  | $                 | 235   |                            | $ | 727             |   | $            | (702   | ) |  | $ | 260   
| |                           |  |                   |       |                            |   |                 |   |              |        |   |  |   |       
| | Assets related to segment |  | $                 | 391   |                            | $ | 11,535          |   | $            | 10,720 |   |  | $ | 22,646
| |                           |  |                   |       |                            |   |                 |   |              |        |   |  |   |       
| | 2004                      |  |                   |       |                            |   |                 |   |              |        |   |  |   |       
| |                           |  |                   |       |                            |   |                 |   |              |        |   |  |   |       
| | Revenues                  |  | $                 | 5,011 |                            | $ | 1,908           |   | $            | -      |   |  | $ | 6,919 
| |                           |  |                   |       |                            |   |                 |   |              |        |   |  |   |       
| | Gross profit              |  | $                 | 2,933 |                            | $ | 327             |   | $            | -      |   |  | $ | 3,260 
| |                           |  |                   |       |                            |   |                 |   |              |        |   |  |   |       
| | Operating income (loss)   |  | $                 | 1,009 |                            | $ | 66              |   | $            | (770   | ) |  | $ | 305   
| |                           |  |                   |       |                            |   |                 |   |              |        |   |  |   |       
| | Assets related to segment |  | $                 | 616   |                            | $ | 8,880           |   | $            | 10,592 |   |  | $ | 22,088

F-48

---

---



|                                                           
|-----------------------------------------------------------
|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:   | SEGMENTS AND GEOGRAPHICAL INFORMATION
  (Cont.)

| |    |                                                                                                                                      
| | -- | -------------------------------------------------------------------------------------------------------------------------------------
| | b. | The
  following presents total revenues and long-lived assets for the years 2006,
  2005 and 2004 based on the location of customers:

| |                     |  |                         |        |                        |   |                  |  |                        |        |                  |   |                        |  |   |       |  |   |       | 
| | ------------------- |  | ----------------------- | ------ | ---------------------- | - | ---------------- |  | ---------------------- | ------ | ---------------- | - | ---------------------- |  | - | ----- |  | - | ----- | 
| |                     |  | Year ended December 31, |       
| |                     |  |                         |       
| |                     |  | 2006                    |        | 2005                   |   | 2004             | 
| |                     |  |                         |        |                        |   |                  | 
| |                     |  | Total
  revenues        |        | Long-lived
  assets *) |   | Total
  revenues |  | Long-lived
  assets *) |        | Total
  revenues |   | Long-lived
  assets *) | 
| |                     |  |                         |        |                        |   |                  |  |                        |        |                  |   |                        | 
|
| | United
  States     |  | $                       | 2,848  |                        | $ | -                |  | $                      | 3,439  |                  | $ | -                      |  | $ | 3,251 |  | $ | -     | 
| | Far
  East          |  |                         | 2,019  |                        |   | -                |  |                        | 6,083  |                  |   | -                      |  |   | 701   |  |   | -     | 
| | Europe              |  |                         | 1,173  |                        |   | -                |  |                        | 1,171  |                  |   | -                      |  |   | 600   |  |   | -     | 
| | Israel
  and others |  |                         | 14,877 |                        |   | 3,101            |  |                        | 13,406 |                  |   | 3,455                  |  |   | 2,367 |  |   | 3,745 | 
| |                     |  |                         |        |                        |   |                  |  |                        |        |                  |   |                        |  |   |       |  |   |       | 
|
| |                     |  | $                       | 20,917 |                        | $ | 3,101            |  | $                      | 24,099 |                  | $ | 3,455                  |  | $ | 6,919 |  | $ | 3,745 | 
| |                     |  |                         |        |                        |   |                  |  |                        |        |                  |   |                        |  |   |       |  |   |       | 

| |    |                                                                                                                                                                                                                                              |                                                                                         
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------
| |    | Total
  revenues are attributed to geographical areas based on the location of
  customers in accordance with Statement of Financial Accounting 131,
  Disclosures about Segments of an Enterprise and Related Information (SFAS
  131).
| |    |                                                                                                                                                                                                                                             
| |    | *)                                                                                                                                                                                                                                           | Long-lived assets comprise goodwill, intangible assets, property,
  plant and equipment.
| |    |                                                                                                                                                                                                                                              |                                                                                         
| | c. | Major
  customers data as a percentage of total revenues:                                                                                                                                                                                  

| |                                                                                                          |  |                         |    |      |  |      |   |  |    |  
| | -------------------------------------------------------------------------------------------------------- |  | ----------------------- | -- | ---- |  | ---- | - |  | -- | -
| |                                                                                                          |  | Year ended December 31, |   
| |                                                                                                          |  |                         |   
| |                                                                                                          |  | 2006                    |    | 2005 |  | 2004 |  
| |                                                                                                          |  |                         |    |      |  |      |  
|
| | Customer A                                                                                               |  |                         | 7  | %    |  | 11   | % |  | 46 | %
| |                                                                                                          |  |                         |    |      |  |      |   |  |    |  
|
| | Customer B                                                                                               |  |                         | 24 | %    |  | 16   | % |  | -  |  
| |                                                                                                          |  |                         |    |      |  |      |   |  |    |  
| |                                                                                                          |  |                         |    |      |  |      |   |  |    |  
| | Major
  customers debt balances as of December 31, 2006 and 2005 are $6,530 and
  $1,433, respectively.

F-49

---

---



|                                                           
|-----------------------------------------------------------
|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:   | RELATED PARTIES                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            | M&A
  Addendum to the Service Agreement of Cukierman & Co.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            | In 2003, the
  Companys audit committee and Board 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, he serves as Chairman of the
  Companys Board, 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 Service
  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, |    
|         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |  |                |    
|         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |  | 2006           |     | 2005 |  
|         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |  |                |     |      |  
|         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |  |                |     |      |   |     | 
|         | Business development                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |  | $              | 120 |      | $ | 109 | 
|         | Success fee in respect of issuance of
  convertible loan,
  investment in Odem and private placements                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |  |                | 75  |      |   | 397 | 
|         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |  |                |     |      |   |     | 
|         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |  |                |     |      |   |     | 
|         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |  | $              | 195 |      | $ | 506 | 
|         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |  |                |     |      |   |     | 
|         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |  |                |     |      |   |     | 
|         | Current
  liabilities in respect of related parties as of December 31, 2006 and 2005
  were $13 and $23, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|NOTE 20: | SUBSEQUENT EVENT                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|         | Right
  offering:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|         | On March 11,
  2007, the Company announced that the registration statement previously filed
  by BOS with the Securities and Exchange Commission and the Israel Securities
  Authority, has been declared effective on March 8, 2007. All of the Companys
  shareholders, who own shares as of March 19, 2007, the record date, will be
  entitled to participate in a $5 million right offering, and receive one right
  for each 3.3724 Ordinary shares owned on the record date. Each right will
  entitle the holder to purchase one Ordinary share, at a subscription price of
  $2.50.

F-50

---

---