---

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|                                                                                     
|-------------------------------------------------------------------------------------
|SECURITIES AND EXCHANGE COMMISSION                                                   
|WASHINGTON, D.C. 20549                                                               
|                                                                                     
|                                                                                     
|                                                                                     
|FORM 20-F                                                                            
|                                                                                     
|ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF                                     
|THE SECURITIES EXCHANGE ACT OF 1934                                                  
|For the fiscal year ended December 31, 2005           Commission File No.
  000-27974
|                                                                                     
|                                                                                     

|                                                                                                                                                  
|--------------------------------------------------------------------------------------------------------------------------------------------------
|CIMATRON LTD.                                                                                                                                     
|(Exact
  name of Registrant as specified in its charter and translation of
  Registrants name into English)                                      
|                                                                                                                                                  
|                                                                                                                                                  
|                                                                                                                                                  
|Israel                                                                                                                                            
|(Jurisdiction
  of incorporation or organization)                                                                                                 
|                                                                                                                                                  
|11 Gush Etzion St., Givat Shmuel 54030,
  Israel                                                                                                  
|(Address
  of principal executive offices)                                                                                                        
|                                                                                                                                                  
|                                                                                                                                                  
|                                                                                                                                                  
|Securities registered or to be registered
  pursuant to Section 12(b) of the Act:                                                                 
|None                                                                                                                                              
|Securities registered or to be registered
  pursuant to Section 12(g) of the Act: Ordinary Shares, nominal value 0.10 New Israeli Shekel per share
|(Title
  of Class)                                                                                                                                
|Securities for which there is a reporting
  obligation pursuant to Section 15(d) of the Act:                                                      
|                                                                                                                                                  
|None                                                                                                                                              
|(Title
  of Class)                                                                                                                                
|                                                                                                                                                  
|                                                                                                                                                  

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

8,001,270 Ordinary Shares

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

| |   |    
| | - | ---
| | o | Yes
| | x | No 

If this report as 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.

| |   |    
| | - | ---
| | o | Yes
| | o | No 

1

---

---



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:

| |   |    
| | - | ---
| | o | Yes
| | x | No 

Indicate by check mark whether the registrant
is a large accelerated filer, an accelerated filer, or a non-accelerated filer.

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

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

Item 17 o 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)

| |   |    
| | - | ---
| | o | Yes
| | x | No 
| |   |    
|



We
have prepared our consolidated financial statements in United States dollars
and in accordance with accounting principles generally accepted in the United
States. All references herein to dollars or $ are to United States dollars,
and all references to Shekels or NIS are to New Israeli Shekels.

*********

2

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|                                                                                        |  |   
|--------------------------------------------------------------------------------------- |  | --
|PART I                                                                                  |  |   
|                                                                                        |  |   
|ITEM 1.
  IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS                         |  |   
|Not applicable                                                                          |  | 4 
|                                                                                        |  |   
|ITEM 2.
  OFFER STATISTICS AND EXPECTED TIMETABLE                                       |  |   
|Not applicable                                                                          |  | 4 
|                                                                                        |  |   
|ITEM 3.
  KEY INFORMATION                                                               |  | 4 
|                                                                                        |  |   
|ITEM 4.
  INFORMATION ON THE COMPANY                                                    |  | 7 
|ITEM 5.
  OPERATING AND FINANCIAL REVIEW AND PROSPECTS                                  |  | 28
|                                                                                        |  |   
|ITEM 6.
  DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES                                    |  | 43
|                                                                                        |  |   
|ITEM 7.
  MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS                             |  | 53
|                                                                                        |  |   
|ITEM 8.
  FINANCIAL INFORMATION                                                         |  | 55
|                                                                                        |  |   
|ITEM 9.
  THE OFFER AND LISTING                                                         |  | 56
|                                                                                        |  |   
|ITEM 10.
  ADDITIONAL INFORMATION                                                       |  | 57
|                                                                                        |  |   
|ITEM 11.
  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                   |  | 69
|ITEM 12.
  DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES                       |  | 71
|                                                                                        |  |   
|PART II                                                                                 |  |   
|                                                                                        |  |   
|ITEM 13.
  DEFAULTS, DIVIDEND AVERAGES AND DELINQUENCIES                                |  | 71
|ITEM 14.
  MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS |  | 71
|ITEM 15. CONTROLS AND PROCEDURES                                                        |  | 71
|ITEM
  16A. AUDIT COMMITTEE FINANCIAL EXPERT                                            |  | 72
|ITEM
  16B. CODE OF ETHICS                                                              |  | 72
|ITEM 16C. PRINCIPAL
  ACCOUNTANT FEES AND SERVICES                                      |  | 72
|ITEM
  16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES                  |  | 73
|ITEM
  16E. REPURCHASE OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS     |  | 73
|                                                                                        |  |   
|PART III                                                                                |  |   
|                                                                                        |  |   
|ITEM 17.
  FINANCIAL STATEMENTS                                                         |  |   
|Not applicable                                                                          |  | 73
|ITEM 18.
  FINANCIAL STATEMENTS                                                         |  | 73
|ITEM 19.
  EXHIBITS                                                                     |  | 74
|                                                                                        |  |   
|SIGNATURES                                                                              |  | 75

3

---

---



PART I

|                 |                                                      
|---------------- | -----------------------------------------------------
|Item 1.          | Identity of Directors, Senior Management and Advisers
|Not
  Applicable
|Item 2.          | Offer Statistics and Expected Timetable              
|Not
  Applicable
|Item 3.          | Key Information                                      

Selected Financial Data

The
following selected financial statement of income data for the years ended
December 31, 2003, 2004 and 2005, and the balance sheet data as of December 31,
2003, 2004 and 2005 are derived from the financial statements set forth
elsewhere in this Report. The selected financial statements of income data for
the years ended December 31, 2001 and 2002 and the selected balance sheet data
as of December 31, 2001, and 2002, are derived from other audited financial
statements not included in this report. The audited financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States, or U.S. GAAP. The financial statements for the year ended
December 31, 2001 were audited by BDO, Ziv & Haft, independent auditors,
and the financial statements for the years ended December 31, 2002, 2003, 2004
and 2005 were audited by Brightman Almagor & Co., a member of Deloitte
Touche Tohmatsu, independent auditors. All of the financial data set forth
below should be read in conjunction with Item 5 - Operating and Financial
Review and Prospects and the audited financial statements and notes thereto
(together, the Financial Statements) and other financial information included
elsewhere in this annual report.

|                                                    |  |                                              |        |      |  |        |   |      |        |      |  |        |   |  |        |  
|--------------------------------------------------- |  | -------------------------------------------- | ------ | ---- |  | ------ | - | ---- | ------ | ---- |  | ------ | - |  | ------ | -
|                                                    |  | December 31,                                 |       
|                                                    |  | 2001                                         |        | 2002 |  | 2003   |   | 2004 |        | 2005 | 
|                                                    |  | (In thousands of US$, except per share data) |       
|Statement
  of Income Data:                         |  |                                              |        |      |  |        |   |      |        |      |  |        |   |  |        |  
|Revenue:                                            |  |                                              |        |      |  |        |   |      |        |      |  |        |   |  |        |  
|                                                    |  |                                              |        |      |  |        |   |      |        |      |  |        |   |  |        |  
|Products                                            |  |                                              | 12,371 |      |  | 11,150 |   |      | 10,448 |      |  | 11,370 |   |  | 8,968  |  
|Services                                            |  |                                              | 10,583 |      |  | 10,478 |   |      | 11,161 |      |  | 11,793 |   |  | 11,957 |  
|                                                    |  |                                              |        |      |  |        |   |      |        |      |  |        |   |  |        |  
|Total                                               |  |                                              | 22,954 |      |  | 21,628 |   |      | 21,609 |      |  | 23,163 |   |  | 20,925 |  
|                                                    |  |                                              |        |      |  |        |   |      |        |      |  |        |   |  |        |  
|Cost of revenue:                                    |  |                                              |        |      |  |        |   |      |        |      |  |        |   |  |        |  
|Products                                            |  |                                              | 4,920  |      |  | 3,234  |   |      | 3,056  |      |  | 2,923  |   |  | 3,367  |  
|Services                                            |  |                                              | 2,394  |      |  | 1,783  |   |      | 1,562  |      |  | 1,678  |   |  | 1,568  |  
|                                                    |  |                                              |        |      |  |        |   |      |        |      |  |        |   |  |        |  
|Total                                               |  |                                              | 7,314  |      |  | 5,017  |   |      | 4,618  |      |  | 4,601  |   |  | 4,935  |  
|                                                    |  |                                              |        |      |  |        |   |      |        |      |  |        |   |  |        |  
|Gross profit                                        |  |                                              | 15,640 |      |  | 16,611 |   |      | 16,991 |      |  | 18,562 |   |  | 15,990 |  
|Research and development
  costs, net               |  |                                              | 7,626  |      |  | 5,562  |   |      | 5,210  |      |  | 5,554  |   |  | 4,815  |  
|Restructuring costs                                 |  |                                              | 250    |      |  | (250   | ) |      | -      |      |  | -      |   |  | -      |  
|Selling, general and
  administrative expenses      |  |                                              | 12,711 |      |  | 11,670 |   |      | 12,645 |      |  | 13,962 |   |  | 15,650 |  
|                                                    |  |                                              |        |      |  |        |   |      |        |      |  |        |   |  |        |  
|Operating loss                                      |  |                                              | (4,947 | )    |  | (371   | ) |      | (864   | )    |  | (954   | ) |  | (4,475 | )
|Financial income
  (expenses), net                  |  |                                              | (467   | )    |  | 428    |   |      | 369    |      |  | 445    |   |  | (148   | )
|Other income (expenses)                             |  |                                              | (81    | )    |  | 1      |   |      | 203    |      |  | 144    |   |  | 1      |  
|                                                    |  |                                              |        |      |  |        |   |      |        |      |  |        |   |  |        |  
|Income (loss) before taxes                          |  |                                              | (5,495 | )    |  | 58     |   |      | (292   | )    |  | (365   | ) |  | (4,622 | )
|Taxes on income                                     |  |                                              | (163   | )    |  | (48    | ) |      | (9     | )    |  | (23    | ) |  | (2     | )
|                                                    |  |                                              |        |      |  |        |   |      |        |      |  |        |   |  |        |  
|Loss after income taxes                             |  |                                              | (5,658 | )    |  | 10     |   |      | (301   | )    |  | (388   | ) |  | (4,624 | )
|Companys equity in results
  of affiliated company |  |                                              | -      |      |  | -      |   |      | -      |      |  | -      |   |  | (5     | )
|Minority interest in
  results of subsidiary        |  |                                              | -      |      |  | -      |   |      | -      |      |  | -      |   |  | 36     |  
|                                                    |  |                                              |        |      |  |        |   |      |        |      |  |        |   |  |        |  
|Net income (loss)                                   |  |                                              | (5,658 | )    |  | 10     |   |      | (301   | )    |  | (388   | ) |  | (4,593 | )
|                                                    |  |                                              |        |      |  |        |   |      |        |      |  |        |   |  |        |  
|Net income (loss) per share                         |  |                                              | (0.71  | )    |  | *      |   |      | (0.04  | )    |  | (0.05  | ) |  | (0.59  | )
|Weighted average number of
  shares outstanding     |  |                                              | 8,001  |      |  | 7,981  |   |      | 7,838  |      |  | 7,835  |   |  | 7,835  |  

* Less than $ 0.01

4

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|                                                        |  |                       |        |      |  |        |  |      |        |      |  |        |  |  |        | 
|------------------------------------------------------- |  | --------------------- | ------ | ---- |  | ------ |  | ---- | ------ | ---- |  | ------ |  |  | ------ | 
|                                                        |  | December 31,          |       
|                                                        |  | 2001                  |        | 2002 |  | 2003   |  | 2004 |        | 2005 | 
|                                                        |  | (In thousands of US$) |       
|Balance Sheet
Data                                      |  |                       |        |      |  |        |  |      |        |      |  |        |  |  |        | 
|Cash and cash equivalents                               |  |                       | 4,534  |      |  | 4,077  |  |      | 3,124  |      |  | 1,711  |  |  | 2,708  | 
|Short-term investments                                  |  |                       | 4,440  |      |  | 4,017  |  |      | 6,358  |      |  | 6,381  |  |  | 2,167  | 
|                                                        |  |                       |        |      |  |        |  |      |        |      |  |        |  |  |        | 
|Total cash, cash equivalents and short-term
investments |  |                       | 8,974  |      |  | 8,094  |  |      | 9,482  |      |  | 8,092  |  |  | 4,875  | 
|Working capital                                         |  |                       | 10,840 |      |  | 10,861 |  |      | 10,639 |      |  | 10,306 |  |  | 4,328  | 
|Total assets                                            |  |                       | 22,855 |      |  | 21,371 |  |      | 22,386 |      |  | 20,804 |  |  | 16,442 | 
|Total liabilities                                       |  |                       | 8,313  |      |  | 7,212  |  |      | 8,826  |      |  | 7,956  |  |  | 8,456  | 
|Shareholders equity                                    |  |                       | 14,542 |      |  | 14,159 |  |      | 13,521 |      |  | 12,848 |  |  | 7,982  | 

Risk Factors

This
annual report and statements that we may make from time to time may contain
forward-looking information. There can be no assurance that actual results will
not differ materially from our expectations, statements or projections. Factors
that could cause actual results to differ from our expectations, statement or
projections include the risks and uncertainties relating to our business
described below.

Risks Related to our Business

We face intensive
competition in our industry.

The
CAD/CAM software industry, characterized by rapid advances in technology and
changing customer requirements, is highly competitive. We design, develop, manufacture,
market and support a family of modular, high performance, fully integrated,
computer-aided design/computer aided manufacturing, or CAD/CAM, software
products. Traditionally, our competitors in the CAD/CAM market are at both the
high and low end of the market. The lower end of the market consists of
dedicated Numerical Control, or NC, programming systems offerings, which have
limited or no modeling capability, while the high end of the market, including
our Cimatron E and its predecessor, the Cimatron IT, consists of integrated
CAD/CAM systems. Many high-end market products are roughly similar to our
Cimatron E and IT products.

5

---

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As the CAD/CAM
software industry is highly fragmented and characterized by many relatively
small and privately owned companies, we face competition from numerous
companies in relation to all of our products. In addition, some of our
competitors are more established, benefit from greater market recognition and
have greater financial, production and marketing resources than us. We believe
that, due to the large number of companies that operate in this market, we do
not have a single major competitor or a group of competitors. The principal
factors permitting our products to compete successfully against our
competitors products are:

|  |                                                                                                                                          
|- | -----------------------------------------------------------------------------------------------------------------------------------------
| | the
  compatibility of our products with other software applications and existing
  and emerging industry standards;                     
|  |                                                                                                                                          
| | our ongoing
  product and feature development;                                                                                           
|  |                                                                                                                                          
| | the offering
  of unique innovative products to the tooling industry;                                                                    
|  |                                                                                                                                          
| | the level of our
  product breadth and integration;                                                                                      
|  |                                                                                                                                          
| | our hardware platform support;                                                                                                           
|  |                                                                                                                                          
| | the technical expertise and support that we provide;                                                                                     
|  |                                                                                                                                          
| | the flexibility of our
  products;                                                                                                       
|  |                                                                                                                                          
| | the
  reputation we maintain among certain independent distributors of our products,
  to which we refer as Providers; and               
|  |                                                                                                                                          
| | the
  relatively low overall price and total cost of ownership of our products
  combined with the high-end capabilities of our products.

Although
we believe that the attributes of our products provide us with a competitive
advantage over our competitors, there can be no assurance that the marketplace
will consider Cimatron E and its predecessor product, the Cimatron IT, to be
superior to existing competing products. In addition, new competitors may arise
in each of the markets in which we currently operate. Furthermore, as we enter
new geographic markets, we may encounter significant competition from companies
that are more established in such markets. Accordingly, there can be no
assurance that our existing or future products will successfully compete
against our competitors products.

We are heavily
reliant on the sale of one family of products.

Sales
and services related to the Cimatron E product family, including its
predecessor, the Cimatron IT, have historically accounted for substantially all
of our revenue. If sales of the Cimatron E family were to decline, or fail to
continue to grow, or the profit margin on these products were to decrease
significantly, our business, financial condition and results of operations
would be materially and adversely affected.

6

---

---



Our business depends
significantly upon sales by our customers of products in the consumer market.
This market is extremely competitive and is highly susceptible to fluctuations in
demand.

Our products
are designed for use by manufacturers of consumer products or consumer product
components. The consumer products market is intensely competitive and price
sensitive. Sales of consumer products have historically been dependent upon
discretionary spending by consumers. Consumers may defer or alter purchasing
decisions based on economic conditions or other factors, and accordingly could
reduce demand for products of our customers which are manufactures using our
products. Softening consumer demand for consumer products has in the past
caused a decline in the demand for our products. As a result of any softening
demand for consumer products, there is uncertainty with respect to our expected
revenues, and delays or reductions in consumer spending could adversely affect
our revenues and operating results.

Two of our
shareholders beneficially own a substantial amount of our ordinary shares and
may therefore influence our affairs.

In
February 2002, two private holding companies, Koonras Technologies Ltd., or
Koonras, a subsidiary of Polar Communications Ltd., and DBSI Investments Ltd.
or DBSI, consummated a transaction with Zeevi Computers and Technology Ltd., or
ZCT, by which they acquired, for approximately $9,900,000, all of our Ordinary
Shares previously held by ZCT, representing 64.3% of our share capital
(including in this calculation 166,100 of our ordinary shares which we have
repurchased and which, pursuant to Israeli law, cannot be voted and possess no
rights other than upon liquidation). Following this transaction, each of
Koonras and DBSI beneficially owns approximately 33% of our ordinary shares.
Koonras and DBSI together are expected to continue to effectively have the
ability to control the outcome of most matters submitted to a vote of our
shareholders, including the election of members of our board of directors and
approval of significant corporate transactions. Koonras and DBSI have entered
into an agreement by which, among other matters, they will each appoint one
half of our directors, not including our external directors, and vote together
at our shareholders meetings. The concentration of ownership of our Ordinary
Shares by Koonras and DBSI could delay or prevent proxy contests, mergers,
tender offers, open-market purchase programs or other purchases of our Ordinary
Shares that might otherwise give you the opportunity to realize a premium over
the then-prevailing market price of our Ordinary Shares. This concentration of
ownership may also adversely affect our share price.

We are subject to
several risks as a result of our international sales.

To
date, our products have been sold primarily in Europe, the Far East, North
America and Israel. We expect that international sales will continue to
represent a substantial portion of our business. Companies that engage in
international sales are subject to a number of risks, such as:

|  |                                                                                                 
|- | ------------------------------------------------------------------------------------------------
| | agreements
  may be difficult to enforce through a foreign companys legal system;              
|  |                                                                                                 
| | foreign
  countries could impose additional withholding or other taxes on our income;           
|  |                                                                                                 
| | foreign
  countries could impose tariffs or adopt other restrictions on foreign trade;          
|  |                                                                                                 
| | fluctuations
  in exchange rates;                                                               
|  |                                                                                                 
| | changes in
  general economic conditions in one or more countries could affect product
  demand;

7

---

---



|  |                                                                                                                                                  
|- | -------------------------------------------------------------------------------------------------------------------------------------------------
| | the
  protection of intellectual property rights in foreign countries may be
  limited or more difficult to enforce; and                         
|  |                                                                                                                                                  
| | difficulties
  in managing overseas subsidiaries and international operations, including
  difficulty in retaining or replacing local management.

There
can be no assurance that these and similar factors will not have a material
adverse effect on our future international sales and, consequently, on our
business, future prospects and results of operations.

Many customers of
the CAD/CAM industry have migrated their operations to the Far East. In order
to remain competitive in the industry, we need to penetrate the Far East
markets; operation in these markets subjects us to specific risks.

Many
mold, tool, die and fixture makers have migrated or intend to migrate their
operations to markets in the Far East, such as China, in order to take
advantage of the relatively lower cost of labor available in those markets for
their manufacturing activities. We anticipate that this migration will
continue. In order to continue to compete in the CAD/CAM software industry, we
will need to increase our penetration of these markets. Many of those markets,
including China, are characterized by lower prices and by higher usage of
pirated copies of software products. While those markets are also often much
larger than a number of our traditional markets in Europe, to the extent that
we cannot offset the effects of lower prices and higher incidents of pirated
software usage, our revenues and profitability may be materially adversely
affected.

We are reliant upon
independent distributors to market and support our products.

We
rely on independent distributors, to whom we refer as Providers, to market,
sell, service and support our products worldwide. Generally, our relationships
with our Providers are based on agreements with two-year terms (subject to
rolling two-year extensions) and which enable Providers to purchase our
products at a discounted price. While we have exclusive relationships with
certain of our Providers, there can be no assurance that these Providers will
give high priority to the marketing and support of our products. In addition,
our Providers in Italy and Japan each accounted for more than 5% of our
revenues in 2005. In July 2005 we acquired 27.5% of the shares of the Italian
Provider and an option to purchase its remaining outstanding shares from its
shareholders and granted the Providers shareholders an option to require us to
purchase 49% of the Providers share capital under specific circumstances. See
Item 5. Operating and Financial Review and Prospects  Overview for
additional details regarding the transaction with our Italian Provider and the
options received both by us and the Providers shareholders. The results of our
operations could be adversely affected by changes in the financial condition of
a Provider, which could occur rapidly, or to other changes in our current
Providers business or marketing strategies. There can be no assurance that we
will retain our current Providers, nor can there be any assurance that, in the
event that we lose any of our Providers, we will be successful in recruiting
other highly professional and technically competent Providers to represent us.
Any such changes in our distribution channels, especially those in the Far East
and Europe, could materially adversely affect our business, operating results
and financial condition. See Item 4 - Information on the Company - Business
Overview.

8

---

---



We have a history of
annual and quarterly losses and cannot assure you that we will return to
profitability on an annual basis or remain profitable on a quarterly basis in
the future.

We
incurred net losses of approximately $0.3 million, $0.4 million and $4.6
million in 2003, 2004 and 2005, respectively. We also incurred net losses in
each of our fiscal quarters in 2005. Although we had net income of $220,000 in
the first quarter of 2006, we cannot be certain that we will return to profitability
on an annual basis or maintain profitability on a quarterly basis or, if we do
return to profitability on an annual basis, remain profitable in future years.

We may experience
significant fluctuations in our quarterly results, which makes it difficult for
investors to make reliable period-to-period comparisons and may contribute to
volatility in the market price for our ordinary shares.

Our
quarterly revenues, gross profits and results of operations have fluctuated
significantly in the past and may be subject to continued fluctuation in the
future. The following events may cause such fluctuations:

| |   |                                                                                                 
| | - | ------------------------------------------------------------------------------------------------
| |  | changes in
  timing of orders, especially large orders, for our products and services;          
| |   |                                                                                                 
| |  | changes in
  the prices for our products and services;                                          
| |   |                                                                                                 
| |  | adverse
  economic conditions and international exchange rate and currency
  fluctuations;      
| |   |                                                                                                 
| |  | delays in
  the implementation of our solutions by customers;                                   
| |   |                                                                                                 
| |  | changes in
  the proportion of service and license revenues;                                    
| |   |                                                                                                 
| |  | timing of
  product releases;                                                                   
| |   |                                                                                                 
| |  | changes in
  the economic conditions of the various industries in which our customers
  operate;
| |   |                                                                                                 
| |  | price and
  product competition;                                                                
| |   |                                                                                                 
| |  | increases in
  selling and marketing expenses, as well as other operating expenses;             
| |   |                                                                                                 
| |  | technological
  changes; and                                                                    
| |   |                                                                                                 
| |  | political
  instability in the Middle East.                                                     

9

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A
substantial portion of our expenses, including most product development,
selling and marketing expenses, must be incurred in advance of when revenue is generated.
If our projected revenue does not meet our expectations, we are likely to
experience a shortfall in our operating profit relative to our expectations. As
a result, we believe that period-to-period comparisons of our historical
results of operations are not necessarily meaningful and that you should not
rely on them as an indication for future performance. Also, our quarterly
results of operations have, on separate occasions, been below the expectations
of public market analysts and investors and the price of our ordinary shares
subsequently decreased. If that would happen in the future, the price of our
ordinary shares will likely decrease again.

Because of our
international operations, changes in exchange rates against the U.S. dollar
could have a significant effect on our results of operations. In addition,
local economic conditions or currency fluctuations could cause customers to
decrease or cancel orders or default on payment.

Although
part of our revenues are denominated and paid in U.S. dollars, the majority are
not so denominated and paid. Therefore we believe that inflation and
fluctuations in the U.S. dollar exchange rate may have a material effect on our
revenue. In addition, a significant portion of our international sales is
denominated in Euros, and in the future additional sales may be denominated in
currencies other than U.S. dollars, thereby exposing us to gains and losses on
non-U.S. currency transactions. We may choose to limit this exposure by
entering into hedging transactions. However, hedging transactions may not
prevent exchange-related losses, and our business may be harmed by exchange
rate fluctuations. Furthermore, as we seek to expand our sales to regions
throughout the world, we might be exposed to risks of customers located in
countries suffering from uncertain economic environments such as high inflation
and solvency problems. Those issues and devaluation in local currencies of our
customers relative to the U.S. dollar where our sales are denominated in U.S. dollars
could cause customers to decrease or cancel orders or default on payment.

During 2005, we
continued to experience decreases in our revenues from products. If this trend
continues, it will likely adversely affect our gross margins and profitability.

Our
revenues from the sale of products decreased to approximately $9.0 million in
2005 from approximately $11.4 million in 2004 and approximately $10.5 million
in 2003. While our revenues from services increased in 2005 to approximately
$12.0 million from approximately $11.8 million in 2004 and approximately $11.2
million in 2003, our gross margin from products is higher than our gross margin
from services. This is because our cost of services, which includes expenses of
salaries and related benefits of the employees engaged in providing the
services, is relatively higher than our cost of products. If the trend of
increases in the percentage of our overall revenues comprised by service
revenue continues, our gross margins and profitability will likely be adversely
affected. In addition, if our revenues from the sale of products continue to
decrease, such decrease may adversely effect our future service revenues, as it
may result in a smaller user base to purchase service contracts from us.

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If we are unable to
accurately predict and respond to market developments or demands, or if our
products are not accepted in the marketplace, our business will be adversely
affected.

It
is difficult to predict demand and CAD/CAM market acceptance for our solutions
and products. We cannot guarantee that the market for our solutions and
products will grow or that they will become widely accepted. If the market for
our solutions and products does not develop as quickly as we expect, our future
revenues and profitability will be adversely affected. Changes in technologies,
industry standards, client requirements and new product introductions by
existing or future competitors could render our existing offerings obsolete and
unmarketable, or require us to develop new products. If our solutions and
products do not achieve or maintain market acceptance or if our competitors
release new products that achieve quicker market acceptance, have more advanced
features, offer better performance or are more price competitive, our revenues
may not grow and may even decline. In addition, if a product we develop and
introduce does not achieve market acceptance, we may not be able to recover the
costs associated with developing the product, which would have a negative effect
on our profitability.

If we are unable to
attract, train and retain qualified personnel, we may not be able to achieve
our objectives and our business could be harmed.

Our
future success depends on our ability to absorb and retain senior employees and
to attract, motivate and retain highly qualified professional employees.
Competition for these employees can be intense, especially in a number of our
key markets and locations, including Israel and Europe. The process of
locating, training and successfully integrating qualified personnel into our
operations can be lengthy and expensive. The market for the qualified personnel
we require is very competitive because of the limited number of people
available with the necessary technical and sales skills and understanding of
our products and technology. This is particularly true in Israel where
competition for qualified personnel is intense. We may not be able to compete
effectively for the personnel we need. Any loss of members of senior management
or key technical personnel, or any failure to attract or retain highly
qualified employees as needed, could materially adversely affect our ability to
achieve our research and development and sales objectives.

Under current
Israeli law, we may not be able to enforce covenants not to compete and
therefore may be unable to prevent our competitors from benefiting from the
expertise of some of our former employees.

We
have entered into non-competition agreements with most of our employees in
Israel and we intend to enter into non-competition with the rest of our
employees. These agreements prohibit our employees, during the term of their
employment with us and after they cease working for us, from competing directly
with us or working for our competitors for a limited period. Under current
Israeli law, we may be unable to enforce these agreements and it may be
difficult for us to restrict our competitors from gaining the expertise our
former employees gained while working for us. For example, Israeli courts have
recently required employers seeking to enforce non-compete undertakings of a
former employee to demonstrate that the competitive activities of the former
employee will harm one of a limited number of material interests of
the employer which have been recognized by the courts, such as the secrecy of a
companys confidential commercial information or its intellectual property. If
we cannot demonstrate that harm would be caused to us, we may be unable to
prevent our competitors from benefiting from the expertise of our former
employees.

11

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Any future
acquisitions of companies or technologies may distract our management and
disrupt our business. In addition, the issuance by us of securities as
consideration payable in such acquisitions could be dilutive to our existing
shareholders.

One
of our strategies is to acquire or make investments in complementary
businesses, technologies, services or products if appropriate opportunities
arise. For instance, in July 2005 we acquired 27.5% of the shares of our
Italian distributor and an option to purchase the remaining outstanding shares
of that company from its stockholders, and granted the distributors
shareholders an option to require us to purchase 49% of the distributors share
capital under specific circumstances. See Item 5. Operating and Financial
Review and Prospects  Overview for additional details regarding the
transaction with our Italian distributor and the options received both by us
and the distributors shareholders. We may in the future engage in discussions
and negotiations with companies about our acquiring or investing in those
companies businesses, products, services or technologies. We cannot give
assurances that we will be able to identify future suitable acquisition or investment
candidates, or, if we do identify suitable candidates, that we will be able to
make the acquisitions or investments on commercially acceptable terms or at
all. If we acquire or invest in another company, we could have difficulty
assimilating that companys personnel, operations, technology or products and
service offerings into our own. The key personnel of the acquired company may
decide not to work for us. These difficulties could disrupt our ongoing
business, distract our management and employees, increase our expenses and
adversely affect our results of operations. In addition, we may incur
indebtedness or dilute our existing shareholders by issuing equity securities
to pay for any future acquisitions.

We are affected by
volatility in the securities markets.

Securities
markets have in recent years experienced volatility that has particularly
affected the securities of many high-technology companies. This volatility has
often been unrelated to the operating performance of these companies, including
Cimatron. As a result, we may experience difficulties in securing the
additional financing required to effectively operate and grow our business due
to the volatility in the price of our shares, resulting in a material adverse
affect on our business and results of operations.

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Risks Related to Licenses and Intellectual
Property

We rely, to a
certain extent, on third parties software. If we lose the ability to continue
to license that software, our business could be materially adversely affected.

To
date, most of the software relating to the Cimatron E and Cimatron IT family of
products has been developed internally by our research and development staff.
However, to accelerate our product development and improve our time to market,
we also review opportunities to acquire or license products or technologies
from third parties. Mainly, we utilize software tools and engines that we
acquire from Spatial Corp., a subsidiary of Dassault Systems, and D-Cubed, for
the representation and processing of three dimensional objects and surfaces in
order to expedite the continued development of our new Cimatron E product family. In addition, we use
software from ModuleWorks GmbH, a German company, for advanced 5-Axis NC
calculations. We rely, to a certain extent, upon such third parties abilities
to enhance their current products and develop new products on a timely and
cost-effective basis that will meet changing customer requirements and emerging
industry standards or other technological changes. Our business would be
disrupted if functional versions of the third party software we rely on were
either no longer available to us or no longer offered to us on commercially
reasonable terms and we may, as a result, suffer a material adverse effect on
our business and operations.

We may not be
successful in protecting our intellectual proprietary technology and this could
result in the loss of revenue.

We
primarily rely on a combination of trade secret, copyright and trademark laws,
together with non-disclosure agreements and trademark measures (such as
software protection locks), to establish and protect proprietary rights in
our products. The measures afford only limited protection and, accordingly,
there can be no assurance that the steps that we take to protect these
proprietary rights will be adequate to provide misappropriation of the
technology or independent development of similar technology by others. This is
particularly a problem in foreign countries where the laws may not protect our
proprietary rights as fully as the laws of the United States do. For instance,
we have encountered significant piracy problems in certain jurisdictions,
including in Brazil, Taiwan, Israel and China, where the main competition we
face is from pirated copies of our products. These problems may increase as
many of our customers and their competitors migrate their businesses to lower
cost labor markets in the Far East. Despite our best efforts to protect
proprietary rights, unauthorized parties may attempt to copy aspects of our
products or to obtain and use information that we regard as proprietary.

We may be subject to
litigation to determine the scope of proprietary rights of others.

Significant
and protracted litigation may be necessary to protect our intellectual property
rights, to determine the scope of the proprietary rights of others or to defend
against claims of infringement. We believe that our systems do not infringe
upon any existing third-party proprietary rights, and to our knowledge there
have been no claims of infringement by us of third-party proprietary rights to
date; however, there can be no assurance that any such claims will not be
asserted against us in the future. If infringement is alleged, we could be
required to discontinue the use of certain software codes or processes, to
cease the manufacture, use and sale of infringing products, to incur
significant litigation damages, costs and expenses and to develop
non-infringing technology or to obtain licenses to the alleged infringing
technology. There can be no assurance that we would be able to develop
alternative technologies or to obtain such licenses on terms commercially
acceptable to us, if at all. See Item 8  Financial Information  Legal
Proceedings for information regarding certain proceedings in which we are
currently involved.

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Risks Related to our Operations in Israel

We may be adversely
affected if the rate of inflation in Israel exceeds the rate of devaluation of
the New Israeli Shekel against the U.S. dollar.

Our
functional currency is the U.S. dollar while a portion of our expenses,
principally salaries and the related personnel expenses, are in new Israeli
shekels, or NIS. As a result, we are exposed to the risk that the rate of
inflation in Israel will exceed the rate of devaluation of the NIS in relation
to the U.S. dollar or that the timing of this devaluation lags behind inflation
in Israel. This would have the effect of increasing the U.S. dollar cost of our
operations. We cannot predict any future trends in the rate of inflation/
deflation in Israel or the rate of devaluation of the NIS against the U.S.
dollar. If the U.S. dollar cost of our operations in Israel increases, our U.S.
dollar-measured results of operations will be adversely affected.

Security, political
and economic instability in Israel may impede our ability to operate and harm
our financial results.

Our
principal executive offices and research and development facilities are located
in Israel. In addition, a portion of our sales is made to customers in Israel.
Accordingly, security, political and economic conditions in Israel may directly
affect our business. Over the past several decades, a number of armed conflicts
have occurred between Israel and its Arab neighbors. Any hostilities involving
Israel or the interruption or curtailment of trade between Israel and its
present trading partners could affect adversely our operations. From October
2000 until recently, terrorist violence in Israel increased significantly and
negotiations between Israel and Palestinian representatives effectively ceased.
In February 2006, Hamas, a radical Islamic organization, won the Palestinian
Parliament elections. There can be no assurance that the recent relative calm
will continue. Increased hostilities, future armed conflicts, political
developments in other states in the region, or continued or increased terrorism
could make it more difficult for us to conduct our operations in Israel, which
could increase our costs and adversely affect our financial results.
Furthermore, several countries still restrict business with Israel and Israeli
companies. These restrictive laws and policies may limit our ability to sell
our products in those countries.

Our operations may
be disrupted by the obligation of our personnel to perform military service.

Many
of our officers and employees in Israel are obligated to perform annual
military reserve duty and may be called to active duty under emergency
circumstances. At various times over the last five years, there have been
significant call-ups of military reservists, and it is possible that there will
be additional call-ups in the future. While we have operated effectively
despite these conditions in the past, we cannot assess what impact these
conditions may have in the future, particularly if emergency circumstances
arise. Our operations could be disrupted by the absence for a significant
period of one or more of our executive officers or key employees or a
significant number of our other employees due to military service. Any
disruption in our operations would harm our business.

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The government
programs and tax benefits that we currently receive require us to meet several
conditions and may be terminated or reduced in the future, which would increase
our costs and taxes.

We
benefit from certain government programs and tax benefits, particularly as a
result of tax exemptions and reductions resulting from the approved enterprise
status of our manufacturing facilities in Israel. To be eligible for these
programs and tax benefits, we must continue to meet conditions, including
making specified investments in property and equipment and financing a
percentage of investments with share capital. If we fail to meet such conditions
in the future, the tax benefits would be canceled and we could be required to
refund the tax benefits already received, together with an adjustment based on
the Israeli consumer price index and an interest factor. These programs and tax
benefits may not be continued in the future at their current levels or at any
level. The Israeli government has reduced the benefits available under some of
these programs in recent years, and Israeli governmental authorities have
indicated that the government may further reduce or eliminate some of these
benefits in the future. The termination or reduction of existing programs and
tax benefits could increase our expenses, thereby reducing our profits or
increasing our losses. In addition, the law and regulations prescribing the
benefits provide an expiration date for the grant of new benefits. The
expiration date has been extended several times in the past. The expiration
date currently in effect is December 31, 2007, and no new benefits will be
granted after that date unless the expiration date is extended again. There can
be no assurance that new benefits will be available after December 31, 2007, or
that existing benefits will be continued in the future at their current levels
or at any level.

In
connection with research and development grants received from the Office of the
Chief Scientist of Israel, or the OCS, we must pay royalties to the OCS on the
revenue derived from the sale of products, technologies and services developed
with the grant from the OCS. The terms of the OCS grants and the law pursuant
to which grants are made may impair our ability to manufacture products or
transfer technologies developed using OCS grants outside of Israel. The
transfer to a non-Israeli entity of technology developed with OCS funding,
including pursuant to a merger or similar transaction, and the transfer of
rights related to the manufacture of more than ten percent of a product
developed with OCS funding are subject to approval by an OCS committee and to
various conditions, including payment by us to the OCS of a percentage of the
consideration paid to us or our shareholders in the transaction in which the
technology is transferred. In connection with a merger or similar transaction,
the amount payable would be a fraction of the consideration equal to the
relative amount invested by the OCS in the development of the relevant
technology compared to the total investment in our company, net of financial
assets that we have at the time of the transaction, but in no event less than
the amount of the grant. In addition, in the event that the committee believes
that the consideration to be paid in a transaction requiring payment to the OCS
pursuant to the provisions of the law described above does not reflect the true
value of the technology or the company being acquired, it may determine an
alternate value to be used as the basis for calculating the requisite payments.
These restrictions may impair our ability to enter into agreements for those
products or technologies, without OCS approval. We cannot be certain that any
approval of the OCS will be obtained on terms that are acceptable to us, or at
all. Furthermore, in the event that we undertake a transaction involving the
transfer to a non-Israeli entity of technology developed with OCS funding
pursuant to a merger or similar transaction, the consideration available to our
shareholders may be reduced by the amounts we are required to pay to the OCS.

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In
connection with our grant applications, we have made certain representations,
including information provided in periodical performance reports, and we have
committed to certain performance-based covenants. The funding from the OCS is
subject to the accuracy of these representations and covenants and to our
compliance with the conditions and restrictions imposed by the OCS. If we fail
to comply with any of these conditions or restrictions, we could be required to
repay any grants previously received, together with an adjustment based on the
Israeli consumer price index and an interest factor in addition to certain
other penalties. In addition, if we fail to comply with any of these conditions
or restrictions, we would likely be ineligible to receive OCS grants in the
future. The inability to receive these grants would result in an increase in
our research and development expenses.

We may be required
to pay royalties to the OCS in respect of sales since January 1, 2005.

We
believe that the majority of products that we have sold since January 1, 2005
are not based on technology developed with funds provided by the OCS and that,
accordingly, such sales should not be subject to the payment of royalties to
the OCS. Therefore, the royalty reports we submitted to the OCS for the period
starting January 1, 2005 and thereafter have reflected significantly reduced
royalty obligations in comparison to our royalty reports for the years prior to
2005. In addition, during the second half of 2005 we initiated a process with
the OCS in an attempt to obtain the agreement of the OCS with our position and
to the cessation of our obligation to pay future royalties. Although we believe
we have strong arguments to support our position, we have accrued royalty
expenses in our financial reports for the periods from January 1st,
2005 to March 31st, 2006, but we have not paid any royalties
associated with the products mentioned above to the OCS. In light of the above
mentioned facts, we intend to consider our next steps with the OCS and whether
further royalty expenses accruals will be necessary. A determination that we
are in fact obligated to pay royalties in respect of sales after January 1,
2005, could negatively impact our liquidity and if that determination is made
after we cease to accrue for any such royalties on our financial statements,
such payments would negatively impact our earnings.

It may be difficult
to effect service of process and enforce judgments against directors or
officers in Israel.

We
are incorporated in Israel. The majority of our executive officers and directors
are located outside the United States, and a majority of our assets and the
assets of these persons are located outside the United States. Therefore, a
judgment obtained against us or any of them in the United States, including one
based on the civil liability provisions of the U.S. federal securities laws,
may not be collectible in the United States and may not be enforced by an
Israeli court. Further, if a foreign judgment is enforced by an Israeli court,
it generally will be payable in Israeli currency. It also may be difficult for
you to assert U.S. securities law claims in original actions instituted in
Israel since Israel is not the most appropriate forum in which to bring such a
claim. In addition, even if an Israeli court agreed to hear such a claim, it
may determine that Israeli law and not U.S. law is applicable to the claim. If
U.S. law is found to be applicable, the content of applicable U.S. law must be
proved as a fact, which can be a time-consuming and costly process. Certain
matters of procedure will also be governed by Israeli law.

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|        |                           
|------- | --------------------------
|Item 4. | Information on the Company

History and development of the Company

We
design, develop, manufacture, market and support a family of modular,
high-performance, CAD/CAM software products. Our products provide an integrated
design through manufacturing solution for small-to-medium-sized companies and
manufacturing divisions of large corporations, and interface easily with other
CAD/CAM systems. They offer high-end functionality, especially in the areas of
design for manufacturing and manufacturing, at an attractive price/performance
ratio. These attributes have made our CAD/CAM products especially popular in
the design and manufacturing segments of the CAD/CAM market, particularly among
mold, tool, die and fixture makers. We focus our research and development
efforts on providing complete design through manufacturing solutions to the
specific needs of this market segment. We are committed to providing mold,
tool, die and fixture makers with comprehensive, cost-effective CAD/CAM
solutions that streamline manufacturing cycles, enable collaboration with
outside vendors and shorten delivery time.

In
July 2005 we acquired 27.5% of the shares of Microsystem Srl, our Italian
distributor, for 575,000 Euro. Under the agreement, we also received an option
to acquire up to 100% of Microsystem from Microsystems shareholders and
Microsystems shareholders received an option to require us to purchase 49% of
Microsystems share capital under specific circumstances. See Item 5.
Operating and Financial Review and Prospects  Overview for additional details
regarding the transaction with Microsystem and the options received both by us
and Microsystems shareholders. The transaction was designed to significantly
enhance Microsystems financial position and balance sheet. Under the terms of
the agreement, Microsystems marketing, sales, and support groups remained in
their current offices throughout Italy. Enrico Gardini, Microsystems founder, President
and CEO has joined our management team.

On
June 30, 2005, Zvika Naggan resigned as our President and CEO. Our board of
directors accepted his resignation and appointed the then Chief Operating
Officer, Dan Haran, as our new President and CEO, effective July 1, 2005.

Our
full name is Cimatron Ltd. and we were incorporated under Israeli law in 1982.
Our corporate headquarters are located at 11 Gush Etzion Street, Givat Shmuel
54030, Israel. Our telephone number is 972-3-531-2121 and our web site is
located at www.cimatron.com. Our U.S. agent is Cimatron Technologies,
Inc., with an address at 26800 Meadowbrook Road, Suite 113, Novi, Michigan
48377

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Industry Background

Manufacturers
worldwide face ever-increasing pressures to produce high-quality and
increasingly complex products in the shortest time possible and at minimum
cost. To meet these demands and keep pace with market changes, production
commitments and the need for product differentiation, companies are increasing
their reliance on CAD/CAM software tools to automate the designing, drafting
and manufacturing of their products.

The
development process for the mechanical design and manufacturing of products
generally includes the following steps:

| |   |                                                                                                                                                                                    
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | conceptual
  design of the product and its components;                                                                                                                             
| |   |                                                                                                                                                                                    
| |  | tool design
  and detailed design for manufacturing;                                                                                                                               
| |   |                                                                                                                                                                                    
| |  | creating the
  toolpath data in the form of numerical control, or NC, codes that provide the
  instructions for a machine to cut a part according to specifications
  received; and
| |   |                                                                                                                                                                                    
| |  | manufacturing
  the product.                                                                                                                                                       

The
earliest users of CAD/CAM systems were dedicated design and engineering departments
of large organizations that could afford the cost and complexity of high-end
CAD/CAM systems. These systems were used by highly trained designers and
engineers, who were responsible for a particular portion of the manufacturing
process. The systems also generally operated on mainframe computers or high-end
workstations which often required many months to master. To improve efficiency,
large corporations that operate with high-cost, highly complex CAD/CAM systems
have increasingly outsourced a portion of the design and manufacturing process
to subcontractors.

This
created a large market need for easier-to-use, less programming-intensive
CAD/CAM solutions that operate on different hardware and operating systems and
interface with a variety of software systems. In addition, as a result of
continuing market pressure and technological changes, including personal
computers offering improved price and performance, divisions of large companies
also shifted towards CAD/CAM software providing more cost-effective solutions
and shorter learning curves which could co-exist in the corporate design and
manufacturing environment. However, while many of these systems were designed
to provide advanced conceptual design capabilities, they were more limited in
their detailed design for manufacturing and toolpath creation
capabilities.  As a result, they did not
meet the needs of users involved in manufacturing the process, such as mold,
tool, die and fixture makers.

At
the other end of the market were low-cost, dedicated toolpath creation software
products, which were limited in their design capabilities.  These limitations caused the process of
taking data regarding the conceptual design of the product and creating a
detailed design for manufacturing to remain largely manual. As a result,
subcontractors and manufacturing divisions of large corporations were hampered
in their ability to take complex conceptual designs received from the design
departments of the manufacturer and produce appropriate molds, tools, dies or
fixtures in a timely manner.  As a
result, an increasing number of these subcontractors and manufacturing
divisions have begun or are continuing to seek comprehensive design through
manufacturing automation solutions to compete more effectively.

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These
trends have created a market for an integrated CAD/CAM system which is geared
towards small-to medium-sized subcontractors or divisions of large corporations
involved in the manufacturing process, particularly mold, tool, die and fixture
makers. These users have a unique set of needs that have generally not been met
by traditional CAD/CAM systems.

The
CAD/CAM software industry that developed in response to these needs is highly
fragmented and characterized by many relatively small and privately owned
companies.  We believe that, due to the
large number of companies that operate in this market, we do not have a single
major competitor or a group of competitors. The principal factors permitting
our products to compete successfully against our competitors products are:

| |   |                                                                                                                                          
| | - | -----------------------------------------------------------------------------------------------------------------------------------------
| |  | the
  compatibility of our products with other software applications and existing
  and emerging industry standards;                     
| |   |                                                                                                                                          
| |  | our ongoing
  product and feature development;                                                                                           
| |   |                                                                                                                                          
| |  | the offering
  of unique innovative products to the tooling industry;                                                                    
| |   |                                                                                                                                          
| |  | the level of
  our product breadth and integration;                                                                                      
| |   |                                                                                                                                          
| |  | our hardware
  platform support;                                                                                                         
| |   |                                                                                                                                          
| |  | the
  technical expertise and support that we provide;                                                                                   
| |   |                                                                                                                                          
| |  | the
  flexibility  of our products;                                                                                                      
| |   |                                                                                                                                          
| |  | the
  reputation we maintain among certain independent distributors of our
  products, to which we refer as Providers; and               
| |   |                                                                                                                                          
| |  | the
  relatively low overall price and total cost of ownership of our products
  combined with the high-end capabilities of our products.

Business Overview

Principal Operations, Products and
Developments

Cimatron
E

Cimatron
E, our current generation of CAD/CAM solutions for the tooling and production
industries, was initially released in September 2001.  Since its release, it has achieved rapid market acceptance and to
date we have successfully sold copies of the product worldwide.  We released our newest version of the Cimatron
E (Version 7.0) in August 2005.  This
product provides comprehensive tools, applications and process-automation
solutions for the tooling industry. Cimatron E is designed with the tooling
industry in mind, where all stages involved in the tooling process are
supported by applications that perform at new levels of speed and flexibility.
Version 7.0 introduces such breakthrough solutions as the NC Lite complete
shop-floor solution, the first commercially available Micro Milling NC
application, and advanced 5-axis milling. Additional CimatronE 7.0 features
include enhancements of speed, quality and coverage through dedicated tools and
functionality.

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Cimatron
E encompasses a set of powerful and easy-to-use 3D design tools. The unified
solid-surface-wireframe environment allows the user to manipulate important
data or create conceptual part designs with equal ease. In the design process,
Cimatron E integrates tools to split part geometry, find and implement changes,
create electrodes and inserts, and detail tooling components. During
manufacturing, Cimatron E implements 2.5 to 5 axis toolpaths using high-speed
machining, knowledge of stock remaining and templates to reduce programming and
machine time. The mission critical tasks of splitting the model, applying
engineering changes, and extracting electrodes and inserts are all handled by
Cimatrons Quick Tooling wizard-based applications.

Cimatron
E communicates with most other CAD/CAM systems, runs on personal computers, as
well as engineering workstations employing Windows based operating systems
(which are the primary operating systems used for the personal computer and
workstation platforms on which our products are used) and transfers data easily
and reliably among different hardware and software environments.

Cimatron
E is built around a set of compatible modules using a unified database, which
can be accessed and modified for all applications. Users can move easily among
wireframe, surface and solid models choosing the application most appropriate
for a specific job. Cimatron E enables the user to work top-down (i.e., beginning at the conceptual level
and moving down to subassemblies and individual parts) or bottom-up (i.e., modeling elements first and then
grouping them into assemblies), and permits the user to combine the two
approaches. Cimatron E stores product data hierarchically to ensure overall
structural integrity of the product and the ability to interface with
engineering data management systems. Cimatron Es CAM applications operate
directly on the design model to generate intelligent toolpaths for NC
manufacturing processes and enable fast and accurate graphic simulation of NC
operations. In addition, Cimatron E includes advanced data exchange interfaces,
which enable the transfer of CAD/CAM data between ourselves and other CAD/CAM systems
through industry standard interfaces, as well as several dedicated interfaces.
Cimatron E offers an intuitive and consistent user interface throughout all
applications (e.g., design,
drafting and NC). Since all applications have the same look and feel, there is
no need for the user to relearn the operation of the system with each module.
Cimatron Es architecture is based upon a software kernel, which includes
database utilities, the graphic sub-system and the user interface, which
provide the operating environment for all applications. Applications are
separate from the software kernel, which facilitates enhancement of the
applications, reduces development and maintenance costs and enables efficient
technological updates to the systems components, without affecting the
application base.

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The
Cimatron E product family includes the following basic modules:

Designer Solution

Designer
Solution is a CAD-only solution. It provides users with full 3D design and
modeling capabilities, as well as fully associative 2D drawing and sketching
functions. Designer Solution includes a hybrid 3D wireframe, surfaces and solid
modeler, with full assembly support. Designer Solution includes SAT, STL, PFM
and one DI optional module (DWG, DXF or VDA).

NC Solution

NC Solution is
a manufacturing-only solution. This base solution offers comprehensive milling,
drilling, simulation and verification capabilities up to 2.5 axes + 2X
Positioning. NC Solution provides access to a wide range of CAD capabilities
necessary to undertake any NC job. The system includes tool libraries and a
post processor. NC Solution includes SAT, STL, PFM and one DI optional module
(DWG, DXF or VDA).

Master Solution

Master
Solution is a comprehensive CAD/CAM solution. It includes all features of the
Designer Solution and the NC Solution integrated into an end-to-end system,
providing the tools and capabilities users need for designing and manufacturing
complex CAD/CAM projects. Master Solution includes SAT, STL, PFM and one DI
optional module (DWG, DXF or VDA)

Electrode Solution

Electrode
Solution includes all the tools necessary to create and design electrodes out
of a given part model, including the industry leading QuickElectrode
application. Electrode Solution comes complete with a choice of one DI optional
module (IGES, STEP or VDA). The Electrode Solution is competitively priced in
comparison with a similar general purpose configuration.

Electrode Pro Solution

Electrode Pro
Solution includes the tools necessary to create, design and manufacture
electrodes, including the industry leading QuickElectrde application and full
3X milling tools. Electrode Pro Solution comes complete with a choice of one DI
module (IGES, STEP or VDA). The Electrode Pro Solution is competitively priced in
comparison with a similar general purpose configuration.

Student Package

The Cimatron
Student Package is a limited Cimatron package for students home use. The
package covers most of Cimatron Es capabilities, and enables execution of
small non-commercial mold design projects. CAD modules include the following:
Wire-frame, Surfacing and Solid part Modeling; Assembly; Drafting; Sketcher;
Catalog Tools; QuickSplit; QuickCompare; QuickElectrode; and MoldDesign. CAM
modules include 2.5X - 3X milling and 3X simulator. The system includes
read-only Data Interface for IGES, VDA, STEP, DXF, and DWG. The package is
protected via software mechanism and does not require a hardware protection
plug.

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View Only System

View Only
System provides tools to view and check CAD/CAM projects. The system includes
powerful 3D modeling and drafting capabilities, as well as key Cimatron
modules, such as QuickSplit, QuickElectrode and viewing of 2.5X - 3X milling,
including the 3X simulator. No save is possible with a View Only system. The
system includes read-only translators to all leading standard formats: DXF,
DWG, IGES, STEP, VDA, SAT, STL, and PFM.

In
addition to these basic modules, we offer over 20 optional modules for a wide
variety of additional applications that allow customers to purchase those
components most helpful for their businesses and grant customers greater
control over the rate of investment in our products.

Cimatron
IT

Cimatron
IT, which preceded Cimatron E, is a family of integrated software tools for
mechanical engineering and manufacturing automation that is designed to provide
a complete solution for the unique needs of the manufacturing segment of the
CAD/CAM market, especially those of mold, tool, die and fixture makers.
Cimatron IT contains design for manufacturing and NC programming capabilities,
along with advanced conceptual design abilities. It is designed to enable users
in this market segment to substantially reduce their time to market.  Based on our data-to-steel philosophy,
Cimatron IT provides advanced data interface, design for manufacturing and NC
machining tools which enable users to translate complex part designs into
finished molds, tools, dies and fixtures in a timely manner.

QuickConcept

QuickConcept
is a preliminary design and review package that allows tool designers and their
suppliers to hold virtual review meetings over the Internet in real-time.
Multiple users can connect to each other to section, label, dimension and identify
points of interest and problem areas of any given tool.

Marketing and Distribution

We
employ a broad range of marketing activities to promote our products and
develop name recognition and visibility.
We use print and online advertising, trade shows, seminars, direct mail,
online promotions, and regional marketing development in an effort to further
penetrate the tooling segment of the CAD/CAM market.  In addition to online promotions, we use the Internet as a
marketing tool that increases our visibility in the marketplace, offers
downloadable product demonstrations and facilitates communication between our
clients and us.

Additionally,
we have been increasing our penetration in the niche market of mold, tool, die
and fixture makers, in an effort to become the lead supplier of CAD/CAM
solutions to this segment of the manufacturing market. Our strategy involves
examining the functionality of current and future products through
in-depth  focus-meetings with mold,
tool, die and fixture makers, thereby making customers partners in the
development of custom solutions for this niche market.

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We
distribute our products to end-users in approximately 28 countries in five
continents through certain of our subsidiaries (in the United States, the
United Kingdom, Canada, Germany, China, France and India), directly in Israel and through a network of 23 independent
Providers. Between us, our subsidiaries and our Providers, our family of
products is currently supported at over 8,500 customer sites with more than
17,000 installations.

Our
sales operations are organized on a regional basis.  In each region we appoint a vice president in charge of sales in
such region. We believe that this will result in a more efficient sales
structure.

Providers

We
believe that our Providers are technically competent in the mechanical
engineering and manufacturing aspects of CAD/CAM markets and offer a full range
of sales, service and support functions. Providers assume overall
responsibility for the integrity of each end-user customers CAD/CAM system in
their respective territories, including selection, installation, training and
maintenance. Providers are carefully selected on the basis of their ability to
distribute and service our entire product line, with special emphasis on the
ability of their engineering and sales teams to provide customer support.

We
furnish our Providers with technical guidance and marketing and sales
resources. Providers regularly visit our Israeli headquarters, while our
employees from various departments visit Provider sites. Our relationship with
our Providers is further enhanced by an annual international conference that we
organize, regional workshops and cooperative exhibitions, and participation in
local user meetings.

Providers
serve as an integral part of our marketing and service network around the
world. They give our products a local feel by (a) offering technical support
in the end-users native language, (b) being available to attend to customer
needs during local business hours, (c) translating our manuals, product and
marketing literature into the local language and (d) frequently organizing user
programs and seminars. Providers continually develop new ways to adapt and
enhance our products to meet their respective customers regional and
company-specific needs.

A
typical agreement with a Provider is for a term of two years (subject to
rolling two-year extensions).  Our
Providers are distributors and our agreements with them enable the Providers to
purchase our products at a discounted price. Certain of our Providers act as
our exclusive distributors in a single country or region. Other than our
Providers in Italy and Japan, no Provider accounted for more than 5% of our
total revenue for the year ended December 31, 2005.  In July 2005 we acquired 27.5% of our Italian Provider and an
option to purchase its remaining outstanding shares from its stockholders.

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There
can be no assurance that all existing relationships with our Providers will be
renewed. We believe that with the exception of our Provider in Japan, the
termination of our relationship with a single Provider would not harm us
materially;  however, the termination of
our relationship with several of our Providers at approximately the same time
or with our Provider in Japan could seriously harm us. There can be no
assurance that, in the event that we lose any of our Providers, we will be
successful in recruiting replacement professional and technically competent
Providers.

Subsidiaries

Our
strategy over the years has been to increase our direct involvement in certain
key markets in which we felt the Providers were not maximizing the business
opportunities, through the formation or acquisition of marketing and support
subsidiaries. In furtherance of this strategy, we have incorporated
subsidiaries in France, Japan, United Kingdom, China, as well as India, where
we formed a subsidiary at the end of 2005 that started commercial activities
during the second quarter of 2006. We have also acquired all of the outstanding
voting interests in Cimatron Technologies, Inc., our North American Provider,
and have had our German subsidiary, Cimatron GmbH, purchase all of the
Cimatron-related business of our German Provider.  In December 2002, we also entered into a joint venture in Korea
with a third party in which we held 30% as of December 31, 2005. In January
2005 we announced the formation of Cimatron Guangzhou, a new joint venture in
Guangzhou, China, with SGV, a distributor of our products since 1998.

Marketing
Representatives

| |                                                                                                                                                                                                                                                                                                                                                                                                                           
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | In 1998 we funded the
  formation and operations of a marketing office in India, which we turned into
  a subsidiary at the end of 2005, and in February 2001 we opened a marketing
  office in South Korea. This marketing office is currently inactive as its
  activities are now undertaken by our Korean JV. The purpose of these offices
  is to assist our local Providers in educating the market on our products.

Customers

Our
end-users are typically small to medium-sized companies involved in the
mechanical engineering and manufacturing industry, subcontractors that supply
major corporations within the core mechanical engineering and manufacturing
industry and departments or divisions within these major corporations.  Our customers are located in approximately
28 countries worldwide.

In
the years ended December 31, 2005, 2004 and 2003, approximately 42%, 57% and
56%, respectively, of our revenues were from Europe; approximately 5%, 8% and
10%, respectively, of our revenues were from Israel; approximately 34%, 19% and
20%, respectively, of our revenues were from the Far East; approximately 18%,
15% and 13%, respectively, of our revenues were from North America; and
approximately 0.8%, 0.7% and 0.5%, respectively, of our revenues were from
other countries.

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Geographical Breakdown of Our Revenue

The
following tables represent a geographical breakdown of our revenues from
products and services from the last three years (in thousands of U.S.
dollars):

|                    |  |          |  |          |       |        |  |         |  |  |       |   | 
|------------------- |  | -------- |  | -------- | ----- | ------ |  | ------- |  |  | ----- | - | 
|2005                |  |          |  |          |       |        |  |         |  |  |       |   | 
|                    |  |          |  |          |       |        |  |         |  |  |       |   | 
|                    |  | Products |  | Services |      
|                    |  |          |  |          |      
|Geographical Region |  | Amount   |  | Percent  |       | Amount |  | Percent | 
|                    |  |          |  |          |       |        |  |         | 
|Europe              |  | 3,802    |  |          | 42.4  | %      |  | 6,974   |  |  | 58.3  | % | 
|Israel              |  | 435      |  |          | 4.9   | %      |  | 1,204   |  |  | 10.1  | % | 
|Far East            |  | 3,048    |  |          | 34.0  | %      |  | 1,576   |  |  | 13.2  | % | 
|North
  America     |  | 1,607    |  |          | 17.9  | %      |  | 2,108   |  |  | 17.6  | % | 
|Other               |  | 76       |  |          | 0.8   | %      |  | 95      |  |  | 0.8   | % | 
|Total               |  | 8,968    |  |          | 100.0 | %      |  | 11,957  |  |  | 100.0 | % | 

|                      |  |          |  |          |      |        |  |         |  |  |      |   | 
|--------------------- |  | -------- |  | -------- | ---- | ------ |  | ------- |  |  | ---- | - | 
|2004                  |  |          |  |          |      |        |  |         |  |  |      |   | 
|                      |  |          |  |          |      |        |  |         |  |  |      |   | 
|                      |  | Products |  | Services |     
|                      |  |          |  |          |     
|Geographical
  Region |  | Amount   |  | Percent  |      | Amount |  | Percent | 
|                      |  |          |  |          |      |        |  |         | 
|Europe                |  | 6,039    |  |          | 53.1 | %      |  | 7,216   |  |  | 61.2 | % | 
|Israel                |  | 734      |  |          | 6.5  | %      |  | 1,206   |  |  | 10.2 | % | 
|Far East              |  | 3,033    |  |          | 26.7 | %      |  | 1,373   |  |  | 11.6 | % | 
|North
  America       |  | 1,498    |  |          | 13.1 | %      |  | 1,911   |  |  | 16.2 | % | 
|Other                 |  | 66       |  |          | 0.6  | %      |  | 87      |  |  | 0.8  | % | 
|Total                 |  | 11,370   |  |          | 100  | %      |  | 11,793  |  |  | 100  | % | 

|                      |  |          |  |          |      |        |  |         |  |  |      |   | 
|--------------------- |  | -------- |  | -------- | ---- | ------ |  | ------- |  |  | ---- | - | 
|2003                  |  |          |  |          |      |        |  |         |  |  |      |   | 
|                      |  | Products |  | Services |     
|                      |  |          |  |          |     
|Geographical
  Region |  | Amount   |  | Percent  |      | Amount |  | Percent | 
|                      |  |          |  |          |      |        |  |         | 
|Europe                |  | 5,394    |  |          | 51.6 | %      |  | 6,809   |  |  | 61.0 | % | 
|Israel                |  | 756      |  |          | 7.2  | %      |  | 1,328   |  |  | 11.9 | % | 
|Far East              |  | 3,028    |  |          | 29.0 | %      |  | 1,366   |  |  | 12.2 | % | 
|North
  America       |  | 1,240    |  |          | 11.9 | %      |  | 1,568   |  |  | 14.0 | % | 
|Other                 |  | 30       |  |          | 0.3  | %      |  | 90      |  |  | 0.8  | % | 
|Total                 |  | 10,448   |  |          | 100  | %      |  | 11,161  |  |  | 100  | % | 

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Other
than our Provider agreements and certain maintenance contracts with customers
in Israel, we currently have no significant long-term contracts with any
customer and sales are generally made pursuant to purchase orders received from
distributors.

Potential Fluctuations in Operating Results;
Seasonality

Potential
Fluctuations in Operating Results

See
Item 3 - Risk Factors - We may experience significant fluctuations in our
quarterly results, which makes it difficult for investors to make reliable
period-to-period comparisons and may contribute to volatility in the market
price for our ordinary shares for a discussion of factors which may cause
annual or quarterly fluctuations in the results of our operations.

Seasonality

We
sell our products to corporations and our sales are therefore subject to the
fiscal and budgeting cycles of these corporations.  Accordingly, a large percentage of our sales occur in the fourth
quarter, while sales in the first quarter are relatively slower.

Organizational Structure

Our
principal shareholders, Koonras and DBSI, hold2,560,360and 2,573,350
shares, representing approximately 32.68% and 32.84% of our outstanding share
capital, respectively.  Koonras and DBSI
have entered into an agreement by which a number of their shares equal to, or
greater than, 25.05% of our issued and outstanding share capital cannot be sold
by either party without first offering such holding to the other party.
Additionally, under such agreement, in the event that the selling partys offer
is refused, the other party shall then have the right to participate, pro-rata,
with the selling party in the sale of his shares to a third party.
Additionally, Koonras and DBSI have agreed that they will each appoint half of
our directors, not including our external directors required to be appointed
under Israeli law and independent directors required to be appointed under the
Nasdaqs listing qualifications, and that they will vote together at our
shareholders meetings.

For
information about Cimatrons subsidiaries and its beneficial ownership therein,
see Exhibit 8.1.

Property, Plants and Equipment

We
do not own any real property.  We lease
the office premises that we occupy in Givat Shmuel, Israel from a private
commercial property owner pursuant to the terms of a lease agreement we entered
into in February 2003. Until January 2006 we occupied an aggregate of
approximately 2100 square meters at this facility. As of January 10, 2006, we
occupy approximately 1,750 square meters at this facility. In 2005, the
aggregate annual lease payments for the office premises were approximately
$224,000. The initial term of this lease ended on June 30, 2006 and we have
exercised our option to extend the lease for an additional three years.

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The
following table represents a breakdown of our approximate aggregate annual
lease payments for office premises worldwide for the year 2005 (in thousands of
U.S. Dollars):

|                            |  |                                                          |  |                                                      |  | 
|--------------------------- |  | -------------------------------------------------------- |  | ---------------------------------------------------- |  | 
|ENTITY                      |  | LOCATIONS                                                |  | APPROXIMATE
  ANNUAL EXPENSE
  (in thousands of US$) | 
|                            |  |                                                          |  |                                                      |  | 
|Headquarters
  in Israel    |  | Givat Shmuel                                             |  | 224                                                  |  | 
|                            |  |                                                          |  |                                                      |  | 
|North
  American subsidiary |  | Michigan and
  Illinois (U.S.)*                          |  | 78                                                   |  | 
|                            |  |                                                          |  |                                                      |  | 
|German
  subsidiary         |  | Ettlingen,
  Hamm, Nurenberg, Koln and Ismaning          |  | 198                                                  |  | 
|                            |  |                                                          |  |                                                      |  | 
|French
  subsidiary         |  | Oyonnax
  (Since February 2005 - Lyons)                  |  | 20                                                   |  | 
|                            |  |                                                          |  |                                                      |  | 
|UK
  subsidiary             |  | Huddersfield                                             |  | 21                                                   |  | 
|                            |  |                                                          |  |                                                      |  | 
|Japanese
  subsidiary       |  | Tokyo                                                    |  | 29                                                   |  | 
|                            |  |                                                          |  |                                                      |  | 
|Chinese
  subsidiaries      |  | Beijing
  Wuxi
  Chengdu
  Shanghai
  Guangzhou
  Fujian |  | 57                                                   |  | 
|                            |  |                                                          |  |                                                      |  | 
|                            |  |                                                          |  |                                                      | 
|                            |  | Total                                                    |  | 627                                                  |  | 

*These offices are
responsible for our marketing efforts in Canada as well.

**Offices for our
newly formed Indian subsidiary were opened towards the end of 2005, and the
annual lease payments for such office in 2006 is expected to be US$12.

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|        |                                             
|------- | --------------------------------------------
|Item 5. | Operating and Financial Review and Prospects

Overview

We
design, develop, manufacture, market and support a family of modular,
high-performance, CAD/CAM software products. Our products provide an integrated
design through manufacturing solution for small-to-medium sized companies and
manufacturing divisions of large corporations, and interface easily with other
CAD/CAM systems.

In
July 2005 we acquired 27.5% of the shares of Microsystem Srl, our Italian
distributor, for 575,000 Euro, and an option, which we refer to as the First
Call Option, to acquire up to additional 23.5% of Microsystem from
Microsystems shareholders.  We may
exercise this option until June 30, 2007.
The exercise price for this option is an aggregate of approximately
$600,000. In the event that we exercise the First Call Option in full, we would
then also have a second option, which we refer to as the Second Call Option, to
acquire up to the remaining 49% of Microsystems share capital, for an exercise
price of approximately $1.25 million.
The Second Call Option is exercisable at any time within a thirty day
period, which we refer to as the Second Option Exercise Period, starting on the
twelve month anniversary of our exercise of the First Call Option. In addition,
in the event that we exercise the First Call Option, the then remaining other
shareholders of Microsystem will have an option to require us to purchase, at
any time during the Second Exercise Period, 49% of Microsystems share capital,
for consideration of approximately $1.25 million. We have accounted for the
transaction under the equity method and accordingly, as of July 1, 2005 we
record our share of Microsystemss profits or losses in our consolidated financial
statements.

Following
the appointment of Dan Haran as President and CEO in July 2005, we entered
into a cost reduction plan, in order to cut our costs in an attempt to achieve
profitability, although, as part of such plan, we increased our sales and
marketing expenses. As part of our plan, we terminated the employment of
certain R&D and administrative employees and reorganized the activities of
our office in Japan. In addition, towards the end of 2005, our European
headquarters, which were located in Germany, were closed, and a VP Sales Europe
was appointed in our headquarters in Israel. We incurred termination expenses
relating to the changes in Germany of approximately $530,000.

We
released our newest version of the Cimatron E (Version 7.0) in August 2005.
Cimatron E7 was developed on the basis of advanced technology and
infrastructure that replaced the infrastructure of the older versions, and
includes new elements that did not exist in older versions.

During the
fourth quarter of 2005, we evaluated our capitalized software costs and wrote
off all the net balance of capitalized costs related to our older products in
the amount of approximately $0.8 million.

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Revenues

We
derive revenues mainly from (a) sale of our products, including software and
hardware components, and (b) services which include primarily maintenance fees
and the provision of technical support for our software products and, to a
lesser extent, fees from the provision of engineering, training, consulting and
implementation services.  Revenues from
sales of our products are generated by a relatively large number of sales and
no one customer accounts for a material portion of our revenues.  We provide maintenance services pursuant to
maintenance contracts, which either provide for annual maintenance fees or for
the payment of maintenance fees upon the provision of upgrades to our
products.  Generally, maintenance
contracts are for a one year term.  It
has been our experience that most of our customers who purchase maintenance
contracts elect to receive maintenance services from us on a continuing
basis.  While customers in most markets
do purchase maintenance services from us, our customers in the Far East (other
than in Japan) generally do not purchase maintenance but instead purchase
product upgrades on a case-by-case basis.

Cost
of Revenues

Our
cost of revenue consists of five major components: (a) the cost of our
Israel-based operations, which include primarily salaries (mostly for technical
support personnel), subcontractors and facilities costs, (b) hardware costs in
Israel, Germany, France and the U.K., (c) royalties payable to third parties
for third party software and maintenance, (d) royalties payable to the Israeli
Office of the Chief Scientist and (e) amortization of capitalized software
development costs.

Software
Development Costs

Costs
for the development of new software products and substantial enhancements to
existing software products are expensed as incurred until technological
feasibility has been established, at which time any additional development
costs are capitalized.  Based on our
product development process, technological feasibility is established upon
completion of a working model.  Any
capitalization of software development costs continues up to the time the
software is available for general release to customers. However, during 2003
and 2004 costs incurred between the completion of the working model and the
point at which the products were ready for general release have been
insignificant. Therefore, all research and development costs incurred in 2003
and 2004 have been expensed. However, in 2005 we capitalized approximately $0.2
million in connection with the development of Cimatron E 7.0.

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Primary
and Reporting Currency

We
market and sell our products and services in Europe, the Far East, North
America and Israel and derive a significant portion of our revenues from
customers in Europe and Asia. A majority of our revenues in 2003, 2004 and 2005
were from customers in Europe. Since our financial results are reported in U.S.
dollars, decreases in the rate of exchange of non-U.S. dollar currencies in
which we make sales relative to the U.S. dollar will decrease the U.S.
dollar-based reported value of those sales. In
2001, the first quarter of 2002 and throughout 2005, decreases in Euro -
U.S. dollar exchange rates adversely affected our results of operation.
However, during the last three quarters of 2002, 2003 and the last quarter of
2004 our results of operations benefited from the increase in the Euro - U.S.
dollar exchange rates during these periods. To the extent that decreases in
exchange rates are not offset by a reduction in our costs, they may in the
future materially adversely affect our results of operations.

Our
reporting currency is the U.S. dollar while a portion of our expenses,
principally salaries and the related personnel expenses, are in new Israeli
shekels, or NIS. As a result, we are exposed to the risk that the rate of
inflation in Israel will exceed the rate of devaluation of the NIS in relation
to the U.S. dollar or that the timing of this devaluation lags behind inflation
in Israel. This would have the effect of increasing the U.S. dollar cost of our
operations. In 2001, 2002 and 2005, the rate of devaluation of the NIS against
the U.S. dollar exceeded the rate of inflation. In 2003, there was on one hand
a devaluation of the U.S. dollar against the NIS and on the other hand a
deflation. In 2004 there was inflation coupled with a devaluation of the U.S.
dollar against the NIS. If the U.S. dollar cost of our operations in Israel
increases, our U.S. dollar-measured results of operations will be adversely affected.

See -
Liquidity and Capital Resources  Impact of Inflation and Devaluation on
Results of Operation, Liabilities and Assets for information relating to our
policy of hedging against currency fluctuations.

Critical Accounting Policies

The
discussion and analysis of our financial condition and results of operations
are based upon our consolidated financial statements, which were prepared in
accordance with U.S. GAAP. The preparation of these financial statements
requires us to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses, and related disclosure of
contingent assets and liabilities. We evaluate these estimates on an on-going
basis.  We base our estimates on our
historical experience and on various other assumptions that we believe to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying amount 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.

We
believe that application of the following critical accounting policies entails
the most significant judgments and estimates used in the preparation of our
consolidated financial statements.

Revenue Recognition

We
recognize revenues in accordance with the American Institute of Certified
Public Accountants Statement of Position 97-2, Software Revenue Recognition, as
amended.

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Revenues
from software license fees are recognized when persuasive evidence of an
arrangement exists, the software product covered by written agreement or a
purchase order signed by the customer has been delivered, the license fees are
fixed and determinable and collection of the license fees is considered
probable. When software arrangements involve multiple elements we allocate
revenue to each element based on the relative fair values of the elements. Our
determination of fair value of each element in multiple element arrangements is
based on vendor-specific objective evidence (VSOE). We limit our assessment
of VSOE for each element to the price charged when the same element is sold
separately.

In
judging the probability of collection of software license fees we continuously
monitor collection and payments from our customers and maintain a provision for
estimated credit losses based upon our historical experience and any specific
customer collection issues that we have identified.  In connection with customers with whom we have no previous
experience, we may utilize independent resources to evaluate the
creditworthiness of those customers.
For some customers, typically those with whom we have long-term
relationships, we may grant extended payment terms.  We perform on-going credit evaluations of our customers and
adjust credit limits based upon payment history and the customers current
creditworthiness, as determined by our review of their current credit
information. If the financial situation of any of our customers were to
deteriorate, resulting in an impairment of their ability to pay the
indebtedness they incur with us, additional allowances may be required.

Our
software products do not require significant customization or modification.
Service revenues include consulting services, post-contract customer support
and maintenance and training. Consulting revenues are generally recognized on a
time and material basis. Software maintenance agreements provide technical
customer support and the right to unspecified upgrades on an
if-and-when-available basis. Post-contract customer support revenues are
recognized ratably over the term of the support period (generally one year) and
training and other service revenues are recognized as the related services are
provided. Deferred revenues represent mainly amounts received on account of
service agreements.

Our
sales are made pursuant to standard purchase orders, containing payment terms
averaging between 30 - 120 days. For some customers with whom we have
longstanding relationships and based on past experience with those customers
and the same software products, we may grant payment terms of not over 180
days. Any payment terms that exceed 180 days must be approved by our Chief
Financial Officer prior to the signing of any purchase order.

Our
arrangements do not include any refund provisions nor are payments subject to
milestones. In addition, our arrangements do not contain customer acceptance
provisions.

We
have no significant expenditures relating to either warranties or post-contract
customer support bundled with the initial sale of the software license and,
therefore, other than a provision of approximately $60,000, no provision in
respect of warranties or post-contract customer support is included in our
financial statements.

31

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Allowance
for Doubtful Accounts

We
evaluate the collectability of our accounts receivable based on a combination
of factors. In circumstances where we are aware of a specific customers
inability to meet its financial obligations to us (e.g. bankruptcy filings,
substantial down-grading of credit ratings), we record a specific reserve for
bad debts against amounts due to reduce the net recognized receivable to the
amount we reasonably believe will be collected. For all other customers, we
recognize reserves for bad debts based on the length of time the receivables
are past due and on our historical experience in collecting such receivables.

Operating Results

|                                                  |  |                                                 |        |      |  |        |   |  |        |  
|------------------------------------------------- |  | ----------------------------------------------- | ------ | ---- |  | ------ | - |  | ------ | -
|                                                  |  | December
  31,                                  |       
|                                                  |  |                                                 |       
|                                                  |  | 2003                                            |        | 2004 |  | 2005   |  
|                                                  |  |                                                 |        |      |  |        |  
|                                                  |  | In
  thousands of US$ (except per share
  data) |       
|Statement of Income Data:                         |  |                                                 |        |      |  |        |   |  |        |  
|Revenue:                                          |  |                                                 |        |      |  |        |   |  |        |  
|                                                  |  |                                                 |        |      |  |        |   |  |        |  
|Products                                          |  |                                                 | 10,448 |      |  | 11,370 |   |  | 8,968  |  
|Services                                          |  |                                                 | 11,161 |      |  | 11,793 |   |  | 11,957 |  
|                                                  |  |                                                 |        |      |  |        |   |  |        |  
|Total                                             |  |                                                 | 21,609 |      |  | 23,163 |   |  | 20,925 |  
|                                                  |  |                                                 |        |      |  |        |   |  |        |  
|Cost of revenue:                                  |  |                                                 |        |      |  |        |   |  |        |  
|Products                                          |  |                                                 | 3,056  |      |  | 2,923  |   |  | 3,367  |  
|Services                                          |  |                                                 | 1,562  |      |  | 1,678  |   |  | 1,568  |  
|                                                  |  |                                                 |        |      |  |        |   |  |        |  
|Total                                             |  |                                                 | 4,618  |      |  | 4,601  |   |  | 4,935  |  
|                                                  |  |                                                 |        |      |  |        |   |  |        |  
|Gross profit                                      |  |                                                 | 16,991 |      |  | 18,562 |   |  | 15,990 |  
|                                                  |  |                                                 |        |      |  |        |   |  |        |  
|Research and development costs                    |  |                                                 | 5,210  |      |  | 5,554  |   |  | 4,815  |  
|Selling, general and administrative expenses      |  |                                                 | 12,645 |      |  | 13,962 |   |  | 15,650 |  
|                                                  |  |                                                 |        |      |  |        |   |  |        |  
|Operating loss                                    |  |                                                 | (864   | )    |  | (954   | ) |  | (4,475 | )
|Financial income (expenses), net                  |  |                                                 | 369    |      |  | 445    |   |  | (148   | )
|Other income (expenses)                           |  |                                                 | 203    |      |  | 144    |   |  | 1      |  
|                                                  |  |                                                 |        |      |  |        |   |  |        |  
|Income (loss) before taxes                        |  |                                                 | (292   | )    |  | (365   | ) |  | (4,622 | )
|Taxes on income                                   |  |                                                 | (9     | )    |  | (23    | ) |  | (2     | )
|                                                  |  |                                                 |        |      |  |        |   |  |        |  
|Loss after income taxes                           |  |                                                 | (301   | )    |  | (388   | ) |  | (4,624 | )
|Companys equity in results of affiliated company |  |                                                 | -      |      |  | -      |   |  | (5     | )
|Minority interest in results of subsidiary        |  |                                                 | -      |      |  | -      |   |  | 36     |  
|                                                  |  |                                                 |        |      |  |        |   |  |        |  
|Net income (loss)                                 |  |                                                 | (301   | )    |  | (388   | ) |  | (4,593 | )
|                                                  |  |                                                 |        |      |  |        |   |  |        |  
|Net income (loss) per share (basic and diluted)   |  |                                                 | (0.04  | )    |  | (0.05  | ) |  | (0.59  | )
|                                                  |  |                                                 |        |      |  |        |   |  |        |  
|Weighted average number of shares outstanding     |  |                                                 | 7,838  |      |  | 7,835  |   |  | 7,835  |  
|                                                  |  |                                                 |        |      |  |        |   |  |        |  

32

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|                                                        |  |                     |        |      |  |        |  |  |        | 
|------------------------------------------------------- |  | ------------------- | ------ | ---- |  | ------ |  |  | ------ | 
|                                                        |  | December 31,        |       
|                                                        |  |                     |       
|                                                        |  | 2003                |        | 2004 |  | 2005   | 
|                                                        |  |                     |        |      |  |        | 
|                                                        |  | In thousands of US$ |       
|Balance Sheet Data                                      |  |                     |        |      |  |        |  |  |        | 
|Cash and cash equivalents                               |  |                     | 3,124  |      |  | 1,711  |  |  | 2,708  | 
|Short-term investments                                  |  |                     | 6,358  |      |  | 6,381  |  |  | 2,167  | 
|                                                        |  |                     |        |      |  |        |  |  |        | 
|Total cash, cash equivalents and short-term investments |  |                     | 9,482  |      |  | 8,092  |  |  | 4,875  | 
|Long term marketable investments                        |  |                     | -      |      |  | -      |  |  | 1,309  | 
|Working capital                                         |  |                     | 10,639 |      |  | 10,306 |  |  | 4,328  | 
|Total assets                                            |  |                     | 22,386 |      |  | 20,804 |  |  | 16,442 | 
|Total liabilities                                       |  |                     | 8,865  |      |  | 7,956  |  |  | 8,456  | 
|Shareholders equity                                    |  |                     | 13,521 |      |  | 12,848 |  |  | 7,982  | 

Revenue

Our
total revenues decreased to approximately $20.9 million in 2005 from
approximately $23.1 million in 2004 and approximately $21.6 million in 2003.
Our revenues from the sale of products decreased to approximately $9.0 million
in 2005 from approximately $11.4 million in 2004 and approximately $10.4
million in 2003.  The decrease in the
sale of products in 2005 was mainly due to a decrease of 37.3% in sales in
Europe. In addition, 5% of the decrease in sales revenues was due to the fall
in the Euro - dollar exchange rate.  As
51% of our 2005 revenues were derived from European countries, changes in the
Euro - dollar exchange rate can significantly influence our revenues. Total
revenues in 2005 were primarily influenced by mold, tool, die and fixture
makers in Europe migrating their operations to low cost labor markets in the
Far East, which markets are also characterized by lower prices and by higher
usage of pirated copies of software products. While we believe that this trend
may continue, we have adjusted our European strategy slightly in order to
increasingly focus on penetrating the high end European market, in which such
migration is less frequent. In addition, we have increased our sales efforts in
China, in order to, among others things, attempt to set off the decreases in
Europe. As a percentage of revenues, our revenues from the sale of products
increased from approximately 48.4% in 2003 to approximately 49.1% in 2004 and
decreased to approximately 42.9% in 2005.
Our revenues from services increased in 2005 to approximately $12.0 million
from approximately $11.8 million in 2004 and $11.2 million in 2003.  The increase in service revenues in 2005 was
due to an increase in service contract renewals, the increase in our installed
base of Cimatron E users and efforts to restore old customers to maintenance,
although such increases were slightly offset by the fall in the Euro - dollar
exchange rate.  As a percentage of
revenues, our revenues from services decreased from approximately 51.6% in 2003
to approximately 50.9% in 2004 and increased to approximately 57.1% in
2005.

Although
we had net income of $0.2 million in the first quarter of 2006, we cannot be
certain that we will return to profitability on an annual basis or maintain
profitability on a quarterly basis or, if we do return to profitability on an
annual basis, remain profitable in future years. If the trend of increases in
the percentage of our overall revenues comprised by service revenue continues,
our gross margins and profitability will likely be adversely affected. In
addition, if our revenues from the sale of products continue to decrease, such
decrease may adversely effect our future service revenues, as it may result in
a smaller user base to purchase service contracts from us. See Item 3  Risk
Factors During 2005, we continued to experience decreases in revenues from
products. If this trend continues, it will likely adversely affect our gross
margins and profitability.

For
a geographical breakdown of our revenue, please refer to Item 4  Information
on the Company  Geographical Breakdown of our Revenue.

33

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Cost
of Revenue

Cost of
revenue increased in 2005 to $4.9 million, from approximately $4.6 million in
both 2004 and 2003.  The increase
resulted from a write-off of capitalized software development expenses of $0.8
million, which was offset by a decrease in all other components of this item,
in line with the decrease in product sales.
Cost of revenues in 2004 included an increase in royalties to the OCS in
the amount of $0.2 million, which offset a decrease in the amount of $0.2
million in salaries and employee benefits.

Gross
Profit

Gross
profit, as a percentage of total revenue, was 76.4%, 80.1% and 78.7% in 2005,
2004 and 2003, respectively.

Research
and Development, Patents and Licenses, etc.

Research
and development costs primarily consist of salaries and related costs of
employees engaged in ongoing research, design and development activities.
Research and development costs were $4.8 million in 2005, $5.6 million in 2004
and  $5.2 million in 2003.  The decrease in 2005 was due to the cost
reduction measures implemented during the year. The increase in 2004 was due to
increased investment of resources in the development of Cimatron E version 6.0,
as well as to an increase in salary and termination payment expenses and to the
operation of a development team in Russia.
In addition, the devaluation of the US dollar against the NIS
contributed 5% of the 2005 decrease and 24% of the 2004 increase.

Selling,
General and Administrative Expenses

Selling
expenses consist of costs relating to promotion, advertising, trade shows and
exhibitions, compensation (including sales commissions), sales support, travel
and travel-related expenses and royalties to the Fund for the Encouragement of
Marketing of the Government of Israel, or the Marketing Fund, including all
such expenses for our subsidiaries. We did not receive any grants from the
Marketing Fund in the years 2003, 2004 or 2005 and do not expect to receive any
such grants in the future. General and administrative expenses consist of
(a) compensation costs for administration, finance and general management
personnel, (b) office maintenance and administrative costs, (c) rent,
(d) fees paid for management services to DBSI and Koonras and (e) reserves
for doubtful debts.

Selling,
general and administrative expenses increased by 12% from $14.0 million in 2004
to $15.6 million in 2005, which increase was due to (a) the implementation of a
cost reduction plan, which resulted in increased selling expenses consisting of
termination expenses relating to certain operations in Europe and (b) increased
selling activities, especially in the U.S and China (including an increase in
sales personnel in China). Of the increase in selling, general and
administrative expenses, 3% was offset by the fall in the Euro - dollar
exchange rate. In 2004, selling, general and administrative expenses increased
by 10% from $12.6 million in 2003 to $14.0 million, which increase was due to
(a) the relatively high Euro  U.S. dollar exchange rate throughout 2004, which
resulted in increase selling expenses consisting of the salaries of the
personnel of our European subsidiaries, (b) increased selling activities,
especially in the U.S, and (c) organizational changes resulting in termination
and severance payments.

34

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Financial
Income (Expenses), net

Financial
income (expenses), net, consists primarily of interest earned on our cash
reserves, gains (losses) from sale of bonds and funds, as well as interest on
trade receivables and tax rebates and currency translation adjustments between
the U.S. dollar exchange rate imposed on our assets and liabilities.  Financial income (expenses), net, were $(0.1
million) in 2005, compared to $0.4 million in 2004 and $0.4 million in 2003,
respectively. The increase in financial income (expenses), net, in 2005 was due
primarily to the devaluation of the Euro in relation to the U.S. dollar. The
increase in financial income in 2004 was due primarily to the revaluation of
the Euro in relation to the U.S. dollar

Effective Corporate Tax Rate

We and each
of our subsidiaries are subject to corporate taxes in various countries in
which we and they operate. We are currently most significantly affected by corporate
taxes in Israel where we received a final tax assessment through the tax year
ended December 31, 2000. Generally, Israeli
companies are subject to corporate tax at the rate of 34% on taxable income and
are subject to capital gains tax at a rate of 25% on capital gains (other than
gains derived from the sale of listed securities that are taxed at the
prevailing corporate tax rates) derived after January 1, 2003.  The
corporate tax rate was reduced in June 2004, from 36% to 35% for the
2004 tax year, 34% for the 2005 tax year, 31%
for the 2006 tax year, 29% for the 2007 tax year, 27% for the 2008 tax year,
26% for the 2009 tax year and 25% for the 2010 tax year.  However,
the effective tax rate payable by a company that derives income from an
approved enterprise (as discussed below) may be considerably less. Our
effective tax rate in Israel would have been approximately 34% for the year
ended December 31, 2005, had we not incurred tax losses in Israel. We believe
that our effective tax rates in the U.S., Germany, France, the U.K., China and
Japan would have been approximately 35%, 40%, 33%, 19%, 33% and 31%,
respectively, for the year ended December 31, 2005, had we not incurred tax
losses in such countries. We believe that we had tax loss carryforwards in
Israel in the aggregate amount of $5,894,000 as of the end of 2005.  In addition, as of December 31, 2005, we had
approximately $6.8 million in net operating loss carryforwards in North
America, $1.7 million in Germany, $2.2 million in France and $0.4 million in
the U.K.  We expect that as our profits
increase and our subsidiaries utilize their respective loss carryforwards,
particularly in countries with relatively high corporate tax rates, our
consolidated effective tax rate will increase.

We have
been granted an Approved Enterprise status under the Israeli Law for the
Encouragement of Capital Investments, 1959 continuously since 1994. The current
status term will expire in the earlier of seven years after we begin to
generate income subject to preferable taxation under the Approved Enterprise
status and 2015.  Consequently, we are
eligible for certain Israeli tax benefits. Income derived from our Approved
Enterprise plan is exempt from tax for a period of two years, commencing in the
first year in which we generate taxable income from such Approved Enterprise,
and is subject to a reduced tax rate of 25% for a further five years,
respectively. See Note 13 of the notes to our consolidated financial statements
included elsewhere in this annual report.

35

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Liquidity and Capital Resources

We finance
our operations primarily from funds provided by operations and, to a lesser
extent, from accumulated cash and cash generated by the sale of our  investments. We believe that our accumulated
cash, in addition to cash generated from operations and available funds, will
be sufficient to meet our cash requirements for working capital and capital
expenditures for at least the next 12 months. Thereafter, if cash generated
from operations is insufficient to satisfy our liquidity requirements, we may
sell additional equity or debt securities or obtain credit facilities.

As of
December 31, 2005, we had $6.2 million in cash and marketable investments.
During 2005, net cash used in operating activities was $0.2 million. The major
component using cash during 2005 was our net loss of $4.6 million from
operations. Partially offsetting the use of cash was the non-cash depreciation
and amortization of $1.7 million, a decrease in accounts receivable and prepaid
expenses of $1.4 million and an increase in trade payables, accrued expenses
and other liabilities of $0.9 million.
In addition, we generated $3.0 million, which consisted of $2.9 million
from proceeds from the maturity of bonds and mutual funds as well as
approximately $0.1 million from the sale of property and equipment and the
acquisition of a newly-consolidated subsidiary. Furthermore, we utilized a
renewable loan in the amount of $$0.5 million from a Swiss bank, which is
secured by a deposit in the amount of $$0.5 million. We classify this deposit
under long term investments. The loan has a 6 month term and is renewable every
6 months provided that the deposit remains in place.  So long as amounts under the loan are outstanding, we are not
allowed to use the deposit. The loan is not subordinated to any other debt we
have.

In addition
to the cash provided by investing activities described above, we invested $0.3
million in bonds, $0.9 million in acquisition of affiliated companies, $0.4
million in the purchase of property and equipment and $0.2 million in
capitalized software development costs, resulting in net cash provided by
investing activities of $1.2 million.

These
transactions caused our aggregate amount of cash and cash equivalents to be
$2.7 million as of December 31, 2005 as compared to $1.7 million as of December
31, 2004, and our short-term and long-term marketable investments to be $3.5
million as of December 31, 2005, as compared to $6.4 million as at December 31,
2004.

As
of December 31, 2005, our combined cash and cash equivalents and short-term
and long-term marketable
investments totaled $6.2 million, compared to $8.1 million as of December 31,
2004.  This decrease was primarily the
result of cash used in operations and for acquisition of affiliated companies.
As of December 31, 2005, our working capital was $4.3 million and our total
assets were $16.4 million, compared to $10.3 million and $20.8 million,
respectively, as of December 31, 2004.  The decrease in working capital resulted from a decrease in
short-term investments and trade
accounts receivable and an increase in other liabilities and accrued expenses,
offset by an increase in cash and cash equivalents. The change in total assets
resulted from a decrease in short-term investments, trade accounts receivable and other assets (due to an
amortization and write-off of software development costs), offset by an
increase in cash and cash equivalents.

36

---

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Our
trade receivables, net of allowance for doubtful accounts on December 31, 2005
totaled $4.5 million, compared to $6.1 million on December 31, 2004.  The decrease was due to lower sales in 2005.
The collection cycle remained unchanged during
2005 compared to 2004.  We believe that,
generally, the quality of receivables remained unchanged and we will continue
our efforts to shorten the collection cycle.

Our
capital expenditures for 2005 amounted to approximately $0.5 million and were
mostly for the purchase of computers, computer equipment and other office
equipment.

Concentration of credit risk. Financial
instruments that potentially subject us to concentration of credit risk consist
principally of cash and cash equivalents, short-term investments and accounts receivable.
Our cash and cash equivalents, short-term investments and long-term investments
are invested in deposits with major banks in the United States, Europe and
Israel. We believe that the financial institutions holding our cash funds are
financially sound, and that minimal credit risk exists with respect to our
marketable securities, which consist of debt securities of the Government of
Israel and highly rated corporate bonds. Our accounts receivable are generated
from a large number of customers located in Europe, Asia, the United States and
Israel. We perform ongoing evaluations of our accounts receivable and maintain
an allowance for doubtful accounts that we believe is adequate to cover all
anticipated losses with respect to our accounts

Impact
of Inflation and Devaluation on Results of Operations, Liabilities and Assets

Although
part of our revenues are denominated and paid in U.S. dollars, the majority are
not so denominated and paid.  Therefore
we believe that inflation and fluctuations in the U.S. dollar exchange rate may
have a material effect on our revenue. The cost of our Israel operations, as
expressed in U.S. dollars, is influenced by the extent to which any increase in
the rate of inflation in Israel is not offset (or is offset on a lagging basis)
by a devaluation of the NIS in relation to the U.S. dollar.

The
exchange rate between NIS and the U.S. dollar has fluctuated during the past
six months (December 2005  May 2006) from a low of NIS 4.428 to the dollar to
a high of NIS 4.725 to the dollar.  The
high and low exchange rates between the NIS and U.S. dollar during the six most
recent months, as published by the Bank of Israel, were as follows:

|MONTH         | LOW 1 U.S.Tdollar = | HIGH 1 U.S. dollar =
|------------- | ------------------- | --------------------
|
|
|
|
|December 2005 | 4.579               | 4.662               
|January 2006  | 4.577               | 4.658               
|February 2006 | 4.664               | 4.725               
|March 2006    | 4.658               | 4.717               
|April 2006    | 4.503               | 4.671               
|May 2006      | 4.428               | 4.522               

37

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The average
exchange rate, using the average of the exchange rates on the last day of each
month during the period, for each of the five most recent fiscal years, was as
follows:

|Period                              | Exchange Rate
|----------------------------------- | -------------
|
|
|
|
|January 1, 2001 - December 31, 2001 | 4.219  NIS/$1
|January 1, 2002 - December 31, 2002 | 4.738  NIS/$1
|January 1, 2003 - December 31, 2003 | 4.548  NIS/$1
|January 1, 2004 - December 31, 2004 | 4.478  NIS/$1
|January 1, 2005 - December 31, 2005 | 4.503  NIS/$1

During
2001, the NIS was devalued against the dollar by 9.3%.  As a result of the
differential between the rate of inflation and the rate of devaluation of the
NIS, we experienced increases and decreases in the costs of our Israel
operations, as expressed in U.S. dollars, in 2001, but they did not materially
affect our results of operations in such periods. In 2002 the rate of inflation
was 6.5% and the rate of devaluation of the NIS against the dollar was 7.27%.
In 2003, there was on the one hand a devaluation of the U.S. dollar against the
NIS and on the other hand a deflation.In 2004 the rate of inflation was
approximately 1.2% and the U.S. dollar was devaluated against the NIS by 1.6%.
In 2005 the rate of inflation was approximately 2.4% and the U.S. dollar was
devaluated against the NIS by 6.4%.

Since our
financial results are reported in dollars, fluctuations in the rates of
exchange between the dollar and non-dollar currencies may have a material
effect on our results of operations. We therefore use currency exchange forward
contracts and currency exchange options to hedge the impact of the variability
in the exchange rates on future cash flows from certain Euro-denominated
transactions, as well as certain NIS-denominated expenses. Our policy is to
hedge 50% to 80% of our Euro denominated future cash flows to protect against a
reduction in reported operating income arising from decreases in the Euro 
U.S. dollar exchange rate and to hedge 60% to 80% of our NIS denominated
expenses to protect against an increase in reported expenses arising from
increases in the U.S. dollar  NIS exchange rate.  However, we may decide not to hedge in accordance with this
policy where, in our judgment, the applicable exchange rate is sufficiently
low.  The counter-parties to our forward
contracts and currency exchange options are major financial institutions with
high credit ratings. We believe the risk of incurring losses on such forward
contracts and currency exchange options related to credit risks is remote and
that any losses would be immaterial. As of December 31, 2005, we had currency
exchange options to sell up to 1.26 million Euro for a total amount of $1.45
million, and had written currency exchange options to sell up to 0.84 million
Euro for a total amount of $1.06 million that were scheduled to expire prior to
June 30, 2006. On May 17, 2006 we exercised currency exchange options to sell
210,000 Euro for $264,000, and on June 19, 2006, we exercised currency exchange
options to sell 210,000 Euro for $264,000.
See Item 11 - Quantitative and Qualitative Disclosure about Market
Risk for a description of hedging and other similar transactions.

38

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Research and development, patents, licenses,
etc.

We conduct
our research and development operations primarily in Israel and to a small
extent in Germany and Russia. Our research and development efforts have been
financed through internal resources and through plans sponsored by the Chief
Scientist of the Government of Israel, or the OCS. In the years ended December
31, 2003, 2004 and 2005 our gross research and development expenditures were
$5.2 million,
$5.5 million and $4.8 million, respectively (24%, 24%, and
23% of total revenues, respectively). Prior to 2001, we were granted
royalty-bearing grants from the OCS for research and development activities.
Under the provisions of Israeli law in effect until 1996, royalties of 2%-3% of
the revenues derived from the sale of software products developed under a
research and development program funded by the OCS and certain related services
must be paid to the State of Israel. Pursuant to an amendment effected in 1996
effective with respect to OCS plans funded in or after 1994, royalties
generally at the rate of 3% during the first three years, 4% over the following
three years and 5% in or after the seventh year of the revenues derived in
connection with products developed according to such plans are payable to the
State of Israel. The maximum aggregate royalties will not exceed 100% (for
funding prior to 1994, 100% to 150%) of the U.S. dollar-linked value of the
total grants received. Pursuant to an amendment effected in 2000, effective
with respect to OCS plans funded in or after 2000, the royalty rates described
above were updated to 3% during the first three years and 3.5% in or after the
fourth year, of the revenues derived in connection with products developed under
such plans. Pursuant to an amendment effected on January 1, 1999, effective
with respect to OCS plans approved in or after 1999, funds received from the
OCS shall bear annual interest at a rate equal to LIBOR for twelve months.  As of December 31, 2005, our contingent
liability with respect to such grants was approximately $3 million, contingent upon us generating
revenues from sales of products developed with funds provided by the OCS.

We believe
that the majority of products that we have sold since January 1, 2005 are not
based on technology developed with funds provided by the OCS and that,
accordingly, such sales should not be subject to the payment of royalties to
the OCS. Therefore, the royalty reports we submitted to the OCS for the period
starting January 1, 2005 and thereafter have reflected significantly reduced
royalty obligations in comparison to our royalty reports for the years prior to
2005.  In addition,
during the second half of 2005 we initiated a process with the OCS in an attempt
to obtain the agreement of the OCS with our position and to the cessation of
our obligation to pay future royalties. Following this application and further
correspondence between the OCS and us, the OCS appointed an external
professional examiner to examine our claim from a technological point of view.
This examiner submitted his report to the OCS during November 2005. In December
2005, the OCS appointed a second professional examiner to submit a second
opinion regarding our technological claim. During January 2006 our management
met with the OCS in an attempt to, among other things, accelerate the OCSs
treatment of our application. However, to date, we have not received any
response from the OCS.

Although we
believe we have strong arguments to support our position, we have accrued
royalty expenses in the amount of $0.8 million in our financial reports for the
periods from January 1st, 2005 to March 31st, 2006, but
we have not paid to the OCS any royalties associated with the products mentioned
above. In light of the above mentioned facts, we intend to consider our next
steps with the OCS and whether further royalty expense accruals will be
necessary.

39

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The State
of Israel does not own proprietary rights in technology developed with OCS
funding and there is no restriction on the export of products manufactured
using technology developed with OCS funding.
The technology is, however, subject to transfer restrictions, as
described below.  These restrictions may
impair our ability to sell our technology assets or to outsource manufacturing
and the restrictions continue to apply even after we have paid the full amount
of royalties payable for the grants.  In
addition, the restrictions may impair our ability to consummate a merger or
similar transaction in which the surviving entity is not an Israeli company.

The
transfer to a non-Israeli entity of technology developed with OCS funding,
including pursuant to a merger or similar transaction, and the transfer of
rights related to the manufacture of more than ten percent of a product
developed with OCS funding are subject to approval by an OCS committee and to
the following conditions:

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Transfer of
  Technology. If the committee approves the transfer of OCS-backed technology, such
  a transfer would be subject to the payment to the OCS of a portion of the
  consideration we receive for such technology.  The amount payable would be a fraction of the consideration
  equal to the relative amount invested by the OCS in the development of such
  technology compared to our total investment in the technology, but in no
  event less than the amount of the grant. However, in the event that in
  consideration for our transfer of technology out of Israel we receive
  technology from a non-Israeli entity for use in Israel, we would not be
  required to make payments to the OCS if the approval committee finds that
  such transfer of non-Israeli technology would significantly increase the
  future return to the OCS.
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |  | Transfer of
  Manufacturing Rights. The committee is authorized to approve transfers of
  manufacturing rights only if the transfer is conditioned upon either (1)
  payment of increased aggregate royalties, ranging from 120% to 300% of the
  amount of the grant plus interest, depending on the percentage of foreign
  manufacture or (2) a transfer of manufacturing rights into Israel of another
  product of similar or more advanced technology.                                                                                                                                                                                                                                                                                                                                                                                                   
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |  | Merger or
  Acquisition. If the committee approves a merger or similar transaction in
  which the surviving entity is not an Israeli company, such a transaction
  would be subject to the payment to the OCS of a portion of the consideration
  paid.  The amount payable would be a
  fraction of the consideration equal to the relative amount invested by the
  OCS in the development of such technology compared to the total investment in
  the company, net of financial assets that the company has at the time of the
  transaction, but in no event less than the amount of the grant.                                                                                                                                                                                                                                                           

In the
event that the committee believes that the consideration to be paid in a
transaction requiring payment to the OCS pursuant to the provisions of the law
described above does not reflect the true value of the technology or the
company being acquired, it may determine an alternate value to be used as the
basis for calculating the requisite payments.

40

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In the
years ended December 31, 2003, 2004 and 2005, we paid or accrued royalties to
the Chief Scientist in the amount of $0.7 million, $0.8 million and $0.7
million, respectively.  We intend to
consider whether further accruals will be necessary in light of the facts
described above concerning our application to the OCS to recognize our claim
that we are no longer obligated to pay royalties on sales subsequent to January
1, 2005.

In addition
to the Chief Scientist grants, we received grants from the Fund for the
Encouragement of Overseas Marketing of the Israeli Governments Ministry of
Industry and Trade, with respect to which we are obligated to pay royalties
amounting to 3% to 4% of the incremental exports, up to a maximum of 100% of
the grants received. Our contingent liability as of December 31, 2005 with
respect to such grants was $0.6 million, contingent upon our incremental
exports.

Trend
Information

We are
subject to various trends and uncertainties in the CAD/CAM business, including
changing customer demands, new products developed by competitors, consolidation
of operations and the use of cost-cutting measures.  Following is a summary of the material trends and uncertainties
influencing our operations:

Migration
to Far East.
Many mold, tool, die and fixture makers have migrated or intend to
migrate their operations to markets in the Far East, such as China, in order to
take advantage of the relatively lower cost of labor available in those markets
for the manufacturing activities.  We
anticipate that this migration will continue and have expanded our operations
in Asia, including in China, in order to increase our share of those growing
markets.  Many of those markets,
including China, are characterized by lower prices and by higher usage of
pirated copies of software products.
While those markets are also often much larger than a number of our
traditional markets in Europe, to the extent that we cannot offset the effects
of lower prices and higher incidents of pirated software usage, our revenues
and profitability may be adversely affected.

Maintenance
Revenues.   It
has been our experience that most of our customers who purchase maintenance
contracts elect to receive maintenance services from us on a continuing
basis.  While customers in most markets
do purchase maintenance services from us, our customers in the Far East (other
than in Japan) generally do not purchase maintenance but instead purchase
product upgrades on a case-by-case basis.
Accordingly, our maintenance revenues may be adversely impacted to the
extent that our customer base shifts to those markets in the Far East where
customers often do not purchase maintenance and there is no corresponding
increase in customers in other markets.

Decrease
in prices. The strong competition in the software
business generally, and in the CAD/CAM business specifically, has caused prices
of products in our industry to decrease. Such decrease in software prices has
resulted in a decrease in our revenues and thus in our profits. As a result, we
have been forced to employ cost-cutting measures. If the foregoing trend
continues, we may have to employ additional cost-reduction measures.

41

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Risk
factors.  In
addition, our results of operations and financial condition may be affected by
various other factors discussed in Item 3 - Key Information - Risk Factors,
including market acceptance of our products, changes in political, military or
economic conditions in Israel and in the Middle East, general slowing of local
or global economies and decreased economic activity in one or more of our
target industries.

|   |                               
|-- | ------------------------------
|E. | OFF-BALANCE SHEET ARRANGEMENTS

Other than
as discussed below, we are not party to any off-balance sheet arrangements or
subject to any contingent liabilities.

1. 
With respect to our contingent liability relating to payment of royalties to
the OCS, see  - Research and development, patents, licenses, etc. above.

2. 
As consideration for grants received from the Fund for the Encouragement of
Overseas Marketing of the Israeli Governments Ministry of Industry and Trade,
we are obligated to pay the Fund royalties amounting to 3% to 4% of the
incremental exports, up to a maximum of 100% of the grants received.  Our contingent liability as of December 31,
2005 was $0.6 million, contingent upon our incremental exports.

|   |                                                
|-- | -----------------------------------------------
|F. | TABULAR DISCLOSURE OF CONTRACTUAL
  OBLIGATIONS

The
following table summarizes our contractual obligations and commercial
commitments as of December 31, 2005:

|                                                |  |                                              |       |                     |       |           |  |           |  |                  |   |  |   | 
|----------------------------------------------- |  | -------------------------------------------- | ----- | ------------------- | ----- | --------- |  | --------- |  | ---------------- | - |  | - | 
|                                                |  | Payments due by Period 
  (US$ in thousands) |      
|                                                |  |                                              |      
|Contractual Obligations as of December 31, 2005 |  | Total                                        |       | Less than 1 
  Year |       | 1-3 Years |  | 4-5 Years |  | After 5 
  Years |  
|                                                |  |                                              |       |                     |       |           |  |           |  |                  |  
|                                                |  |                                              |       |                     |       |           |  |           |  |                  |  
|Operating
  Leases                              |  |                                              | 2,766 |                     | 1,145 |           |  | 1,621     |  |                  | - |  | - | 
|Purchase
  Obligations and Commitments          |  |                                              | 774   |                     | 774   |           |  | -         |  |                  | - |  | - | 
|Other
  Long-Term Liabilities                   |  |                                              | 2,532 | (1)                 | -     |           |  | -         |  |                  | - |  | - | 
|Total
  Contractual Cash Obligations            |  |                                              | 6,072 |                     | 1,919 |           |  | 1,621     |  |                  | - |  | - | 

(1) Represents a provision for future severance pay obligations.

42

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|   |            
|-- | -----------
|G. | Safe Harbor

This
annual report on Form 20-F contains forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended (the 1934 Act)
(collectively, the Safe Harbor Provisions).
These are statements that are not historical facts and include
statements about our beliefs and expectations.
These statements contain potential risks and uncertainties, and actual
results may differ significantly.
Forward-looking statements are typically identified by the words
believe,  expect,  intend,
estimate and similar expressions.
Such statements appear in this annual report and include statements
regarding the intent, belief or current expectation of the Company or its
directors or officers.  Actual results
may differ materially from those projected, expressed or implied in the
forward-looking statements as a result of various factors, including, without
limitation, the factors set forth in Item 3 (Key Information) under the
caption Risk Factors (Cautionary Statements).  Any forward-looking statements contained in this annual report
speak only as of the date hereof, and we caution potential investors not to
place undue reliance on such statements.
We undertake no obligation to update or revise any forward-looking
statements.  All subsequent written or
oral forward-looking statements attributable to us or to persons acting on our
behalf are expressly qualified in their entirety by the Cautionary Statements.

|        |                                           
|------- | ------------------------------------------
|Item 6. | Directors, Senior Management and Employees

Directors and Senior Management

As of the date
of this annual report, our directors, senior management and key employees were
as follows:

|                   |  |     |  |                                        
|------------------ |  | --- |  | ---------------------------------------
|Name               |  | Age |  | Position                               
|                   |  |     |  |                                        
|                  
|Yossi Ben
  Shalom |  | 51  |  | Chairman of
  the Board                
|Rimon
  Ben-Shaoul |  | 61  |  | Director                               
|Barak Dotan        |  | 38  |  | Director                               
|Kenny Lalo         |  | 48  |  | Director                               
|David Golan        |  | 65  |  | Director                               
|Ofra Brown         |  | 52  |  | External
  Director                    
|Rami Entin         |  | 55  |  | External
  Director                    
|Dan Haran          |  | 48  |  | President
  and Chief Executive Officer
|Ilan Erez          |  | 38  |  | Chief
  Financial Officer              

Yossi Ben Shalom is a co-founder of
DBSI Investments Ltd.  Prior to
establishing DBSI Investments, Mr. Ben Shalom served as Executive Vice
President and Chief Financial Officer of Koor Industries Ltd. (NYSE:KOR), from
1998 through 2000.  Prior to that, he
served as Chief Financial Officer of Tadiran Ltd.  Mr. Ben Shalom has also been an active director on numerous
boards, such as NICE Systems (NASDAQ:NICE), Machteshim Agan, Bank Klali and
others.  Mr. Ben Shalom holds a
bachelors degree in economics and a masters degree in business administration
from Tel Aviv University.

43

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Rimon Ben-Shaoul has served since February 2001 as
Co-Chairman, President and Chief Executive Officer of Koonras Technologies Ltd.
and as a Chairman or member of the boards of various companies of the Polar
Investments Group.  From June 1997 to
February 2001 he served as President and Chief Executive Officer of Clal
Industries and Investments Ltd. and served as a member of the board of Clal
(Israel) Ltd. and on the board of several of its subsidiaries.  From 1985 to June 1997, he served as President
and Chief Executive Officer of Clal Insurance Company Ltd., as a member of its
board and as Chairman or a member of the board of several of its
subsidiaries.  Mr. Ben-Shaoul holds a
bachelors degree in economics and a masters degree in business administration
from Tel Aviv University.

Barak Dotan is a
co-founder of DBSI Investments Ltd.
Prior to establishing DBSI Investments, Mr. Dotan worked as Product
Manager for Jacada (NASDAQ:JCDA), formerly CST and later managed private
investments in high-tech and other areas.
Mr. Dotan graduated summa cum laude from the Hebrew University of
Jerusalem with a bachelors degree in computer science and business
administration.

Kenny Lalo has
served since 2001 as Vice President of Koonras Technologies Ltd. and as a
member of the board of several of its affiliates.  Mr. Lalo has acted in the capacity of of-counsel to the law
firm of Eitan, Pearl, Latzer & Cohen-Zedek since 2001.  From 1993 to 2001, he served as general
counsel and later as Vice President of Clal Industries and Investments Ltd. and
as a member of the board of several of its affiliates.  From 1986 to 1992, Mr. Lalo was an attorney
in Maryland, USA.  Mr. Lalo holds an
LL.B. from Tel Aviv University, an M.C.L. from Georgetown University and a masters
degree in business administration from Northwestern University, Chicago.

David Golan has been
a director on our board since 1992 and is a former Chairman of the board.  Mr. Golan is currently an independent
businessman and a director. Previously he was an executive director in the
Binat Group and served on the board of directors of several public and private
companies.  From May 1998 to September
2000 Mr. Golan was Managing Director in charge of Zeevi Holdings investments,
not including ZCT.  From March 1997 to
May 1998, he was the Chief Executive Officer of Clal Trading Ltd., a subsidiary
of the IDB group.  From 1992 to March
1997, he was Executive Vice President of Clal Trading.  Mr. Golan was formerly president of Gal
Weisfield Industries Ltd.  Mr. Golan
holds a bachelors degree in economics and statistics from Hebrew University in
Jerusalem and a masters degree in business administration from New York
University.

Ofra Brown currently
serves as the Chief Financial Officer of VIZRT Ltd., a public company traded on
the Frankfurt Stock Exchange and on the Oslo Stock Exchange in Norway. From
1999 to 2001, Ms. Brown served as the Chief Financial Officer of BVR
Technologies Ltd., a company previously publicly traded on the NASDAQ.  From 1978 through 1998 Ms. Brown served as
the Credit Manager for Electronic and Hi-Tech Industries  Industrial
Development Bank of Israel Ltd.  Ms.
Brown holds a bachelors degree in economics from Tel Aviv University and a
masters degree in business administration from City University of Seattle.

44

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Rami Entin currently
serves as a director of ECtel Ltd., a Nasdaq-traded company that develops and
markets fraud prevention and revenue assurance solutions for circuit-switched
and packet-switched wireline and wireless networks, Maccabee-Dent, which is
engaged in the management and operation of dental clinics, and is an external
director of Solomon Holdings Ltd., an Israeli publicly traded construction
company. Mr. Entin is also a director of Hilan-Tech Ltd. and of Assuta Medical
Center in Tel-Aviv, Israel. From 2002 until 2003, Mr. Entin was the chairman of
the Hashavim Group, a data center for direct taxation and employment laws and a
processor of wages and personnel data. From 1999 until 2001, Mr. Entin was
Co-Chief Executive Officer and a director of Hilan-Tech Ltd., where he was in
charge of financial, personnel, sales and marketing and Lotus Notes operations.
From 1985 until 1999 he was financial manager and a director of Hilan Ltd.,
where he was in charge of financial and personnel operations. From 1981 until
1985, Mr. Entin worked for Kesselman & Kesselman, an accounting firm, where
he served various publicly traded companies engaged in the services and
industry fields. Mr. Entin holds a B.A. degree in accounting and economics and
an M.B.A. degree from the Tel Aviv University, and is a certified accountant in
Israel. He is also a graduate of the Advanced Management Program at Harvard
University.

Dan Haran has
been our President and Chief Executive Officer since July 2005. Mr. Haran
joined Cimatron as Vice President of Marketing and Chief Operating Officer in
November 2003 after having been employed by Comverse (Nasdaq:CMVT) where he
held several senior management positions, most recently as Chief Operating
Officer of the Intelligent Network Division. Prior to Comverse, Mr. Haran
managed Medcon Systems, an Israeli-based start-up company. 
Mr. Haran holds a bachelor of science degree in computer engineering from the
Technion, a master of science degree from the Weitzman Institute, and a master
of business administration degree from Tel Aviv University.

Ilan Erez, joined us
as VP Finance in May 2005 and became CFO in July, 2005. From
1998 to 2005 Mr. Erez served as the Chief Financial Officer of  Silicom Ltd., a NASDAQ listed company
engaged in the design, manufacturing and selling of server-networking cards. He
also served as VP Operations of Silicom from May 2001 until his departure. From
1996 to 1998 Mr. Erez served as a Controller and assistant to the Chief
Executive Officer at Bio-Dar Ltd. From 1994 until 1996 Mr. Erez served as an
Auditor at Kesselman & Kesselman, a member of PriceWaterhouseCoopers. Mr.
Erez is a Certified Public Accountant in Israel and holds a B.A in Accounting
and Economics from the Hebrew University in Jerusalem and an LL.M. in Business
Law from Bar-Ilan University.

Arrangements for the election of Directors

Koonras
Ltd. and DBSI Investments Ltd., our two largest shareholders (each holding
approximately 33% of our share capital), control the outcome of most matters
submitted to a vote of our shareholders, including the election of members of
our board of directors.  Koonras and
DBSI have entered into an agreement by which, among other matters, they will each
appoint one half of our directors, not including our external directors, and
vote together at our shareholders meetings.

45

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Compensation

During
the year ended December 31, 2005, we paid, in the aggregate, approximately $0.8
million in direct remuneration to our directors and officers for services
provided by them to the Company in such capacities, including compensation paid
to Zvika Naggan, our former CEO, who resigned in June 2005 and Eli Gendler, our
former CFO who left Cimatron in July 2005.
The above does not include amounts expended by us for automobiles made
available to our officers, expenses (including business travel, professional
and business association dues and expenses) reimbursed to officers and other
fringe benefits commonly reimbursed or paid by companies in Israel.

Board of Directors

Our
Articles of Association provide for a Board of not less than two members. Each
director, with the exception of external directors who are elected to serve set
periods of time as described below, is elected to serve until the next annual
general meeting of shareholders and until his or her successor has been duly
elected. Officers serve at the discretion of the Board.

Substitute
Directors

Our
Articles of Association provide that any director may, by written notice to us,
appoint another person to serve as a substitute director and may cancel such
appointment. A person may not serve as a substitute director for more than one
director and may not serve as both director and as a substitute director.

The term of
appointment of a substitute director may be for one meeting of the board of
directors or for a specified period or until notice is given of the
cancellation of the appointment.  Any
substitute director will have all of the rights and obligations of the director
appointing him or her, except the power to appoint a substitute (unless the
instrument appointing him or her provides otherwise), and the right to
remuneration.  The substitute director
may not act at any meeting at which the director appointing him or her is
present.  Unless the appointing director
limits the time period or scope of any appointment, the appointment is
effective for all purposes, but will expire upon the expiration of the appointing
directors term.  To our knowledge, no
director currently intends to appoint any other person as a substitute
director, except if the director is unable to attend a meeting of the board of
directors.

External
Directors

The Israeli
Companies Law requires Israeli companies with shares that have been offered to
the public in or outside of Israel to appoint at least two external
directors.

46

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No person may be appointed as an external director if the person or the
persons relative, partner, employer 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 external director, any affiliation with the company or
any entity controlling, controlled by or under common control with the 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.                                          

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 may otherwise interfere with the
persons ability to serve as an external director.  If, at the time external directors are to be appointed, all
current members of the board of directors are of the same gender, and then at
least one external director must be of the other gender.

External
directors are to be elected by a majority vote at a shareholders meeting,
provided that either:

| |   |                                                                                                                                                                                                       
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the majority
  of shares voted at the meeting, including at least one-third of the shares
  held by non-controlling shareholders voted at the meeting, vote in favor of
  election of the director; or
|
| |  | the total number
  of shares held by non-controlling shareholders voted against the election of
  the director does not exceed one percent of the aggregate voting rights in
  the company.           

The initial
term of an external director is three years and may be extended for an
additional three years.  External
directors may be removed only by the same percentage of shareholders as is
required for their election, or by a court, in each case only if the external
directors cease to meet the statutory qualifications for their appointment or
if they violate their duty of loyalty to the company.  Each committee of a companys board of directors must include at
least one external director.  Our external
directors are Ofra Brown and Rami Entin, who will complete their current terms
in May 2008, in accordance with Israeli law.

An external
director is entitled to compensation as provided in regulations adopted under
the Companies Law and is otherwise prohibited from receiving any other
compensation, directly or indirectly, in connection with service provided as an
external director.

Under
recent amendments to the Companies Law, at least one of the external directors
serving on a companys board of directors is required to
have financial expertise and the other
external director or directors are required to have professional expertise. A
director is deemed to have professional expertise if he or she either (i) has
an academic degree in economics, business management, accounting, law or public
service, (ii) has an academic or other degree or completed another higher
education, all in the field of business of the company or relevant for his/her
position, or (iii) has at least 5 years experience as either a senior managing
officer in the companys line of business with a significant volume of
business, a public office, or a senior position in the companys main line of
business. A director with financial expertise is a director that
due to his education, experience and skills has a high expertise and understanding
in financial and accounting matters and financial statements, in such a manner
which allows him to deeply understand the financial statements of the company
and initiate a discussion about the presentation of financial data.

47

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Audit
Committee

The
Companies Law requires public companies to appoint an audit committee.  The responsibilities of the audit committee
include identifying irregularities in the management of the companys business,
approving related party transactions as required by law, and reviewing the
quarterly and annual balance reports and recommending their approval before our
board or directors.  An audit committee
must consist of at least three directors, including the external directors of
the company.  The chairman of the board
of directors, any director employed by or otherwise providing services to the
company, and a controlling shareholder or any relative of a controlling
shareholder, may not be a member of the audit committee.

Under the
Nasdaq rules, we are required to have at least three independent directors on
the audit committee. In addition, Nasdaq requires that the members of the audit
committee (a) not have any relationship to the company that may interfere with
the exercise of their independence, and (b) must be financially literate.

Under the
Nasdaq rules and the Sarbanes-Oxley Act, the audit committee (i) has the sole
authority and responsibility to select, evaluate, and, where appropriate,
replace the companys independent auditors, (ii) is directly responsible for
the appointment, compensation and oversight of the work of the independent
auditors for the purpose of preparing its audit report or related work, and
(iii) is responsible for establishing procedures for (A) the receipt, retention
and treatment of complaints received by the company regarding accounting,
internal accounting controls or auditing matters, and (B) the confidential,
anonymous submission by employees of the company of concerns regarding
questionable accounting or auditing matters. The audit committee is required to
consult with management but may not delegate these responsibilities.  In addition, under the Sarbanes-Oxley Act,
the audit committee is responsible, among other things, for the following:

| |   |                                                                                                                                                                                                                                                                                                     
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Have the
  sole authority to review in advance, and grant any appropriate pre-approvals
  of, (i) all audit and non-audit services to be provided by the independent
  auditors and (ii) all fees and other terms of engagement;                                                                    
| |   |                                                                                                                                                                                                                                                                                                     
| |  | Review and
  discuss with management and the independent auditors the companys quarterly
  financial statements (including the independent auditors review of the
  quarterly financial statements) prior to any required submission to
  shareholders, the SEC, any stock exchange or the public;
| |   |                                                                                                                                                                                                                                                                                                     
| |  | Review and
  discuss with management and the independent auditors the companys annual
  audited financial statements prior to any required submission to
  shareholders, the SEC, any stock exchange or the public;                                                                                
| |   |                                                                                                                                                                                                                                                                                                     
| |  | Recommend to
  the Board, if appropriate, that the companys annual audited financial
  statements be included in the companys annual report;                                                                                                                                                      

48

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Review and
  discuss with management all disclosures made by the company concerning any
  material changes in the financial condition or operations of the company;                                                                                                                                                                                                                                                                           
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |  | Review
  disclosures made to the audit committee by the companys chief executive
  officer and chief financial officer during their certification process for
  the companys annual report about any significant deficiencies in the design
  or operation of internal controls or material weaknesses therein and any
  fraud involving management or other employees who have a significant role in
  the companys internal controls; and
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |  | Review and
  approve all related-party transactions.                                                                                                                                                                                                                                                                                                                                                                                          

As
of the date of this annual report, Mr. David Golan, Ms. Ofra Brown and Mr. Rami
Entin are serving as members of our audit committee. Mr. Kenny
Lalo serves as a non-voting member of our audit committee.

Internal
Auditor

Under the
Companies Law, the board of directors must appoint an internal auditor,
nominated by the audit committee.  The
role of the internal auditor is to examine, among other matters, whether the
companys actions comply with the law and orderly business procedure.  Under the Companies Law, the internal
auditor may be an employee of the company but not an office holder, or an
affiliate, or a relative of an office holder or affiliate, and he may not be
the companys independent accountant or its representative.  Ernst & Young  Kost, Forer, Gabbay
& Kasierer Business Risk Services serves as our internal auditor.

Nasdaq
Listing Requirements

Recently adopted Nasdaq rules enable foreign
private issuers, such as ourselves, to comply with the prevalent
practice in our jurisdiction of incorporation in place of certain Nasdaq
listing requirements. To the extent that we choose to do so, we are required to disclose in our
annual reports filed with the Commission each Nasdaq listing requirement that
we do not follow and describe the home country practice we follow in lieu of
such requirement.

We are not in compliance with Nasdaq Marketplace Rules 4350(c)(4)(B)
(requiring companies to adopt a formal written charter or board resolution
addressing the companys nominations process) and 4350(c)(2) (Regularly
scheduled meetings of the companys independent directors).  Under Israeli law, the nominations process
is conducted by the full board of directors. Similarly, under Israeli law all
matters that are subject to the approval of a companys board of directors are
discussed by the full board of directors. In addition, we do not intend to
comply (if and when the events underlying such rule become relevant) with the
Nasdaq listing requirement of shareholder approval for the establishment of and
amendments to stock option or purchase plans (Rule 4350(i)(A)), which matter is
not subject to shareholder approval under Israeli law and practice.

49

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Employees

The
following table sets forth for the last three financial years, the number of
our employees broken down into categories.

| |                                                   |  |      |  |      |  |     
| | ------------------------------------------------- |  | ---- |  | ---- |  | ----
| | Period ending December 31,                        |  | 2005 |  | 2004 |  | 2003
| |                                                   |  |      |  |      |  |     
| | Research and Development                          |  | 59   |  | 84   |  | 84  
| | Marketing, Sales and Customer Support             |  | 125  |  | 106  |  | 109 
| | Administration Management and Information Systems |  | 20   |  | 24   |  | 22  
| | Total                                             |  | 204  |  | 214  |  | 215 

As of May 31, 2006, we employed
203 full-time personnel, of whom 59 (most of whom hold advanced technical degrees) were
employed in research and development, 125 were employed in marketing, sales and customer
support and 19 were employed in various administrative, information systems and management
positions. Of these employees, 100 were employed in Israel operations, 21 were employed by
our North American subsidiary, 33 were employed by our German subsidiary, 3 were employed
by our French subsidiary, 1 was employed by our Japanese subsidiary, 3 were employed by
our British subsidiary, 39 were employed by our Chinese subsidiaries, and 3 were employed
by our Indian subsidiary. In addition, we employed 14 subcontractors or free-lance
personnel on average during the year 2005 and as of May 31, 2006 we employed 13
subcontractors personnel.

Certain
provisions of the collective bargaining agreements between the Histadrut
(General Federation of Labor in Israel) and the Coordination Bureau of Economic
Organizations (including the Industrialists Associations) are applicable to
our employees in Israel by order of the Israeli Ministry of Labor. These
provisions concern principally the length of the workday; minimum daily wages
for professional workers, insurance for work-related accidents, procedures for
dismissing employees, determination of severance pay and other conditions of
employment. We generally provide our employees with benefits and working
conditions beyond the required minimums. In addition to salary and other
benefits, certain of our marketing personnel are paid commissions based on our
performance in certain territories worldwide.

Israeli law
generally requires severance pay, which may be funded by Managers Insurance
described below, upon the retirement or death of an employee or termination of
employment without cause (as defined in the law). The payments thereto amount
to approximately 8.33% of wages. Furthermore, Israeli employees and employers
are required to pay predetermined sums to the National Insurance Institute,
which is similar to the United States Social Security Administration. Such
amounts also include payments by the employee for national health insurance.
The total payments to the National Insurance Institute are equal to
approximately 14.6% of the employees wages (up to a specified amount), of
which the employee contributes approximately 66% and the employer contributes
approximately 34%.

50

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A general
practice that we follow, although not legally required, is the contribution of
funds on behalf of most of its employees to a fund known as Managers
Insurance. This fund provides a combination of savings plan, insurance and
severance pay benefits to the employee, giving the employee payments upon
retirement or death and securing the severance pay, if legally entitled, upon
termination of employment. We decide whether each employee is entitled to
participate in the plan, and each employee who agrees to participate
contributes an amount equal to 5% of his salary and the employer contributes
between 13.3% and 15.8% of his salary.

Share Ownership

1996
Share Option Plan

In January
1996, the Board adopted a share option plan (the 1996 Share Option Plan)
pursuant to which 316,000 Ordinary Shares were reserved for issuance upon the
exercise of options to be granted to our directors, officers, employees and
consultants. The 1996 Share Option Plan is administered by a committee of the
Board, which designates the optionees and dates of grant. The exercise price of
an option granted under the 1996 Share Option Plan may be no less than 85% of
the fair market value of an Ordinary Share, as determined by that committee on
the date that the option is granted. The options are for a 10-year term and are
non-assignable except by the laws of descent. The option committee has the
authority to amend the terms of option grants, provided that any such amendment
is in the best interest of the grantee. In March and April 2000, options to
purchase 39,750 shares were exercised.
As of May 31, 2006, none of these options were outstanding. All of these
options were originally granted with an exercise price of $8.00 per share. In
January 1998, the board of directors amended the exercise price of such options
to $5.00 per share.

1998
Share Option Plan

In April
1998, the board of directors adopted an additional share option plan (the 1998
Share Option Plan) pursuant to which 620,000 Ordinary Shares were reserved for
issuance upon the exercise of options to be granted to our directors, officers,
employees and consultants. The 1998 Share Option Plan is administered by a
committee of the Board, which designates the optionees and dates of grant. The
exercise price of an option granted under the 1998 Share Option Plan may be no
less than 85% of the fair market value of an Ordinary Share, as determined by
that committee on the date that the option is granted. Options granted vest over
a period determined by the option committee, terminate three years after they
become exercisable, and are non-assignable except by the laws of descent. The
option committee has the authority to amend the terms of option grants,
provided that any such amendment is in the best interest of the grantee. As of
May 31, 2006, options to purchase 19,750of
such shares were outstanding at a price of $4.00 per share under the 1998 Share
Option Plan. These options are
exercisable commencing two years after the date of grant at a rate of 25% per
year, subject to the continued employment of each employee. The grantee will be
responsible for all personal tax consequences of the grant and the exercise
thereof.

51

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In October
1999, the option committee approved the grant of options to purchase 160,000 of
the Companys shares at a price of $2.00 per share to the former president and
CEO of the Company. All these options expired during September 2005.

In March
2000, the option committee adopted new guidelines for the options to purchase
Ordinary Shares reserved for issuance under each of the 1996 Share Option Plan
and the 1998 Share Option Plan upon the exercise of options to be granted to
our directors, officers, employees and consultants. As a result of the new
guidelines, as of May 31, 2006, options to purchase 22,750 of such shares were
outstanding at a price of $4.50 per share.

Such
options are exercisable commencing two years after the date of grant at a rate
of 50% on the second anniversary of the date of grant and 25% in each of the
following two years, subject to the continued employment of the grantee.

In August
2003, the board of directors approved the grant of options to purchase 150,000
of the Companys shares at a price of $2.50 per share to two officers of the
Company. These options are exercisable commencing one year after the date of
grant at a rate of 25%-33.3% per year, subject to the continued employment of
the officers. 50,000 of such options were outstanding as of May 31, 2006. For
additional information relating to the stock options granted by us under the
1996 Share Option Plan and the 1998 Share Option Plan, see Note 12(B) to our
financial statements included in Item 18.

2004
Share Option Plan

In October
2004, our board of directors and shareholders adopted the 2004 Share Option and
Restricted Shares Incentive Plan (2004 Share Option Plan) pursuant to which
240,000 Ordinary Shares were reserved for issuance upon the exercise of options
to be granted to our directors, officers, employees and consultants. The 2004
Share Option Plan is administered by a committee of the Board, which designates
the optionees and dates of grant. The exercise price of an option granted under
the 2004 Share Option Plan may be no less than 100% of the fair market value of
an Ordinary Share, as determined by that committee on the date that the option
is granted. Options granted vest over a period determined by the option
committee, terminate ten years from the date of grant, unless otherwise
determined by the Board, and are non-assignable except by the laws of descent.
The option committee has the authority to amend the terms of option grants,
provided that any such amendment is in the best interest of the grantee. In February
2005, 238,500 of such options were granted to employees of the Company at an
exercise price of $2.20 per share and with a term of ten years , and in August
2005, the board of directors approved the grant of 32,000 of such options at an
exercise price of $2.00 per share to the Companys Chief Executive Officer. In
December 2005 our board of directors increased the 2004 Share Option Plan
reserve by an additional 250,000 shares. In May 2006 an additional 189,000
options were granted to Company employees under the 2004 Share Option Plan at
an exercise price of $1.75-$2.00 and with a term of five years. As of May 31,
2006, 418,500 of such options were outstanding. These options are exercisable pursuant to a three (3) year
vesting schedule as follows: (i) thirty three percent (33%) of the shares
covered by the options become exercisable on the first anniversary of the grant
date; and (ii) sixteen and one-half percent (16.5%) of the shares covered by
the options become exercisable at the end of each subsequent six months period
over the course of the following two (2) years, subject to the continued
employment of each employee. The grantee will be responsible for all personal
tax consequences of the grant and the exercise thereof. We intend to grant
additional options under the 2004 Share Option Plan to various of our
directors, executive officers and employees.

52

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At May 31,
2006 options to purchase 255,000, 329,000 and 62,000 of our ordinary shares
were available for grants to various of our directors, officers, employees and
consultants under the 1996, 1998 and 2004 Share Option Plans, respectively.

Repurchase
of Our Shares

We
purchased 159,600 of our shares in the open market between September 2002 and
February 2003 at an average price of $0.95 per share. During 2003, we
repurchased 26,000 shares at an average price of $1.04 per share. Under Israeli
law, while these shares are considered to be part of our outstanding share
capital that can be reissued by us in the future, they are dormant shares and
as such they cannot be voted and do not provide any other rights, other than
upon liquidation.

Beneficial Ownership by Officers and Directors

Messrs.
Ben Shalom, Ben Shaoul, Dotan and Lalo may be deemed to have beneficial
ownership of an aggregate of 5,133,710 of our shares, representing 65.5% of our
issued and outstanding capital share, by virtue of their positions with Polar
and DBSI and the voting agreement between Koonras and DBSI described elsewhere
in this report.

|        |                                                  
|------- | -------------------------------------------------
|Item 7. | Major Shareholders and Related Party Transactions

Major Shareholders

The
following table sets forth information, as of May 31, 2006, concerning the
beneficial ownership (as defined in Rule 13d-3 under the Securities Exchange
Act of 1934) of ordinary shares by (i) any person who is known to own at least
5% of the ordinary shares of our company and (ii) all directors and executive
officers as a group.  The voting rights
of our major shareholders do not differ from the voting rights of holders of
all our ordinary shares.

53

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|                                                                  |  |                            |     |                           |       |   | 
|----------------------------------------------------------------- |  | -------------------------- | --- | ------------------------- | ----- | - | 
|Name and Address                                                  |  | Number ofOrdinary
  Shares |     | Percent ofOrdinary Shares |      
|                                                                  |  |                            |     |                           |      
|Koonras Ltd. 21 Haarbaah St. Tel-Aviv, Israel                   |  | 2,560,360                  |     |                           | 32.68 | % | 
|DBSI
  Investments Ltd. 85 Medinat Hayehudim St. Herzliya, Israel |  | 2,573, 350                 |     |                           | 32.84 | % | 
|All
  directors and executive officers as a group (11 persons)    |  | 5,146,699                  | (1) |                           | 65.7  | % | 

(1) Includes
an aggregate of 5,133,710 shares beneficially held by Koonras and DBSI, by
virtue of the positions held by certain of our directors on the board of
directors of Koonras and DBSI, as to which such individuals disclaim beneficial
ownership.

Record Holders

As of May
31, 2006, there were 27 record holders of our ordinary shares, of which 16
represented United States record holders owning an aggregate of approximately
36% of our outstanding ordinary shares.

54

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Related Party Transactions

Services Agreement
and Lease Agreement

Until
February 2002, our former principal shareholder ZCT, provided us with certain
corporate and administrative services, including, but not limited to, executive
management, facilities and other such services as were agreed upon from time to
time between us and ZCT. The primary executive management services that we
received under the agreement represented the services of the chief executive
officer and the chief financial officer of ZCT, who did not receive separate
fees for such services. Pursuant to such agreement, we shared the expenses
relating to the specific services we received from ZCT with the other
subsidiaries of ZCT that also received such services from ZCT. For the period
of January 1, 2002, through February 21, 2002 we paid ZCT an aggregate of
$230,000 for such services and for rent payments for such months.

As
of February 21, 2002, ZCT assigned all rights and obligations under the
foregoing services agreement to Koonras and DBSI.  An assignment of this agreement to Koonras and DBSI was ratified
by our shareholders on July 11, 2002. From February 21, 2002 through December
31, 2003 we paid Koonras and DBSI an aggregate of NIS 2,919,500 for these
services. Koonras and DBSI will continue to provide these services to the
Company for an annual fee of NIS 1,560,000 (linked to the Israeli Consumer
Price Index as of July 2002).

|        |                      
|------- | ---------------------
|Item 8. | Financial Information

Consolidated Statements and Other Financial
Information

Our
consolidated financial statements and other financial information are included
in this annual repot in Item 18 - Financial Statements.

Legal
Proceedings

In
April 2004, Omega  Adem Technologies Ltd., an Israeli privately held company
engaged in the development of software, filed a lawsuit against us, claiming
that we caused four employees of the plaintiff located in Russia to terminate
their employment with the plaintiff and join us. During a period of two years
(until March 2003), the plaintiff provided certain services to us. The four
employees were among several employees who provided such services. The
plaintiff claimed, among other things, that we undertook not to employ Omegas
employees after the termination of the project Omega performed for us. The
plaintiff requested the District Court in Tel Aviv, Israel to grant an
injunction and a permanent order that would prevent us from hiring the four
employees. In June, 2004, the court rejected the plaintiffs request for an
injunction. In September 2004, Omega initiated arbitration proceedings against
us pursuant to the services agreement between the parties and submitted to an
arbitrator agreed upon between the parties a statement of claim for an amount
of $20,000,000 for damages caused to Omega due to the employment of the four
employees in question. In November 2004, we submitted a statement of defense
denying all of Omegas claims and asserting, among other things, that we
engaged the employees upon expiration of a one-year period following
termination of the agreement between us and Omega and that we therefore were allowed
to do so. On October 11, 2005 Omega submitted affidavits and on January 25,
2006 we submitted our affidavits. The arbitration process is now at the stage
of cross-examinations in front of the arbitrator. We believe that there is no
merit to the claim and intend to continue to oppose it vigorously, but we have
nevertheless accrued in the fourth quarter of 2005 a sum of $250,000 for this
claim.

55

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Dividend
Distribution Policy

Certain
of our enterprises are Approved Enterprises. In the event of a distribution to
shareholders of cash dividends out of earnings subject to the exemption from
the payment of corporate tax provided to an Approved Enterprise, the Company
will be subject to tax at a rate of 25%. We have not provided deferred taxes on
future distributions of tax-exempt earnings, as management and the Board of
Directors have determined not to make any distribution that may result in a tax
liability for the Company. Accordingly, such earnings have been considered to
be permanently reinvested. The tax-exempt earnings may be distributed to
shareholders without subjecting the Company to taxes only upon a complete
liquidation of the Company.

Significant
Changes

Since
the date of our consolidated financial statements there has not been a
significant change in our Company other then as set forth in the Financial
Statements.

|        |                      
|------- | ---------------------
|Item 9. | The Offer and Listing

Offer and listing details

Our
ordinary shares were quoted on the NASDAQ National Market System from March
1996 until April 17, 2001, from which time our ordinary shares have been traded
on the NASDAQ SmallCap Market. Through April 16, 2000, we were quoted under the
symbol CIMTF and since April 17, 2000 we have been quoted under the symbol
CIMT. The Ordinary Shares are not listed on any other stock exchange and have
not been publicly traded outside the United States. The table below sets forth
the high and low bid prices of the Ordinary Shares, as reported by NASDAQ (on
each of the National and SmallCap Markets as applicable) during the indicated
fiscal quarters:

|                          |  |                 |      |                | 
|------------------------- |  | --------------- | ---- | -------------- | 
|Period                    |  | High (U.S.
  $) |      | Low (U.S.
  $) | 
|                          |  |                 |      |                | 
|Six most
  recent months: |  |                 |      |                | 
|May 2006                  |  |                 | 1.41 |                | 
|April 2006                |  |                 | 1.53 |                | 
|March 2006                |  |                 | 1.49 |                | 
|February
  2006           |  |                 | 1.40 |                | 
|January 2006              |  |                 | 1.30 |                | 
|December
  2005           |  |                 | 1.14 |                | 

56

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|                                                               |  |                 |      |                |  |      | 
|-------------------------------------------------------------- |  | --------------- | ---- | -------------- |  | ---- | 
|Period                                                         |  | High (U.S.
  $) |      | Low (U.S.
  $) | 
|                                                               |  |                 |      |                | 
|                                                              
|Two most
  recent full financial years and subsequent periods: |  |                 |      |                |  |      | 
|First
  Quarter 2006                                           |  |                 | 1.49 |                |  | 1.00 | 
|Fourth
  Quarter 2005                                          |  |                 | 1.29 |                |  | 1.05 | 
|Third
  Quarter 2005                                           |  |                 | 1.61 |                |  | 1.14 | 
|Second
  Quarter 2005                                          |  |                 | 1.79 |                |  | 1.12 | 
|First
  Quarter 2005                                           |  |                 | 2.14 |                |  | 1.58 | 
|Fourth
  Quarter 2004                                          |  |                 | 2.38 |                |  | 1.26 | 
|Third
  Quarter 2004                                           |  |                 | 1.99 |                |  | 1.25 | 
|Second
  Quarter 2004                                          |  |                 | 2.65 |                |  | 1.75 | 
|First
  Quarter 2004                                           |  |                 | 2.95 |                |  | 2.05 | 
|                                                               |  |                 |      |                |  |      | 
|Five most
  recent years:                                      |  |                 |      |                |  |      | 
|2005                                                           |  |                 | 2.14 |                |  | 1.05 | 
|2004                                                           |  |                 | 2.95 |                |  | 1.25 | 
|2003                                                           |  |                 | 2.48 |                |  | 0.88 | 
|2002                                                           |  |                 | 1.49 |                |  | 0.7  | 
|2001                                                           |  |                 | 1.63 |                |  | 0.51 | 

Markets

Our
shares are traded only on the NASDAQ SmallCap Market, where they are listed and
traded under the symbol CIMT.

|         |                       
|-------- | ----------------------
|Item 10. | Additional Information

Memorandum and Articles of Association

Articles of Association; Israeli Companies
Law

In
February 2000 the Companys Ordinance (New Version)-1983 was replaced by the
Companies Law. Since our Articles were approved before the enactment of the
Companies Law, they are not always consistent with the provisions of the new
law. In all instances in which the Companies Law changes or amends provisions
in the Companies Ordinance, and as such, our Articles are not consistent with
the Companies Law, the provisions of the Companies Law shall prevail unless
specifically stated otherwise in the Companies Law. Similarly, in all places
that our Articles refer to a section of the Companies Ordinance that has been
replaced by the Companies Law, the Articles shall be understood to be referring
to the relevant Section of the Companies Law.

Our
shareholders approved our Articles of Association in March of 1996. Our
objective as stated in our Articles and in our Memorandum of Association is to
engage in any lawful activity.

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We
currently have only one class of securities outstanding, our Ordinary Shares,
par value NIS 0.10 per share. No preferred shares are currently authorized.

Holders
of Ordinary Shares have one vote per share, and are entitled to participate
equally in the payment of dividends and share distributions and, in the event of
our liquidation, in the distribution of assets after satisfaction of
liabilities to creditors. Our Articles may be amended by a resolution carried
at a General Meeting by 75% of the shares present and voting thereon (excluding
abstained votes). The shareholders rights may not be modified in any other way
unless otherwise expressly provided in the terms of issuance of the shares.

Our
Articles require that we hold our annual general meeting of shareholders each
year no later than 15 months from the last annual meeting, at a time and place
determined by the board of directors, upon at least 21 days prior notice to our
shareholders. No business may be commenced in any annual meeting until a quorum
of two or more shareholders holding at least one third of the voting rights are
present in person or by proxy. Shareholders may vote in person or by proxy, and
will be required to prove title to their shares as required by the Companies
Law pursuant to procedures established by the board of directors. Resolutions
regarding the following matters must be passed at a general meeting of
shareholders:

| |   |                                                                                                                                                                                                                                                                     
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | amendments
  to our Articles (other than modifications of shareholders rights as mentioned
  above);                                                                                                                                                                
| |   |                                                                                                                                                                                                                                                                     
| |  | appointment
  or termination of our auditors;                                                                                                                                                                                                                       
| |   |                                                                                                                                                                                                                                                                     
| |  | appointment
  and dismissal of directors;                                                                                                                                                                                                                           
| |   |                                                                                                                                                                                                                                                                     
| |  | approval of
  acts and transactions requiring general meeting approval under the Companies
  Law;                                                                                                                                                                   
| |   |                                                                                                                                                                                                                                                                     
| |  | increase or
  reduction of our authorized share capital or the rights of shareholders or a
  class of shareholders;                                                                                                                                                 
| |   |                                                                                                                                                                                                                                                                     
| |  | any merger
  as provided in section 320 of the Companies Law;                                                                                                                                                                                                       
| |   |                                                                                                                                                                                                                                                                     
| |  | the exercise
  of the board of directors powers by a general meeting, if the board of
  directors is unable to exercise its powers and the exercise of any of its
  powers is vital for our proper management, as provided in section 52(a) of
  the Companies Law.

In
addition, the Companies Law provides that an extraordinary meeting of our
shareholders shall be convened by the board, at the request of any two
directors or one quarter of the officiating directors, or by request of one or
more shareholders holding at least 5% of our issued share capital and 1% of the
voting rights, or by request of one or more shareholders holding at least 5% of
the voting rights. Shareholders requesting a special meeting must submit their
proposed resolution(s) with their request.

Our
Articles provide that our board of directors may from time to time, at their
discretion, borrow or secure the payment of any sum of money for the objectives
of the Company. Our directors may raise or secure the repayment of such sum in
a manner, time and terms as they see fit.

58

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According
to our Articles, the board of directors may delegate any authority they have to
a committee comprised of members of the board. Any committee to whom the boards
powers were delegated to must abide by the regulations enacted by the board in
respect of such delegated powers. In the absence of any such regulations, the
committee must abide by our Articles. Our board has currently appointed one
committee, which is our Audit Committee as described above in Item 6.

Transactions
with Certain Shareholders

The
Companies Law codifies the fiduciary duties that office holders, including
directors and executive officers, owe to a company. An office holder, is
defined in the Companies Law, as a (i) director, (ii) general manager, (iii)
chief business manager, (iv) deputy general manager, (v) vice general manager,
(vi) executive vice president, (vii) vice president, (viii) another manager
directly subordinate to the managing director or (ix) any other person assuming
the responsibilities of any of the forgoing positions without regard to such
persons title. The duty of care prescribed by the Companies Law requires an
office holder to act with the level of care, which a reasonable office holder
in the same position would have acted under the same circumstances. The duty of
loyalty prescribed by the Companies Law generally requires an office holder to
act in good faith and for the good of the company.

The
Companies Law requires that an office holder of a company promptly disclose any
personal interest that he or she may have and all related material information
known to him or her, in connection with any existing or proposed transaction by
the company. In addition, if the transaction is an extraordinary transaction,
as defined under Israeli law, the office holder must also disclose any personal
interest held by the office holders spouse, siblings, parents, grandparents,
descendants, spouses descendants and the spouses of any of the foregoing, or
by any corporation in which the office holder is a 5% or greater shareholder,
holder of 5% or more of the voting power, director or general manager or in
which he or she has the right to appoint at least one director or the general
manager. An extraordinary transaction is defined as a transaction not 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 requirement, only board
approval is required unless the Articles of Association of the company provide
otherwise. The transaction must not be adverse to the companys interest. If
the transaction is an extraordinary transaction, then, in addition to any
approval required by the Articles of Association, it must also be approved by
the audit committee and by the board of directors, and, under specified
circumstances, by a meeting of the shareholders.

Agreements
regarding directors terms of employment require the approval of the audit
committee, the board of directors and the shareholders. In all matters in which
a director has a personal interest, including matters of his/her terms of
employment, he/she shall not be permitted to vote on the matter or be present
in the meeting in which the matter is considered. However, should a majority of
the audit committee or of the board of directors have a personal interest in
the matter then:

59

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| |   |                                                                                                                                
| | - | -------------------------------------------------------------------------------------------------------------------------------
| |  | all of the
  directors shall be permitted to vote on the matter and attend the meeting in
  which the matter is considered; and
| |   |                                                                                                                                
| |  | the matter
  requires approval of the shareholders at a general meeting.                                                       

According
to the Companies Law, the disclosure requirements discussed above also apply to
a controlling shareholder of a public company. In general, extraordinary
transactions with a controlling shareholder or in which a controlling
shareholder has a personal interest, and agreements relating to employment and
compensation terms of a controlling shareholder require the approval of the
audit committee, the board of directors and the shareholders of the company.
The term controlling shareholder is defined as a shareholder who has the
ability to direct the activities of a company, other than if this power derives
solely from the shareholders position on the board of directors or any other
position with the company. The definition also includes shareholders that hold
25% or more of the voting rights if no other shareholder owns more than 50% of
the voting rights in the company.

The
shareholder approval must either include at least one-third of the shares held
by disinterested shareholders who are present in person or by proxy at the
meeting and who are voting thereon, or, alternatively, the total shareholdings
of the disinterested shareholders who vote against the transaction must not
represent more than one percent of the voting rights in the company.

In
addition, a private placement of securities that (i) includes the issuance of
twenty percent or more of the companys outstanding voting rights (prior to
such issuance) in which the consideration, in whole or in part, is not in cash
or in registered securities or is not at market value, and as a result of which
a person holding five percent of more of the companys share capital or voting
rights will increase or that will cause any person to become, as a result of
the issuance, a holder of more than five percent of the companys outstanding
share capital, or (ii) will cause any person to become, as a result of the
issuance, a controlling shareholder of the company, requires approval by the
board of directors and the shareholders of the company. The regulations to the
Companies Law provide certain exceptions. Any placement of securities that does
not fit the above description may be issued at the discretion of the Board of
Directors.

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

| |   |                                                                               
| | - | ------------------------------------------------------------------------------
| |  | any
  amendment to the Articles of Association;                               
| |   |                                                                               
| |  | an increase
  of the companys authorized share capital;                      
| |   |                                                                               
| |  | a merger; or                                                                  
| |   |                                                                               
| |  | approval of
  interested party transactions that require shareholder approval.

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In
addition, any controlling shareholder, any shareholder who knows that it
possesses the power to determine the outcome of a shareholder vote and any
shareholder who has the power to appoint or prevent the appointment office
holder in the company is under a duty to act with fairness towards the company.
The Companies Law does not describe the substance of this duty, except
to state that the remedies generally available upon a breach of contract will
apply also in the event of a breach of the duty to act with fairness. The
Companies Law requires that specified types of transactions, actions and
arrangements be approved as provided for in a companys articles of association
and in some circumstances by the audit committee, by the board of directors and
by the shareholders. The vote required by the audit committee and the board of
directors for approval of these matters, in each case, is a majority of the
disinterested directors participating in a duly convened meeting.

Limitation on Ownership of Securities

The
ownership and voting of our ordinary shares by non-residents of Israel are not
restricted in any way by our articles of association or by the laws of the
State of Israel, except for shareholders who are subjects of countries which are
in a state of war with Israel.

Mergers and Acquisitions; Anti-Takeover
Provisions

The
Companies Law includes provisions with respect to the approval of corporate
mergers that are applicable to us. These provisions require that the board of
directors of each company that is party to the merger approve the transaction. In
addition, the shareholders of each company must approve the merger by a vote of
75% of the companys shares, present and voting on the proposed merger at a
shareholders meeting. In determining whether the requisite majority has
approved the merger, shares held by the other party to the merger or any person
holding at least 25% of such other party or otherwise affiliated with such
other party are excluded from the vote.

The
Companies Law does not require court approval of a merger other than in
specified situations. However, upon the request of a creditor of either party
to the proposed merger, a 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 to their creditors.

A
merger may not be completed unless at least 50 days have passed from the date
that a proposal of the merger was filed with the Israeli Registrar of Companies
by each merging company and 30 days from the date that shareholder approval of
both merging companies was obtained. The merger proposal may be filed once a
shareholder meeting has been called to approve the merger.

The
Companies Law also provides that the acquisition of shares in a public company
on the open market must be made by means of a tender offer if, as a result of
the acquisition, the purchaser would become a 25% shareholder of the company. The
rule does not apply if there already is another 25% shareholder of the company.
Similarly, the 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 45% shareholder of the company, unless there already
is a 45% shareholder of the company.

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If,
following any acquisition of shares, the purchaser would hold 90% or more of
the shares of the company that acquisition must be made by means of a tender
offer for all of the target companys shares. An acquirer who wishes to
eliminate all minority shareholders must do so by means of a tender offer and
acquire 95% of all shares not held by or for the benefit of the acquirer prior
to the acquisition. However, in the event that the tender offer to acquire that
95% is not successful, the acquirer may not acquire tendered shares if by doing
so the acquirer would own more than 90% of the shares of the target company.

Material Contracts

Other
than the service agreement and lease agreement described in Item 6 - Major
Shareholders and Related Party Transactions  Related Party Transactions, our
current lease agreement described below and the Microsystems investment
contract described in Item 4. History and development of the Company, all of
the contracts that we have entered into over the past two years have been in
the ordinary course of our business.

In
February 2003, we leased from a private commercial property owner the same
office space that we had previously leased from ZCT, under a new lease
agreement. The initial term of the lease was three years, expiring in June 30,
2006, following which we exercised our option to extend the lease for an additional
three years.

Exchange Controls

There
are currently no Israeli currency control restrictions on payments of dividends
or other distributions with respect to our ordinary shares or the proceeds from
the sale of the shares, except for the obligation of Israeli residents to file
reports with the Bank of Israel regarding some transactions. However,
legislation remains in effect under which currency controls can be imposed by
administrative action at any time.

The ownership or voting of our ordinary
shares by non-residents of Israel, except with respect to citizens of countries
which are in a state of war with Israel, is not restricted in any way by our
memorandum of association or articles of association or by the laws of the
State of Israel.

Taxation

The
following is a summary of the current tax law applicable to companies in
Israel, with special reference to its effect on our subsidiaries and us. The
following also contains a discussion of specified Israeli tax consequences to
our shareholders and government programs from which we, and some of our
subsidiaries, benefit. To the extent that the discussion is based on tax
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 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.

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General Corporate Tax Structure

Until
2003, Israeli companies were generally subject to corporate tax at the rate of
36% of their taxable income. However, as a result of legislation adopted in
July 2004, tax rates were reduced to 35% for 2004, 34% for 2005, 31% for 2006,
29% for 2007, 27% for 2008, 26% for 2009 and 25% for 2010. However, the
effective tax rate payable by a company that derives income from an Approved
Enterprise (as further discussed below) may be considerably less. Under the
Income Tax Law (Adjustment for Inflation) 1985, income for tax purposes is
measured in terms of earnings in NIS adjusted for the increase in the Israeli
Consumer Price Index. The difference between the annual changes in the Israeli
Consumer Price Index and in the NIS/U.S. Dollar exchange rates causes a
difference between taxable income and the income reflected in our financial
statements. See note 13D of our financial statements.

Law for the Encouragement of Capital
Investments, 1959

Certain
of our operations have been granted Approved Enterprise status under the Law
for the Encouragement of Capital Investments, 1959, as amended (referred to as
the Investment Law).

The
Investment Law provides that a capital investment in eligible facilities may,
upon application to the Investment Center of the Ministry of Industry and Trade
of the State of Israel (referred to as the Investment Center), 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.

Taxable
income of a company derived from an Approved Enterprise is subject to company
tax at the rate of up to 25% (rather than 34% as stated above) for a period of
time termed the benefit period. The benefit period is a period of 7 years
commencing with the year in which the Approved Enterprise first generated
taxable income. The benefit period is in any event limited to 12 years from the
commencement of production or 14 years from the date of approval, whichever is
earlier. Under certain circumstances (as further detailed below), the benefits
period may extend to a maximum of ten years from the commencement of the
benefit period. Notwithstanding the foregoing, taxable income of a company
located in certain geographic locations, derived from an Approved Enterprise
approved after January 1, 1997, is tax exempt for the first two years of the
benefit period and is taxed at a rate of 25% or lower for the remainder of the
benefit period. A company which operates under more than one approval or that
has capital investments which are only partly approved (such a company being
designated as a Mixed Enterprise), its effective Company Tax rate is the result
of a weighted combination of the various applicable rates.

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A company that qualifies as a
Foreign Investors Company is entitled to further reductions in the tax rate
normally applicable to Approved Enterprises. Such benefits will be granted only
to enterprises that sought approval no later than December 31, 2002. Subject to
certain conditions, a Foreign Investors Company is a company which has more
than 25% of its combined shareholders investment in share capital (in terms of
rights to profits, voting and the appointment of directors) and in long term
shareholders loans made by persons who are not residents of Israel. The
percentage owned by nonresidents of Israel for any tax year will be determined
by the lowest percentage of any of the above rights held by nonresidents during
that year. Such a company will pay company tax at reduced rates for an extended
ten-year (rather than the otherwise applicable seven-year) period and is exempt
from any other tax on the income from its Approved Enterprise:

The
table below reflects the tax rates applicable to companies with foreign
investments as set forth below:

|                                |  |                    |   | 
|------------------------------- |  | ------------------ | - | 
|Foreign
  Investments           |  | Company
  Tax Rate |  
|                                |  |                    |  
|                               
|Over 25% but
  less than 49%    |  | 25                 | % | 
|49% or more
  but less than 74% |  | 20                 | % | 
|74% or more
  but less than 90% |  | 15                 | % | 
|90% or more                     |  | 10                 | % | 

Should
our foreign shareholders exceed 25%, future Approved Enterprises might qualify
for reduced tax rates for an additional three years, after the seven years
mentioned above. However, there can be no assurance that we will attain
approval for additional Approved Enterprises or that the provisions of this Law
will be extended without change or that the above-mentioned shareholding
proportion will be reached for each subsequent year.

In
addition, a company owning an Approved Enterprise may elect (as we have) to
forego certain Government grants extended to Approved Enterprises in return for
an alternative package of tax benefits (the Alternative Package). 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, depending in part on the geographic location of the Approved Enterprise
within Israel, and such company will be eligible for the regular tax benefits
under the Investment Law for the remainder of the Benefits Period if any.

A
company, such as ours, that has elected the Alternative Package and that
subsequently pays a dividend out of income derived from the Approved
Enterprise(s) during the tax exemption period will be subject to deferred
company tax in respect of the amount distributed (including the company tax
thereon) at the rate which would have been applicable had such company not
elected the Alternative Package. This rate is generally 10% to 25%, depending
on the extent to which non-Israeli shareholders hold such companys shares.

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The
dividend recipient is taxed at the reduced rate applicable to dividends from
Approved Enterprises (generally, 15% as compared to 25%), if the dividend is distributed
during the tax benefit period or within 12 years after this period. However,
the limitation does not apply if the company qualifies as a foreign investors
company. In the event, however, that the company also qualifies as a Foreign
Investors Company, there is no such time limit. This tax must be withheld by
such company at source, regardless of whether the dividend is converted into
foreign currency.

Subject
to certain provisions concerning income subject to the Alternative Package, all
dividends are considered to be attributable to the entire enterprise and the
effective tax rate on the dividend is the result of a weighted combination of
the various applicable tax rates. However, such company is not obliged to
distribute exempt retained profits under the Alternative Package, and such
company may generally decide from which years profits to declare dividends.

The
Investment Law also provides that an Approved Enterprise is entitled to
accelerated depreciation on its property and equipment that are included in an
approved investment program. We have not utilized this benefit.

Each
application to the Investment Center is reviewed separately, and a decision as
to whether or not to approve such application is based, among other things, on
the then prevailing criteria set forth in the Investment Law, on the specific
objectives of the applicant company set forth in such application and on
certain financial criteria of the applicant company. 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 certain conditions stipulated in the Investment Law and its
regulations and the criteria set forth in the certificate of approval, as
described above. In the event that these conditions are violated, in whole or
in part, a company with an Approved Enterprise would be required to refund the
amount of tax benefits, with the addition of the Israeli CPI linkage
differences and interest. See note 13 of our financial statements.

In
March 2005, the government of Israel passed an amendment to the Investment Law
in which it revised the criteria for investments qualified to receive tax
benefits as an approved enterprise. Among other things, companies that meet the
criteria of the alternate package of tax benefits will receive those benefits
without prior approval. However, no assurance can be given that we will, in the
future, be eligible to receive additional tax benefits under this law.

Law for the Encouragement of Industrial
Research and Development, 1984

Under
the Law for the Encouragement of Industrial Research and Development, 1984 (the
Research Law), research and development programs approved by the Research
Committee of the Office of the Chief Scientist (the Research Committee) are
eligible for grants or loans if they meet certain criteria, in return for the
payment of royalties from the sale of the product developed in accordance with
the program. Once a project is approved, the Office of the Chief Scientist, or
OCS, will award grants of up to 50% of the projects expenditures in return for
royalties, usually at rates between 3% to 5% of sales of products developed
with such grants, up to a dollar-linked amount equal to 100% to 150% of such
grants. Grants
received under programs approved after January 1, 1999, are subject to interest
at an annual rate of LIBOR for 12 months applicable to dollar deposits, which
will accrue annually based on the LIBOR rate published on the first day of each
year.

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For
information regarding restrictions upon, and conditions to, (a) the manufacture
outside of Israel of products using technology developed using OCS funding and
(b) the transfer of such technology to a non-Israeli entity whether through the
direct transfer of the technology or through a transaction involving the
company that received such funding, see Item 5  Operating and Financial
Review and Prospects - Research and development, patents, licenses, etc.

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) and 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. Expenditures not so approved are
deductible over a three-year period. However, expenditures made out of proceeds
made available to us through government grants are not deductible according to
Israeli law.

Law for the Encouragement of Industry
(Taxes), 1969

The
following preferred corporate tax benefits, among others, are available to
Industrial Corporations (including us).

| |   |                                                                                                                                                                              
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Deduction of
  purchases of know-how and patents over eight years for tax purposes.                                                                                          
| |   |                                                                                                                                                                              
| |  | Deduction,
  for tax purposes, of expenses incurred in connection with certain public
  securities issuances.                                                                
| |   |                                                                                                                                                                              
| |  | Accelerated
  depreciation rates on both equipment and buildings.                                                                                                            
| |   |                                                                                                                                                                              
| |  | The right to
  elect, under specified conditions, to file a consolidated tax return with
  additional related Israeli industrial companies and an industrial holding company.

Taxation under Inflationary Conditions

The
Income Tax Law (Inflationary Adjustments), 1985 (the Inflationary Adjustments
Law) is intended to neutralize the erosion of capital investments in business
and to prevent tax benefits resulting from deduction of inflationary expenses. This
law applies a supplementary set of inflationary adjustments to the normal
taxable profits computed under regular historical cost principles. We are taxed
under this law, although the application of certain of the provisions of this
law was suspended for the tax years 2000 and 2001 because of the nil rate of
inflation in those years.

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Under
the Inflationary Adjustments Law, results for tax purposes are measured in real
terms, in accordance with the changes in the consumer price index. 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 consumer
price index.

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

A
special tax adjustment for the preservation of equity whereby certain corporate
assets are classified broadly into Fixed (inflation resistant) Assets and
Non-Fixed (soft) 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 on a
linked basis to the following year, to be deducted from any taxable income, and
any excess deduction in that year will be considered a business loss). 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.

The
law also provides for the full taxation of gains from the sale of certain
traded securities, which would otherwise be taxed at a reduced rate when
derived by certain categories of corporate taxpayers.

Capital Gains Tax

Israeli
law imposes a capital gains tax on the sale of capital assets by both residents
and non-residents of Israel. The law distinguishes between the Real Gain and
the Inflationary Amount. The Real Gain is the excess of the total capital
gain over the Inflationary Amount, computed on the basis of the increase in the
Israeli Consumer Price Index between the date of purchase and the date of sale.
The Inflationary Amount accumulated prior to December 31, 1993 is taxed at a
rate of 10% for residents of Israel (reduced to no tax for non-residents if
calculated according to the exchange rate of the dollar instead of the Israeli
CPI), while the Inflationary Amount accumulated following December 31, 1993 is
exempt from any capital gains tax. Until the end of the year 2002, capital
gains from the sale of our ordinary shares were generally exempt from Israeli
Capital Gains Tax. This exemption did not apply to a shareholder whose taxable
income is determined pursuant to the Israeli Income Tax Law (Inflationary
Adjustments), 1985, or to a person whose gains from selling or otherwise
disposing of our securities are deemed to be business income.

As a result of
the recent tax reform legislation in Israel, gains from the sale of our
ordinary shares derived from January 1, 2003 and thereafter for individual
shareholders will in general be liable to capital gains tax of 20%. With
respect to an individual who is a substantial shareholder (which is someone who
alone, or together with another person, holds, directly or indirectly, at least
10% in one or all of any of the means of control in the company), the
applicable capital gains tax rate will be 25%. This will be the case so long as
our securities remain listed for trading on a designated foreign stock market
such as the NASDAQ. However, according to the tax reform legislation,
non-residents of Israel will be exempt from any capital gains tax from the sale
of our ordinary shares so long as the gains are not derived through a permanent
establishment that the non-resident maintains in Israel, and so long as our
ordinary shares remain listed for trading as described above. These provisions
dealing with capital gains are not applicable to persons whose gains from
selling or otherwise disposing of our ordinary shares are deemed to be business
income or whose taxable income is determined pursuant to the Israeli Income Tax
Law (Inflation Adjustments), 1985; the latter law would not normally be
applicable to non-resident shareholders who have no business activity in
Israel.

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U.S.-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 (referred to as the
U.S.-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 U.S.-Israel Tax Treaty and who is entitled to claim the benefits
afforded to such resident by the U.S.-Israel Tax Treaty (called a Treaty U.S.
Resident) will generally not be subject to Israeli capital gains tax unless
(a) such Treaty U.S. Resident is an individual and was present in Israel for
more than 183 days during the relevant taxable year or (b) such Treaty U.S.
Resident holds, directly or indirectly, shares representing 10% or more of the
voting power of a company during any part of the 12-month period preceding such
sale, exchange or disposition. A sale, exchange or disposition of shares by a
Treaty U.S. Resident who either is an individual and was present in Israel for
more than 183 days during the relevant taxable year or who holds, directly or
indirectly, shares representing 10% or more of the voting power of a company at
any time during such preceding 12-month period would be subject to such Israeli
tax, to the extent applicable; however, under the U.S.-Israel Tax Treaty, such
Treaty U.S. Resident would be permitted to claim a credit for such taxes
against the U.S. income tax imposed with respect to such sale, exchange or
disposition, subject to the limitations in U.S. laws applicable to foreign tax
credits.

Taxation of Non-Residents

Non-residents
of Israel are subject to income tax on income accrued or derived from sources
in Israel or received in Israel. Such sources of income include passive income
such as dividends, royalties and interest, as well as active income from
services rendered in Israel. On distributions of dividends other than bonus
shares (stock dividends), income tax at the rate of 25% is withheld at source,
unless a different rate is provided in a treaty between Israel and the
shareholders country of residence. For example, the tax rate would be 12.5% if
the non-resident were a company which holds at least 10% of our voting power
pursuant to the U.S.-Israel Tax Treaty, except for dividends generated by an
Approved Enterprise from which tax is withheld at the rate of 15%. However, as
of tax year 2006. the tax rate on dividends to individuals will be reduced to
20% and the withholding rate may be reduced as well. With respect to an
individual who is a substantial shareholder (which is someone who alone, or
together with another person, holds, directly or indirectly, at least 10% in
one or all of any of the means of control in the company), the applicable tax
rate will remain 25%.

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Documents on Display

We
are required to file reports and other information with the SEC under the
Securities Exchange Act of 1934 and the regulations thereunder applicable to
foreign private issuers. Reports and other information filed by us with the SEC
may be inspected and copied at the SECs public reference facilities described
below. Although as a foreign private issuer we are not required to file
periodic information as frequently or as promptly as United States companies,
we generally do publicly announce our quarterly and year-end results promptly
and file periodic information with the SEC under cover of Form 6-K. As a
foreign private issuer, we are also exempt from the rules under the Exchange
Act prescribing the furnishing and content of proxy statements and our
officers, directors and principal shareholders are exempt from the reporting
and other provisions in Section 16 of the Exchange Act.

This
annual report and the exhibits thereto, are available for inspection and
copying at the public reference facilities of the Securities and Exchange
Commission located a Room 1024, 450 Fifth Street, NW, Washington, D.C. 20549,
and the Commissions regional offices located in New York, New York and
Chicago, Illinois. Copies of all or any part of the annual report or other
filings may be obtained from these offices after payment of fees required by
the Commission. Please call the Commission at 1-800-SEC-0330 for further
information. The Exchange Act file number for our Securities and Exchange
Commission filing is 1-8201.

The
Commission also maintains a website at http://www.sec.gov from which certain
filings may be accessed.

All
documents referenced herein concerning us are archived and may also be
inspected at our head offices located at 11 Gush Etzion Street, Givat Shmuel,
Israel. Information about us is also available on our website at http://www.cimatron.com.
Such information is not part of this annual report.

|         |                                                            
|-------- | -----------------------------------------------------------
|Item 11. | Quantitative and Qualitative Disclosures About Market Risks

We
are exposed to market risks from changes in foreign currency exchange rates and
interest rates, which could impact our results of operations and financial
condition. We seek to manage the exposure to these market risks through our
regular operating and financing activities and through the use of foreign
currency exchange contracts and other financial instruments.

All
of such financial instruments are managed and controlled under a program of
risk management in accordance with established policies. These policies are
reviewed and approved by our Board of Directors. Our treasury operations are
subject to an internal audit on a regular basis.

As
of December 31, 2005, we had currency exchange options to sell up to 2.52
million Euro for a total amount of $2.9 million, and had written currency
exchange options to sell up to 2.1 million Euro for a total amount of $2.7
million that were scheduled to expire prior to December 31, 2006. The total
fair value of all such options on December 31, 2005 amounted to an asset of
$5,000. All such options are designated as cash flow hedges. On May 17, 2006 we
exercised currency exchange options to sell 210,000 Euro for $264,000, and on
June 19, 2006, we exercised currency exchange options to sell 210,000 Euro for
$264,000.

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Interest Rate Risks

Our
exposure to market rate risk for changes in interest rates relates primarily to
our investment portfolio. We have not used derivative financial instruments in
our investment portfolio. As of December 31, 2005, we had financial assets
totaling approximately $6.2 million. Fixed rate financial assets, comprised of
cash, bank deposits and debt securities, totaled approximately $4.9 million.
For the year 2005 we have classified all of our marketable debt securities as available
for sale securities which exposes the consolidated statement of operations or
balance sheets to fluctuations in interest rates. Variable rate financial
assets totaled approximately $1.3 million. The net decrease in our earnings for
the next year from our variable rate financial assets resulting from a 10%
interest rate decrease would be approximately $9,000, holding other variables
constant. Assuming an interest rate increase of 10%, the fair value of our fixed-rate
marketable debt securities would be reduced by approximately $25,000.

Currency Exchange Rate Risks

Our
operating and pricing strategies take into account changes in exchange rates
over time. However, there can be no assurance that future fluctuations in the
value of foreign currencies will not have a material adverse effect on our
business, operating results or financial condition. As of the beginning of
2000, we have been using financial instruments to hedge the following foreign
currency exposure risks:

Our
Subsidiaries - We operate internationally and our
subsidiaries in Germany and France conduct their respective operations in
Euros. This exposes us to market risk from changes in foreign exchange rates to
the extent that the functional currency of our subsidiaries will decline in
value as compared to the U.S. dollar, resulting in a foreign currency exchange
rate loss. Assuming an adverse 20% foreign exchange rate fluctuation, we would
experience exchange rate losses of approximately $661,000 excluding the effect
of our hedging transactions.

Our
Providers - Commencing on June 1, 2000 we initiated a
Euro denominated price list for all of our Providers in countries whose
currency is linked to the Euro. Our revenues from these Providers are therefore
exposed to exchange rate differences between the Euro and the United States
dollar. Assuming an adverse 20% foreign exchange rate fluctuation, we would
experience exchange rate losses from these providers of approximately $907,000
excluding the effect of our hedging transactions.

Expenses
in New Israeli Shekels

The
cost of our Israel operations, as expressed in U.S. dollars, is influenced by
the extent to which any increase in the rate of inflation in Israel is not
offset (or is offset on a lagging basis) by a devaluation of the NIS in
relation to the U.S. dollar. The inflation rate in Israel was 2.4%, 1.2%, and
-1.9% in 2005, 2004 and 2003, respectively. The devaluation (revaluation) of
the NIS against the U.S. dollar was 6.4%, (1.6)% and (7.6)% in 2005, 2004, and
2003, respectively. Assuming a 10% devaluation of the U.S. dollar against the
NIS, and assuming a maximum deviation of 1% in inflation, we would experience
exchange rate losses of approximately $1.0 million excluding the effect of our
hedging transactions.

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A
significant portion of our expenditures is employee compensation-related.
Salaries are paid
in NIS and may be adjusted for changes in the CPI through salary increases or
adjustments. This increases salary expenses in U.S. dollar terms. The
devaluation / revaluation of the NIS against the U.S. dollar decreases /
increases employee compensation expenditures as expressed in dollars
proportionally. Some of our other NIS-based expenses are either currently
adjusted to U.S. dollars or are adjusted to the CPI.

|         |                                                        
|-------- | -------------------------------------------------------
|Item 12. | Descriptions of Securities Other than Equity Securities

Not Applicable

PART II

|         |                                                
|-------- | -----------------------------------------------
|Item 13. | Defaults, Dividend Arrearages and Delinquencies

None.

|         |                                                                             
|-------- | ----------------------------------------------------------------------------
|Item 14. | Material Modifications to the Rights of Security Holders and Use of
Proceeds

None.

|         |                        
|-------- | -----------------------
|Item 15. | Controls and Procedures

(a)
Disclosure Controls and Procedures
- our management evaluated, with the participation of our principal executive
and principal financial officers, the effectiveness of our disclosure controls
and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange
Act), as of December 31, 2005. Based on their evaluation, our principal
executive and principal financial officers concluded that our disclosure
controls and procedures were effective as of December 31, 2005.

(b)
Not applicable.

(c)
Not applicable.

(d)
Changes in Internal Control Over Financial
Reporting - There has been no change in our internal control over
financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the
Exchange Act) that occurred during 2005, that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.

71

---

---



|          |                                 
|--------- | --------------------------------
|Item 16A. | AUDIT COMMITTEE FINANCIAL EXPERT

Our
Board of Directors has determined that Ofra Brown qualifies to serve as our
audit committee financial expert as well as our external director with financial
expertise under the Companies Law.

|          |               
|--------- | --------------
|Item 16B. | CODE OF ETHICS

We
have adopted a code of ethics that applies to our Chief Executive Officer,
Chief Financial Officer, Controller and persons performing similar functions,
and which complies with the rules promulgated by the SEC. We will provide to
any person, without charge, upon request, a copy of the code of ethics and
respond to any questions concerning the code. Requests to receive a copy of the
code should be sent to us at our corporate headquarters located at 11 Gush
Etzion Street, Givat Shmuel 54030, Israel, Attention: Chief Financial Officer. In
addition, we have adopted a code of business conduct that applies to all of our
directors, officers and employees, and which complies with the rules of the
Nasdaq Capital Market (formerly the Nasdaq SmallCap Market).

The
Chairman of our Audit Committee may approve a request by our Chief Executive
Officer, Chief Financial Officer, Principal Accounting Officer, Controller or
any person performing similar functions for a waiver from the requirements of
the code of ethics pertaining to (i) honest and ethical conduct, including the
ethical handling of actual or apparent conflicts of interest between personal
and professional relationship; (ii) full, fair, accurate, timely and
understandable disclosure in reports and documents that we must file with, or submit
to, the Securities and Exchange Commission and in other public communications
made by us; (iii) compliance with applicable governmental laws, rules and
regulations; (iv) the prompt internal reporting of violation of the code to the
Chairman of our Audit Committee; and (v) accountability for adherence to the
code; provided in each case that the person requesting such waiver provides to
our Audit Committee a full disclosure of the particular circumstances relating
to such request. The Chairman of our Audit Committee will first determine
whether a waiver of the relevant requirements of the code of ethics is required
and, if such waiver is required, whether a waiver will be granted. The person
requesting such waiver may be required to agree to certain conditions before a
waiver or a continuing waiver is granted.

Any
amendments to the code of ethics and all waivers from compliance with the code
of ethics granted to the persons subject thereto have to be publicly disclosed
by us as, and to the extent, required by any applicable law, rule and
regulations.

|          |                                       
|--------- | --------------------------------------
|Item 16C. | PRINCIPAL ACCOUNTANT FEES AND SERVICES

Audit and Audit-related Fees

The
aggregate fees billed for professional services rendered to us by our principal
accountants for the audit of our financial statements and for audit-related
services in 2003,2004 and 2005 were $116,000, $69,000 and $73,000,
respectively.

72

---

---



Tax
Fees

The
aggregate fees billed for professional services rendered to us by our principal
accountants for tax compliance, tax advice and tax planning in 2003, 2004 and
2005 were $27,000, $37,000 and $18,000, respectively. The services provided to
us by our principal accountants in both 2003 and 2004 are related to the
preparation and filing of our tax returns with income tax authorities. In
addition, in 2005 we received from our principal accountants tax advice with
respect to a transfer pricing study.

All
Other Fees

We
did not receive from our principal accountants any other products or services,
other than the services disclosed above, in 2004 and 2005.

73

---

---



Audit
Committee Approval

In
December 2005, our shareholders approved the engagement of Brightman Almagor
& Co., a member of Deloitte Touche Tohmatsu, as our independent auditors
for the fiscal year ended December 31, 2005. Such approval followed the
approval by our board of directors and audit committee of such engagement.

|                             |                                                                                                                                                          
|---------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------
|Item 16D.                    | EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES -Not
  applicable                                                                             
|                             |                                                                                                                                                          
|Item 16E.                    | REPURCHASE OF EQUITY SECURITIES BY THE ISSUER AND AFFLIATED
PURCHASERS During 2003, we repurchased 26,000
shares at an average price of $1.04 per share.
|                             |                                                                                                                                                          
|PART III                     |                                                                                                                                                          
|                             |                                                                                                                                                          
|Item 17.                     | Financial Statements                                                                                                                                     
|                             |                                                                                                                                                          
|Not
  Applicable             |                                                                                                                                                          
|                             |                                                                                                                                                          
|Item 18.                     | Financial Statements                                                                                                                                     
|                             |                                                                                                                                                          
|See page F-1
  through F-25.
|                             |                                                                                                                                                          
|Item 19.                     | Exhibits                                                                                                                                                 

|     |                                                                                                                                                                                                                                                                                                                                                       
|---- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|1.1  | Articles of
  Association.*                                                                                                                                                                                                                                                                                                                           
|     |                                                                                                                                                                                                                                                                                                                                                       
|4.1  | Services
  Agreement with Koonras Technologies Ltd. and DBSI Investments Ltd., as
  assigned to them by Zeevi Computers and Technology Ltd.*.                                                                                                                                                                                                         
|     |                                                                                                                                                                                                                                                                                                                                                       
|4.2  | Letter of
  Agreement with Microsystem Srl and all the shareholders of Microsystem Srl
  dated May 24, 2005, including the First Call Option Agreement, the Second
  Call Option Agreement, and the Put Option Agreement, and the Shareholders
  Agreement, all dated July 1, 2005 with Microsystem Srl and all the
  shareholders of Microsystem Srl.
|     |                                                                                                                                                                                                                                                                                                                                                       
|8.1  | List of
  subsidiaries.                                                                                                                                                                                                                                                                                                                               
|     |                                                                                                                                                                                                                                                                                                                                                       
|12.1 | Certificate
  of Chief Executive Officer pursuant to Rule 13a-14(a)/Rule 15d-14(a)                                                                                                                                                                                                                                                                    
|     |                                                                                                                                                                                                                                                                                                                                                       
|12.2 | Certificate
  of Chief Financial Officer pursuant to Rule 13a-14(a)/Rule 15d-14(a)                                                                                                                                                                                                                                                                    
|     |                                                                                                                                                                                                                                                                                                                                                       
|13   | Certification
  of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350                                                                                                                                                                                                                                             
|     |                                                                                                                                                                                                                                                                                                                                                       
|14.1 | Consent of
  Independent Public Accountants.                                                                                                                                                                                                                                                                                                          
|     |                                                                                                                                                                                                                                                                                                                                                       
|*    | Incorporated by reference
  from our Registration Statement on Form F-1, File No. 333-1484, as amended,
  filed with the Securities and Exchange Commission on February 16, 1996.                                                                                                                                                                     

74

---

---



SIGNATURES

Pursuant to the requirements of
Section 12 of the Securities Exchange Act of 1934, the registrant certifies that it meets
all the requirements for filing on Form 20-F and has duly caused and authorized the
undersigned to sign this annual report on its behalf in the City of Givat Shmuel, State
of Israel, on this 29th day of June, 2006.

|              |                                                |  | 
|------------- | ---------------------------------------------- |  | 
|CIMATRON LTD.
|             
|              | By: /s/
 Dan Haran                            
|              |                                                |  | 
|              | Name: Dan Haran                               
|             
|              | Title:
  President and Chief Executive Officer

75

---

---

CIMATRON LIMITED

CONSOLIDATED FINANCIAL STATEMENTS

TABLE OF CONTENTS

|                                                                                                                       |            
|---------------------------------------------------------------------------------------------------------------------- | -----------
|                                                                                                                       | Page       
|                                                                                                                       |            
|                                                                                                                       |            
|Report of Independent Registered
  Public Accounting Firm                                                              | F-2        
|                                                                                                                       |            
|Consolidated Financial Statements:                                                                                     |            
|                                                                                                                       |            
|Balance Sheets as of December 31, 2005
and 2004                                                                        | F-3        
|                                                                                                                       |            
|Statements of Operations for the years ended
December 31, 2005, 2004 and 2003                                          | F-4        
|                                                                                                                       |            
|Statement of Shareholders Equity and
Comprehensive Income (Loss) for the years ended December 31, 2005, 2004 and
2003 | F-5        
|                                                                                                                       |            
|Statements of Cash Flows for the years ended
December 31, 2005, 2004 and 2003                                          | F-6        
|                                                                                                                       |            
|Notes to the Consolidated Financial
  Statements                                                                       | F-7-
  F-26

---

---



REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholders of
Cimatron Limited

We have audited the
accompanying consolidated balance sheets of Cimatron Limited and subsidiaries
(the Company) as of December 31, 2005 and 2004 and the related consolidated
statements of operations, shareholders equity and comprehensive income (loss)
and cash flows for each of the three years in the period ended December 31, 2005. These consolidated
financial statements are the responsibility of the Companys management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

We did not audit the
financial statements of consolidated subsidiaries, whose revenues constitute
approximately 46% of consolidated total revenues for the year ended December
31, 2003.
Those financial statements were audited by other auditors, whose reports have
been furnished to us, and our opinion, insofar as it relates to amounts
included for those companies, is based solely on the reports of such other
auditors.

We conducted our audits in
accordance with the standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. The Company is not required to have, nor were we engaged
to perform, an audit of its 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, as
well as evaluating the overall financial statements presentation. We believe
that our audits provide a reasonable basis for our opinion.

In our opinion, based on our
audits and the reports of the other auditors, the consolidated financial
statements referred to above present fairly, in all material respects, the
consolidated financial position of the Company as of December 31, 2005 and 2004 and the
results of its operations and its cash flows for each of the three years in the
period ended December 31, 2005 in conformity with U.S. generally accepted accounting
principles.

Brightman Almagor & Co.
Certified Public Accountants
A member firm of Deloitte Touche Tohmatsu

Tel-Aviv, Israel
March 12, 2006

F-2

---

---



CIMATRON LIMITED

CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)

|                                                                                                                                                    |  |                |        |         |   |        |  
|--------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------- | ------ | ------- | - | ------ | -
|                                                                                                                                                    |  | December
  31, |       
|                                                                                                                                                    |  |                |       
|                                                                                                                                                    |  | 2 0 0 5        |        | 2 0 0 4 |  
|                                                                                                                                                    |  |                |        |         |  
|ASSETS                                                                                                                                              |  |                |        |         |   |        |  
|                                                                                                                                                    |  |                |        |         |   |        |  
|Current assets                                                                                                                                      |  |                |        |         |   |        |  
|Cash and cash equivalents                                                                                                                           |  | $              | 2,708  |         | $ | 1,711  |  
|Short-term investments (Note 3)                                                                                                                     |  |                | 2,167  |         |   | 6,381  |  
|Trade accounts receivable (Note 4)                                                                                                                  |  |                | 4,541  |         |   | 6,130  |  
|Other accounts receivable and prepaid expenses
(Note 5)                                                                                             |  |                | 774    |         |   | 712    |  
|Inventory                                                                                                                                           |  |                | 62     |         |   | 60     |  
|                                                                                                                                                    |  |                |        |         |   |        |  
|Total current assets                                                                                                                                |  |                | 10,252 |         |   | 14,994 |  
|                                                                                                                                                    |  |                |        |         |   |        |  
|                                                                                                                                                    |  |                |        |         |   |        |  
|Long-term investments (Note 3)                                                                                                                      |  |                | 2,195  |         |   | -      |  
|                                                                                                                                                    |  |                |        |         |   |        |  
|                                                                                                                                                    |  |                |        |         |   |        |  
|Deposits with insurance companies and severance pay
  funds (Note 10)                                                                               |  |                | 2,219  |         |   | 2,946  |  
|                                                                                                                                                    |  |                |        |         |   |        |  
|                                                                                                                                                    |  |                |        |         |   |        |  
|Property and equipment (Note 6)                                                                                                                     |  |                |        |         |   |        |  
|Cost                                                                                                                                                |  |                | 5,321  |         |   | 5,478  |  
|Less - accumulated depreciation                                                                                                                     |  |                | 4,325  |         |   | 4,405  |  
|                                                                                                                                                    |  |                |        |         |   |        |  
|Property and equipment, net                                                                                                                         |  |                | 996    |         |   | 1,073  |  
|                                                                                                                                                    |  |                |        |         |   |        |  
|                                                                                                                                                    |  |                |        |         |   |        |  
|Other assets                                                                                                                                        |  |                |        |         |   |        |  
|Software development costs, net (Note 7)                                                                                                            |  |                | 193    |         |   | 1,204  |  
|Goodwill, net                                                                                                                                       |  |                | 587    |         |   | 587    |  
|                                                                                                                                                    |  |                |        |         |   |        |  
|Total other assets                                                                                                                                  |  |                | 780    |         |   | 1,791  |  
|                                                                                                                                                    |  |                |        |         |   |        |  
|                                                                                                                                                    |  |                |        |         |   |        |  
|Total
  assets                                                                                                                                      |  | $              | 16,442 |         | $ | 20,804 |  
|                                                                                                                                                    |  |                |        |         |   |        |  
|                                                                                                                                                    |  |                |        |         |   |        |  
|LIABILITIES AND SHAREHOLDERS
EQUITY                                                                                                                |  |                |        |         |   |        |  
|                                                                                                                                                    |  |                |        |         |   |        |  
|Current liabilities                                                                                                                                 |  |                |        |         |   |        |  
|Short-term bank credit                                                                                                                              |  | $              | 501    |         | $ | 500    |  
|Related parties                                                                                                                                     |  |                | 304    |         |   | 99     |  
|Trade payables                                                                                                                                      |  |                | 663    |         |   | 778    |  
|Other liabilities and accrued expenses (Note
8)                                                                                                     |  |                | 3,977  |         |   | 3,131  |  
|Deferred revenues                                                                                                                                   |  |                | 479    |         |   | 180    |  
|                                                                                                                                                    |  |                |        |         |   |        |  
|Total current liabilities                                                                                                                           |  |                | 5,924  |         |   | 4,688  |  
|                                                                                                                                                    |  |                |        |         |   |        |  
|                                                                                                                                                    |  |                |        |         |   |        |  
|Long-term liabilities                                                                                                                               |  |                |        |         |   |        |  
|Accrued severance pay (Note 9)                                                                                                                      |  |                | 2,532  |         |   | 3,268  |  
|                                                                                                                                                    |  |                |        |         |   |        |  
|                                                                                                                                                    |  |                |        |         |   |        |  
|Minority interest                                                                                                                                   |  |                | 4      |         |   | -      |  
|                                                                                                                                                    |  |                |        |         |   |        |  
|                                                                                                                                                    |  |                |        |         |   |        |  
|Contingent liabilities and commitments (Note 10)                                                                                                    |  |                |        |         |   |        |  
|                                                                                                                                                    |  |                |        |         |   |        |  
|Shareholders equity                                                                                                                                |  |                |        |         |   |        |  
|Share capital (Note 11):                                                                                                                            |  |                |        |         |   |        |  
|Ordinary shares of NIS 0.10
  par value (Authorized - 19,950,000 shares, issued and outstanding - 8,001,270
  shares at December 31, 2005 and 2004) |  |                | 264    |         |   | 264    |  
|Additional paid-in capital                                                                                                                          |  |                | 13,417 |         |   | 13,417 |  
|Accumulated other comprehensive loss:                                                                                                               |  |                |        |         |   |        |  
|Foreign currency translation adjustments                                                                                                            |  |                | (478   | )       |   | (299   | )
|Unrealized loss on available for-sale
securities                                                                                                    |  |                | (202   | )       |   | (266   | )
|Unrealized gain on derivative instruments                                                                                                           |  |                | (158   | )       |   | -      |  
|Accumulated deficit                                                                                                                                 |  |                | (4,702 | )       |   | (109   | )
|                                                                                                                                                    |  |                |        |         |   |        |  
|                                                                                                                                                    |  |                | 8,141  |         |   | 13,007 |  
|Treasury stock, at cost; 166,100 shares at December 31, 2005 and
2004                                                                               |  |                | (159   | )       |   | (159   | )
|                                                                                                                                                    |  |                |        |         |   |        |  
|Total shareholders equity                                                                                                                          |  |                | 7,982  |         |   | 12,848 |  
|                                                                                                                                                    |  |                |        |         |   |        |  
|                                                                                                                                                    |  |                |        |         |   |        |  
|Total liabilities and shareholders
equity                                                                                                          |  | $              | 16,442 |         | $ | 20,804 |  
|                                                                                                                                                    |  |                |        |         |   |        |  

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

F-3

---

---



CIMATRON LIMITED

CONSOLIDATED
STATEMENTS OF OPERATIONS(in thousands, except per share data)

|                                                                  |  |                         |        |         |   |         |   |   |        |  
|----------------------------------------------------------------- |  | ----------------------- | ------ | ------- | - | ------- | - | - | ------ | -
|                                                                  |  | Year ended December 31, |       
|                                                                  |  |                         |       
|                                                                  |  | 2 0 0 5                 |        | 2 0 0 4 |   | 2 0 0 3 |  
|                                                                  |  |                         |        |         |   |         |  
|Revenues (Note 14a):                                              |  |                         |        |         |   |         |   |   |        |  
|Products                                                          |  | $                       | 8,968  |         | $ | 11,370  |   | $ | 10,448 |  
|Services                                                          |  |                         | 11,957 |         |   | 11,793  |   |   | 11,161 |  
|                                                                  |  |                         |        |         |   |         |   |   |        |  
|Total                                                             |  |                         | 20,925 |         |   | 23,163  |   |   | 21,609 |  
|                                                                  |  |                         |        |         |   |         |   |   |        |  
|                                                                  |  |                         |        |         |   |         |   |   |        |  
|Cost of revenues (Note 14b):                                      |  |                         |        |         |   |         |   |   |        |  
|Products                                                          |  |                         | 3,367  |         |   | 2,923   |   |   | 3,056  |  
|Services                                                          |  |                         | 1,568  |         |   | 1,678   |   |   | 1,562  |  
|                                                                  |  |                         |        |         |   |         |   |   |        |  
|Total                                                             |  |                         | 4,935  |         |   | 4,601   |   |   | 4,618  |  
|                                                                  |  |                         |        |         |   |         |   |   |        |  
|                                                                  |  |                         |        |         |   |         |   |   |        |  
|Gross
  profit                                                    |  |                         | 15,990 |         |   | 18,562  |   |   | 16,991 |  
|                                                                  |  |                         |        |         |   |         |   |   |        |  
|Research and development expenses, net                            |  |                         | 4,815  |         |   | 5,554   |   |   | 5,210  |  
|Selling, general and administrative expenses (Note 14c)           |  |                         | 15,650 |         |   | 13,962  |   |   | 12,645 |  
|                                                                  |  |                         |        |         |   |         |   |   |        |  
|                                                                  |  |                         |        |         |   |         |   |   |        |  
|Operating
  loss                                                  |  |                         | (4,475 | )       |   | (954    | ) |   | (864   | )
|                                                                  |  |                         |        |         |   |         |   |   |        |  
|Financial income (expenses), net                                  |  |                         | (148   | )       |   | 445     |   |   | 369    |  
|Other income                                                      |  |                         | 1      |         |   | 144     |   |   | 203    |  
|                                                                  |  |                         |        |         |   |         |   |   |        |  
|                                                                  |  |                         |        |         |   |         |   |   |        |  
|Loss
  before income taxes                                        |  |                         | (4,622 | )       |   | (365    | ) |   | (292   | )
|                                                                  |  |                         |        |         |   |         |   |   |        |  
|Income taxes (Note 12)                                            |  |                         | (2     | )       |   | (23     | ) |   | (9     | )
|                                                                  |  |                         |        |         |   |         |   |   |        |  
|                                                                  |  |                         |        |         |   |         |   |   |        |  
|Loss
  after income taxes                                         |  |                         | (4,624 | )       |   | (388    | ) |   | (301   | )
|                                                                  |  |                         |        |         |   |         |   |   |        |  
|Companys equity in results of affiliated company                 |  |                         | (5     | )       |   | -       |   |   | -      |  
|                                                                  |  |                         |        |         |   |         |   |   |        |  
|Minority interest in results of subsidiary                        |  |                         | 36     |         |   | -       |   |   | -      |  
|                                                                  |  |                         |        |         |   |         |   |   |        |  
|                                                                  |  |                         |        |         |   |         |   |   |        |  
|Net
  loss                                                        |  | $                       | (4,593 | )       | $ | (388    | ) | $ | (301   | )
|                                                                  |  |                         |        |         |   |         |   |   |        |  
|                                                                  |  |                         |        |         |   |         |   |   |        |  
|Net loss per share (basic and diluted)                            |  | $                       | (0.59  | )       | $ | (0.05   | ) | $ | (0.04  | )
|                                                                  |  |                         |        |         |   |         |   |   |        |  
|                                                                  |  |                         |        |         |   |         |   |   |        |  
|Weighted average number of shares outstanding (basic and
diluted) |  |                         | 7,835  |         |   | 7,835   |   |   | 7,838  |  
|                                                                  |  |                         |        |         |   |         |   |   |        |  

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

F-4

---

---



CIMATRON LIMITED

STATEMENTS
OF SHAREHOLDERS EQUITY AND COMPREHENSIVE INCOME (LOSS)
(in thousands)

|                                                 |  |                 |     |                                |   |                                                     |  |                                               |      |                  |   |                               |   |                                |      |   |   |        |   |   |        |  
|------------------------------------------------ |  | --------------- | --- | ------------------------------ | - | --------------------------------------------------- |  | --------------------------------------------- | ---- | ---------------- | - | ----------------------------- | - | ------------------------------ | ---- | - | - | ------ | - | - | ------ | -
|                                                 |  | Share
  capital |     | Additional
  paid-in
  capital |   | Accumulated
  other
  comprehensive
  income (loss) |  | Retained
  earnings
  (accumulated
  deficit) |      | Treasury
  stock |   | Comprehensive
  income (loss) |   | Total
  shareholders
  equity |     
|                                                 |  |                 |     |                                |   |                                                     |  |                                               |      |                  |   |                               |   |                                |     
|Balance at January 1, 2003                       |  | $               | 264 |                                | $ | 13,417                                              |  | $                                             | 30   |                  | $ | 580                           |   | $                              | (132 | ) |   |        |   | $ | 14,159 |  
|Changes during the year ended December 31, 2003: |  |                 |     |                                |   |                                                     |  |                                               |      |                  |   |                               |   |                                |      |   |   |        |   |   |        |  
|Net loss                                         |  |                 |     |                                |   |                                                     |  |                                               |      |                  |   | (301                          | ) |                                |      |   |   | (301   | ) |   | (301   | )
|Unrealized loss on available-for-sale securities |  |                 |     |                                |   |                                                     |  |                                               | (97  | )                |   |                               |   |                                |      |   |   | (97    | ) |   | (97    | )
|Unrealized gain on derivative instruments        |  |                 |     |                                |   |                                                     |  |                                               | 120  |                  |   |                               |   |                                |      |   |   | 120    |   |   | 120    |  
|Foreign currency translation adjustment          |  |                 |     |                                |   |                                                     |  |                                               | (333 | )                |   |                               |   |                                |      |   |   | (333   | ) |   | (333   | )
|Investment in treasury stock                     |  |                 |     |                                |   |                                                     |  |                                               |      |                  |   |                               |   |                                | (27  | ) |   |        |   |   | (27    | )
|                                                 |  |                 |     |                                |   |                                                     |  |                                               |      |                  |   |                               |   |                                |      |   |   |        |   |   |        |  
|Total comprehensive loss                         |  |                 |     |                                |   |                                                     |  |                                               |      |                  |   |                               |   |                                |      |   | $ | (611   | ) |   |        |  
|                                                 |  |                 |     |                                |   |                                                     |  |                                               |      |                  |   |                               |   |                                |      |   |   |        |   |   |        |  
|Balance at December 31, 2003                     |  |                 | 264 |                                |   | 13,417                                              |  |                                               | (280 | )                |   | 279                           |   |                                | (159 | ) |   |        |   |   | 13,521 |  
|                                                 |  |                 |     |                                |   |                                                     |  |                                               |      |                  |   |                               |   |                                |      |   |   |        |   |   |        |  
|Changes during the year ended December 31, 2004: |  |                 |     |                                |   |                                                     |  |                                               |      |                  |   |                               |   |                                |      |   |   |        |   |   |        |  
|Net loss                                         |  |                 |     |                                |   |                                                     |  |                                               |      |                  |   | (388                          | ) |                                |      |   |   | (388   | ) |   | (388   | )
|Unrealized loss on available-for-sale securities |  |                 |     |                                |   |                                                     |  |                                               | (222 | )                |   |                               |   |                                |      |   |   | (222   | ) |   | (222   | )
|Unrealized loss on derivative instruments        |  |                 |     |                                |   |                                                     |  |                                               | (174 | )                |   |                               |   |                                |      |   |   | (174   | ) |   | (174   | )
|Foreign currency translation adjustment          |  |                 |     |                                |   |                                                     |  |                                               | 111  |                  |   |                               |   |                                |      |   |   | 111    |   |   | 111    |  
|                                                 |  |                 |     |                                |   |                                                     |  |                                               |      |                  |   |                               |   |                                |      |   |   |        |   |   |        |  
|Total comprehensive loss                         |  |                 |     |                                |   |                                                     |  |                                               |      |                  |   |                               |   |                                |      |   | $ | (673   | ) |   |        |  
|                                                 |  |                 |     |                                |   |                                                     |  |                                               |      |                  |   |                               |   |                                |      |   |   |        |   |   |        |  
|Balance at December 31, 2004                     |  |                 | 264 |                                |   | 13,417                                              |  |                                               | (565 | )                |   | (109                          | ) |                                | (159 | ) |   |        |   |   | 12,848 |  
|                                                 |  |                 |     |                                |   |                                                     |  |                                               |      |                  |   |                               |   |                                |      |   |   |        |   |   |        |  
|Changes during the year ended December 31, 2005: |  |                 |     |                                |   |                                                     |  |                                               |      |                  |   |                               |   |                                |      |   |   |        |   |   |        |  
|Net loss                                         |  |                 |     |                                |   |                                                     |  |                                               |      |                  |   | (4,593                        | ) |                                |      |   |   | (4,593 | ) |   | (4,593 | )
|Unrealized loss on available-for-sale securities |  |                 |     |                                |   |                                                     |  |                                               | 64   |                  |   |                               |   |                                |      |   |   | 64     |   |   | 64     |  
|Unrealized loss on derivative instruments        |  |                 |     |                                |   |                                                     |  |                                               | (158 | )                |   |                               |   |                                |      |   |   | (158   | ) |   | (158   | )
|Foreign currency translation adjustment          |  |                 |     |                                |   |                                                     |  |                                               | (179 | )                |   |                               |   |                                |      |   |   | (179   | ) |   | (179   | )
|                                                 |  |                 |     |                                |   |                                                     |  |                                               |      |                  |   |                               |   |                                |      |   |   |        |   |   |        |  
|Total comprehensive loss                         |  |                 |     |                                |   |                                                     |  |                                               |      |                  |   |                               |   |                                |      |   | $ | (4,866 | ) |   |        |  
|                                                 |  |                 |     |                                |   |                                                     |  |                                               |      |                  |   |                               |   |                                |      |   |   |        |   |   |        |  
|Balance at December 31, 2005                     |  | $               | 264 |                                | $ | 13,417                                              |  | $                                             | (838 | )                | $ | (4,702                        | ) | $                              | (159 | ) |   |        |   | $ | 7,982  |  
|                                                 |  |                 |     |                                |   |                                                     |  |                                               |      |                  |   |                               |   |                                |      |   |   |        |   |   |        |  

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

F-5

---

---



CIMATRON LIMITED

CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

|                                                                                            |  |                         |        |         |   |         |   |   |        |  
|------------------------------------------------------------------------------------------- |  | ----------------------- | ------ | ------- | - | ------- | - | - | ------ | -
|                                                                                            |  | Year ended December 31, |       
|                                                                                            |  |                         |       
|                                                                                            |  | 2 0 0 5                 |        | 2 0 0 4 |   | 2 0 0 3 |  
|                                                                                            |  |                         |        |         |   |         |  
|                                                                                            |  |                         |        |         |   |         |   |   |        |  
|CASH FLOWS - OPERATING ACTIVITIES                                                           |  |                         |        |         |   |         |   |   |        |  
|                                                                                            |  |                         |        |         |   |         |   |   |        |  
|Net loss                                                                                    |  | $                       | (4,593 | )       | $ | (388    | ) | $ | (301   | )
|                                                                                            |  |                         |        |         |   |         |   |   |        |  
|Adjustments to reconcile net loss to net cash
  provided by (used in) operating activities: |  |                         |        |         |   |         |   |   |        |  
|Depreciation and amortization                                                               |  |                         | 1,676  |         |   | 820     |   |   | 859    |  
|Increase (decrease) in accrued severance
pay                                                |  |                         | (736   | )       |   | (179    | ) |   | 473    |  
|Gain from sale of property and equipment,
net                                               |  |                         | (13    | )       |   | (71     | ) |   | (2     | )
|Loss (gain) from sale and devaluation (revaluation)
of bonds and
  funds                    |  |                         | 284    |         |   | (2      | ) |   | 58     |  
|Companys equity in results of affiliated
company                                           |  |                         | 5      |         |   | -       |   |   | -      |  
|Minority interest in results of
subsidiary                                                  |  |                         | (36    | )       |   | -       |   |   | -      |  
|                                                                                            |  |                         |        |         |   |         |   |   |        |  
|Changes in assets and liabilities:                                                          |  |                         |        |         |   |         |   |   |        |  
|Decrease (increase) in accounts receivable and
prepaid expenses                             |  |                         | 1,354  |         |   | (416    | ) |   | 855    |  
|Decrease (increase) in inventory                                                            |  |                         | (11    | )       |   | 13      |   |   | 19     |  
|Decrease (increase) in deposits with insurance
companies and
  severance pay fund           |  |                         | 727    |         |   | 99      |   |   | (407   | )
|Increase in debts to related parties                                                        |  |                         | 205    |         |   | 2       |   |   | 13     |  
|Increase (decrease) in trade payables, accrued
expenses and other
  liabilities             |  |                         | 935    |         |   | (797    | ) |   | (115   | )
|                                                                                            |  |                         |        |         |   |         |   |   |        |  
|Net cash provided by (used in) operating
activities                                         |  |                         | (203   | )       |   | (919    | ) |   | 1,452  |  
|                                                                                            |  |                         |        |         |   |         |   |   |        |  
|                                                                                            |  |                         |        |         |   |         |   |   |        |  
|CASH FLOWS - INVESTING ACTIVITIES                                                           |  |                         |        |         |   |         |   |   |        |  
|Investment in bonds                                                                         |  |                         | (250   | )       |   | (577    | ) |   | (3,138 | )
|Proceeds from sale and redemption of
bonds                                                  |  |                         | 2,935  |         |   | 334     |   |   | 642    |  
|Purchase of property and equipment                                                          |  |                         | (429   | )       |   | (505    | ) |   | (538   | )
|Proceeds from sale of property and
equipment                                                |  |                         | 27     |         |   | 221     |   |   | 44     |  
|Acquisition of affiliated companies                                                         |  |                         | (891   | )       |   | -       |   |   | 43     |  
|Capitalization of software development
costs                                                |  |                         | (193   | )       |   | -       |   |   | -      |  
|Acquisition of newly consolidated
subsidiary                                                |  |                         | 40     |         |   | -       |   |   | -      |  
|                                                                                            |  |                         |        |         |   |         |   |   |        |  
|Net cash provided by (used in) investing
activities                                         |  |                         | 1,239  |         |   | (527    | ) |   | (2,947 | )
|                                                                                            |  |                         |        |         |   |         |   |   |        |  
|                                                                                            |  |                         |        |         |   |         |   |   |        |  
|CASH FLOWS - FINANCING ACTIVITIES                                                           |  |                         |        |         |   |         |   |   |        |  
|Short-term bank credit                                                                      |  |                         | -      |         |   | -       |   |   | 500    |  
|Investment in treasury stock                                                                |  |                         | -      |         |   | -       |   |   | (27    | )
|                                                                                            |  |                         |        |         |   |         |   |   |        |  
|Net cash provided by financing
activities                                                   |  |                         | -      |         |   | -       |   |   | 473    |  
|                                                                                            |  |                         |        |         |   |         |   |   |        |  
|                                                                                            |  |                         |        |         |   |         |   |   |        |  
|Net increase (decrease) in cash and cash equivalents                                        |  |                         | 1,036  |         |   | (1,446  | ) |   | (1,022 | )
|Effect of exchange rate changes on cash                                                     |  |                         | (39    | )       |   | 33      |   |   | 69     |  
|Cash and cash equivalents at beginning of year                                              |  |                         | 1,711  |         |   | 3,124   |   |   | 4,077  |  
|                                                                                            |  |                         |        |         |   |         |   |   |        |  
|Cash and cash equivalents at end of year                                                    |  | $                       | 2,708  |         | $ | 1,711   |   | $ | 3,124  |  
|                                                                                            |  |                         |        |         |   |         |   |   |        |  
|                                                                                            |  |                         |        |         |   |         |   |   |        |  
|Supplemental information:                                                                   |  |                         |        |         |   |         |   |   |        |  
|Cash paid during the year for income taxes                                                  |  | $                       | 29     |         | $ | 173     |   | $ | 25     |  
|                                                                                            |  |                         |        |         |   |         |   |   |        |  
|                                                                                            |  |                         |        |         |   |         |   |   |        |  
|Appendix A - Non-cash transactions                                                          |  |                         |        |         |   |         |   |   |        |  
|                                                                                            |  |                         |        |         |   |         |   |   |        |  
|Purchase of property on credit                                                              |  | $                       | 36     |         | $ | 38      |   | $ | 28     |  
|                                                                                            |  |                         |        |         |   |         |   |   |        |  

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

F-6

---

---



CIMATRON LIMITED

NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)

|              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE
  1     | GENERAL                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|              | Cimatron Limited (the
  Company) designs, develops, manufactures, markets and supports a family of
  modular CAD/CAM software products which offer integrated
  design-through-manufacturing solutions for small to medium-sized companies.
  The Companys products have been sold to end-users in numerous industries,
  including automotive, aviation and aerospace, household goods, mold and die
  making, machinery and tools, and telecommunications. The Company markets its
  line of products through distributors and through its subsidiaries located in
  different countries.
|              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|NOTE 2       | SIGNIFICANT
  ACCOUNTING POLICIES                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|              | The financial statements
  are prepared in conformity with U.S. generally accepted accounting principles
  (GAAP).                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|              | A.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             | Useof estimates in
  preparation of financial statements                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                | The preparation of
  financial statements in conformity with GAAP requires management to make
  estimates and assumptions in determining the reported amounts of assets and
  liabilities and disclosure of contingent assets and liabilities at the date
  of the financial statements and the reported amounts of revenues and expenses
  during the reporting period. Actual results could differ from those
  estimates.                                                                                                                                                                                                                                  
|              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|              | B.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             | Financial
  statements in U.S. dollars                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                | The reporting currency of
  the Company is the U.S. dollar (dollar).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                | The dollar is the
  functional currency of the Company and its subsidiaries in the United States
  and Canada. Transactions and balances originally denominated in dollars are
  presented at their original amounts. Non-dollar transactions and balances are
  remeasured into dollars in accordance with the principles set forth in Statement
  of Financial Accounting Standards (SFAS) No. 52 Foreign Currency
  Translation (SFAS No. 52). All exchange gains and losses from
  remeasurement of monetary balance sheet items resulting from transactions in
  non-dollar currencies are recorded in the statement of operations as they
  arise.
|              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                | The financial statements
  of certain subsidiaries whose functional currency is other than the dollar
  are translated into dollars in accordance with the principles set forth in
  SFAS No. 52. Assets and liabilities have been translated at year-end exchange
  rates; results of operations have been translated at average exchange rates.
  The translation adjustments have been reported as a separate component of
  shareholders equity.                                                                                                                                                                                                         
|              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|              | C.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             | Principles
  of consolidation                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                | The consolidated financial
  statements include the financial statements of the Company and all of its
  subsidiaries. All significant intercompany transactions and balances have
  been eliminated in consolidation.                                                                                                                                                                                                                                                                                                                                                                                                                                        
|              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|              | D.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             | Cash and
  cash equivalents                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                | Cash equivalents consist
  of short-term, highly liquid investments that are readily convertible into
  cash with original maturities of three months or less.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                

F-7

---

---



CIMATRON LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS
(in thousands, except share and per share data)

|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|----------- | ----------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2     | SIGNIFICANT
  ACCOUNTING POLICIES (Cont.)
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            | E.                                        | Marketable
  debt securities                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            |                                           | The
  Company accounts for its investments in marketable securities in accordance
  with SFAS No. 115, Accounting for Certain Investments in Debt and Equity
  Securities (SFAS 115).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            |                                           | Management
  determines the appropriate classification of the Companys investments in
  marketable debt securities at the time of purchase and reevaluates such
  determinations at each balance sheet date. Debt securities for which the
  Company does not have the intent or ability to hold to maturity are
  classified as available-for-sale.                                                                                                                                                                                                                                                                                                                                                                                
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            |                                           | As of
  December 31, 2005 and 2004 all marketable debt securities are designated as
  available-for-sale and accordingly are stated at fair value, with the
  unrealized gains and losses reported in shareholders equity under
  accumulated other comprehensive income (loss). Realized gains and losses on
  sales of investments, as determined on a specific identification basis, are
  included in the consolidated statement of operations.                                                                                                                                                                                                                                                                                 
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            | F.                                        | Fair
  value of financial instruments                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            |                                           | The
  financial instruments of the Company consist mainly of cash and cash
  equivalents, short-term investments, current and non-current accounts
  receivable, accounts payable and long-term liabilities. In view of their
  nature, the fair value of the financial instruments included in working
  capital of the Company is usually identical or close to their carrying
  amounts.                                                                                                                                                                                                                                                                                                                                          
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            | G.                                        | Concentrations
  on credit risk                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            |                                           | Financial instruments
  which potentially subject the Company to concentration of credit risk consist
  principally of cash and cash equivalents, and accounts receivable. The
  Companys cash and cash equivalents are invested primarily in deposits with
  major banks worldwide. Management believes that the financial institutions
  that hold the Companys investments are financially sound, and accordingly,
  minimal credit risk exists with respect to these investments. The Companys
  trade receivables are derived from sales to customers located primarily in
  the U.S., Europe, Asia and Israel. The allowance for doubtful accounts is
  provided with respect to all balances deemed doubtful of collection.
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            | H.                                        | Allowance
  for doubtful accounts                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            |                                           | The allowance for doubtful
  accounts is computed on the specific identification basis for accounts, the
  collection of which, in managements estimation, is doubtful.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            | I.                                        | Inventory                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            |                                           | Inventory is presented at
  the lower of cost or market. Cost is determined by the first in, first out
  method.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   

F-8

---

---



CIMATRON LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS
(in thousands, except share and per share data)

|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |            |       | 
|----------- | ----------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ---------- | ----- | 
|NOTE 2     | SIGNIFICANT
  ACCOUNTING POLICIES (Cont.)
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            | J.                                        | Property
  and equipment                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                                           | Property and equipment are
  stated at cost. Depreciation is computed using the straight-line method,
  over the estimated useful life of assets, as follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                                           | Computers and software                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   | 3          | years | 
|            |                                           | Furniture and office
  equipment                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         | 6.5 - 16.5 | years | 
|            |                                           | Vehicles                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 | 6.5        | years | 
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                                           | Leasehold improvements are
  amortized over the shorter of the life of the respective lease or the service
  life of the improvements.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            | K.                                        | Impairment
  of long-lived assets                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                                           | The Company regularly
  reviews whether facts and circumstances exist which indicate that the
  carrying amount of assets may not be recoverable. The Company assesses the
  recoverability of the carrying amount of its long-lived assets based on
  expected undiscounted cash flows. If an assets carrying amount is determined
  to be not recoverable, the Company recognizes an impairment loss based upon
  the difference between the carrying amount and the fair value of such assets,
  in accordance with SFAS No. 144 Accounting for the Impairment or Disposal of
  Long-Lived Assets (SFAS No. 144).                                                                                                               
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            | L.                                        | Software
  development costs                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                                           | The Company capitalized
  certain software development costs in accordance with SFAS No. 86 Accounting
  for Costs of Computer Software to be Sold, Leased or Otherwise Marketed.
  Capitalization of software development costs begins upon the establishment of
  technological feasibility and continues up to the time the software is
  available for general release to customers, at which time capitalized
  software costs are amortized to product development expenses on the straight-line
  basis over the expected life of the related product which is greater than the
  ratio that current gross revenues for a product bear to the total of current
  and anticipated future gross revenues, generally five years.
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                                           | Management periodically
  reviews the carrying amount of capitalized software development costs, and if
  impairment is determined to have occurred, the Company writes off the
  respective carrying amount to expenses. Management believes that future
  revenues related to capitalized software development costs will be sufficient
  to realize the carrying amounts of such costs at December 31, 2005 and, as
  such, these amounts will be recovered over the lives of the related projects.
  The estimates of anticipated future revenues and remaining useful life of the
  Companys products are subject to risk inherent in the software industry,
  such as changes in technology and customer perceptions.            

F-9

---

---



CIMATRON LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS
(in thousands, except share and per share data)

|              |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|------------- | ----------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE
  2     | SIGNIFICANT
  ACCOUNTING POLICIES (Cont.)
|              |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|              | M.                                        | Stock-based
  -Compensation                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|              |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|              |                                           | The
  Company accounts for employee stock-based compensation in accordance with
  Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
  Employees (APB No. 25) and in accordance with FASB Interpretation No. 44.
  Pursuant to these accounting pronouncements, the Company records compensation
  for stock options granted to employees over the vesting period of the options
  based on the difference, if any, between the exercise price of the options
  and the market price of the underlying shares at the date of grant.
|              |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|              |                                           | Deferred
  compensation is amortized to compensation expense over the vesting period of
  the options.                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|              |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|              |                                           | Had compensation cost for
  the Companys option plans been determined on the basis of the fair value at
  the grant dates in accordance with
  the provisions of SFAS No. 123 Accounting for Stock-Based Compensation, as
  amended by SFAS No. 148 Accounting for Stock-Based compensation (SFAS No.
  148), the Companys pro forma net loss and pro forma basic and diluted net
  loss per share would have been as follows:                                                                                                                         

| |                                                           |  |                         |        |         |   |         |   |   |       |  
| | --------------------------------------------------------- |  | ----------------------- | ------ | ------- | - | ------- | - | - | ----- | -
| |                                                           |  | Year ended December 31, |       
| |                                                           |  |                         |       
| |                                                           |  | 2 0 0 5                 |        | 2 0 0 4 |   | 2 0 0 3 |  
| |                                                           |  |                         |        |         |   |         |  
| | Pro forma net loss:                                       |  |                         |        |         |   |         |   |   |       |  
| | Net loss for the year, as reported                        |  | $                       | (4,593 | )       | $ | (388    | ) | $ | (301  | )
| | Deduct - stock-based compensation determined under APB 25 |  |                         | -      |         |   | -       |   |   | -     |  
| | Add - stock-based compensation determined under SFAS 123  |  |                         | (77    | )       |   | (70     | ) |   | (90   | )
| |                                                           |  |                         |        |         |   |         |   |   |       |  
| |                                                           |  | $                       | (4,670 | )       | $ | (458    | ) | $ | (391  | )
| |                                                           |  |                         |        |         |   |         |   |   |       |  
| |                                                           |  |                         |        |         |   |         |   |   |       |  
| | Pro forma basic and diluted loss per
  share:             |  |                         |        |         |   |         |   |   |       |  
| | As reported                                               |  | $                       | (0.59  | )       | $ | (0.05   | ) | $ | (0.04 | )
| |                                                           |  |                         |        |         |   |         |   |   |       |  
| |                                                           |  |                         |        |         |   |         |   |   |       |  
| | Pro forma                                                 |  | $                       | (0.60  | )       | $ | (0.06   | ) | $ | (0.05 | )
| |                                                           |  |                         |        |         |   |         |   |   |       |  

F-10

---

---



CIMATRON LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS
(in thousands, except share and per share data)

|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|----------- | ----------------------------------------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2     | SIGNIFICANT
  ACCOUNTING POLICIES (Cont.)
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            | M.                                        | Stock-based
  compensation (Cont.)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                           | Datain respect of the
  stock option plans                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                           | For
  purposes of estimating fair value in accordance with SFAS No. 123, the
  Company utilized the Black-Scholes option-pricing model. The following
  assumptions were used for grants in 2003 and 2005, respectively: a dividend
  yield of 0.0% for both years ; weighted average expected volatility of 96%
  and 51%; weighted average risk-free interest rates of 3.3% and 3.5%; and
  weighted average expected lives of 4 years and 6 years. No grants were made
  in 2004.                                                                                                                                                                                                                                                                                               
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                           | Because
  additional option grants are expected to be made each year, and due to the
  factors described above, the above proforma disclosures are not necessarily
  representative of proforma effects of reported net income for future years.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            | N.                                        | Revenue
  recognition                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                           | The Company recognizes revenues
  in accordance with the American Institute of Certified Public Accountants
  (AICPA) Statement of Position 97-2, Software Revenue Recognition, as
  amended.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                           | Revenues from software
  license fees are recognized when persuasive evidence of an arrangement
  exists, the software product covered by written agreement or a purchase order
  signed by the customer has been delivered, the license fees are fixed and
  determinable and collection of the license fees is considered probable. When software arrangements involve multiple
  elements the Company allocates revenue to each element based on the relative
  fair values of the elements. The Companys determination of fair value of
  each element in multiple element arrangements is based on vendor-specific
  objective evidence (VSOE). The Company limits its assessment of VSOE for
  each element to the price charged when the same element is sold separately.
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                           | Service revenues include
  consulting services, post-contract customer support and training. Consulting
  revenues are generally recognized on a time and material basis. Software
  maintenance agreements provide technical customer support and the right to
  unspecified upgrades on an if-and-when-available basis. Post-contract
  customer support revenues are recognized ratably over the term of the support
  period (generally one year) and training and other service revenues are
  recognized as the related services are provided. Deferred revenues represent
  mainly amounts received on account of service agreements.                                                                                                                                       
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                           | The
  Company has no significant expenditures relating to either warranties or
  post-contract customer support bundled with the initial sale of the software
  license and, therefore, no provision in respect thereof is included in the
  financial statements.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                           | The
  Companys sales are made pursuant to standard purchase orders, containing
  payment terms ranging between 30 - 120 days. For some customers with whom the
  Company has long-standing relationships and based on past experience with
  those customers and the same software products, the Company may grant payment
  terms of not over 180 days. Any payment terms that are above 180 days must be
  approved by the Companys Chief Financial Officer, prior to signing any
  purchase order.                                                                                                                                                                                                                                                                            

F-11

---

---



CIMATRON LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS
(in thousands, except share and per share data)

|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|----------- | ----------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2     | SIGNIFICANT
  ACCOUNTING POLICIES (Cont.)
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            | N.                                        | Revenue
  recognition (Cont.)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                                           | The
  Companys arrangements do not include any refund provisions nor are payments
  subject to milestones. In addition, the Companys arrangements do not contain
  customer acceptance provisions.                                                                                                                                                                                                                                                                                                                                                                                                                                
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            | O.                                        | Research
  and development costs                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                                           | Research
  and development costs are expensed as incurred.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            | P.                                        | Advertising
  costs                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                                           | Advertising
  costs are charged to expenses, as incurred.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            | Q.                                        | Deferred
  income taxes                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                                           | Deferred
  income taxes are provided for temporary differences between the assets and
  liabilities, as measured in the financial statements and for tax purposes, at
  the tax rates expected to be in effect when these differences reverse, in
  accordance with SFAS No. 109 Accounting for Income Taxes (SFAS No. 109).                                                                                                                                                                                                                                                                                                    
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            | R.                                        | Net loss
  per ordinary share                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                                           | Basic
  and diluted net loss per share have been computed in accordance with SFAS No.
  128 Earning per Share using the weighted average number of ordinary shares
  outstanding. Basic loss per share excludes any dilutive effect of options and
  warrants. A total of 0, 12,000 and 3,000 incremental shares were excluded
  from the calculation of diluted net loss per ordinary share for 2005, 2004
  and 2003, respectively due to the anti-dilutive effect.                                                                                                                                                             
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            | S.                                        | Derivative
  financial instruments                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                                           | The
  Companys primary objective for holding derivative financial instruments is
  to manage mainly currency market risks. The Company transacts business in
  various currencies other than the U.S. dollar, primarily the Euro and NIS.
  The Company has established forecasted transaction risk management programs
  to protect against volatility of future cash flows caused by changes in
  exchange rates. It uses currency forward contracts and currency options in
  these risk management programs. These programs reduce, but do not always
  entirely eliminate, the impact of currency exchange movements.         
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                                           | In
  accordance with SFAS No. 133, Accounting for Derivative Instruments and
  Hedging Activities, as amended, the Company recognizes all derivative
  instruments as either assets or liabilities on the balance sheet at fair
  value. Fair values of currency forward contracts and currency options are
  based on quoted market prices or pricing models using current market rates.
  The accounting for gains or losses from changes in fair value of a derivative
  instrument depends on whether it has been designated and qualifies as part of
  a hedging relationship as well as on the type of hedging relationship.

F-12

---

---



CIMATRON LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS
(in thousands, except share and per share data)

|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|----------- | ----------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2     | SIGNIFICANT
  ACCOUNTING POLICIES (Cont.)
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            | S.                                        | Derivative
  financial instruments (Cont.)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                                           | The
  Companys accounting policies for these instruments are based on whether they
  meet the criteria for designation as hedging transactions, either as cash
  flow or fair value hedges. The criteria for designating a derivative as a
  hedge include the instruments effectiveness in risk reduction and one-to-one
  matching for the derivative instrument to its underlying transaction. Gains
  and losses on derivatives that are not designated as hedges for accounting
  purposes are recognized currently in earnings, and generally offset changes
  in the value of assets and liabilities.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                                           | The
  Companys outstanding derivative instruments as of the balance sheet date are
  included in other receivables and other accrued liabilities.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                                           | Currency
  forward contracts and currency options, which generally expire within 12
  months and are used to hedge exposures to variability in expected future
  foreign-denominated cash flows, are designated as cash flows hedges. For
  these derivatives, the effective portion of the gain or loss is reported as a
  component of other comprehensive income in shareholders equity and is
  reclassified into earnings in the same period or periods during which the
  hedged transaction affects earnings, and within the same income statement
  line item.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                                           | The
  ineffective portion of the gain or loss on the derivative in excess of the
  cumulative change in the present or future cash flows of the hedged item, if
  any, is recognized in financial income (expenses) net during the period of
  change.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                                           | The
  carrying amount of foreign currency forward contracts and foreign currency
  options outstanding at December 31, 2005 and 2004 is $154 and $154,
  respectively. As of the balance sheet dates, the fair value of these contracts
  approximates their carrying amount.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            | T.                                        | Recently
  issued accounting pronouncements                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                                           | In
  December 2004, the Financial Accounting Standards Board (FASB) issued
  SFAS No. 123(R). SFAS No. 123(R) requires employee
  share-based equity awards to be accounted for under the fair value method,
  and eliminates the ability to account for these instruments under the
  intrinsic value method prescribed by APB Opinion No. 25 and allowed
  under the original provisions of SFAS No. 123. SFAS No. 123(R)
  requires the use of an option pricing model for estimating fair value, which
  is then amortized to expense over the service periods. Had the Company
  adopted SFAS 123(R) in prior periods, the impact of that standard would have
  approximated the impact of SFAS 123 as described in the disclosure of pro
  forma net income and income per share above. SFAS No. 123(R) allows
  for either prospective recognition of compensation expense or retrospective
  recognition. In the first quarter of 2006, the Company began to apply the
  prospective recognition method and implemented the provisions of SFAS
  No. 123(R). In January 2005, the SEC issued SAB No. 107, which provides
  supplemental implementation guidance for SFAS No. 123(R). SFAS No. 123(R)
  will be effective for the Company beginning in the first quarter of fiscal
  2006.

F-13

---

---



CIMATRON LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS
(in thousands, except share and per share data)

|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|----------- | ----------------------------------------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2     | SIGNIFICANT
  ACCOUNTING POLICIES (Cont.)
|            |                                          
|            | T.                                        | Recently
  issued accounting pronouncements                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                                           | In
  May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error
  Corrections. SFAS No. 154 replaces APB Opinion No. 20. Accounting
  Changes and SFAS No. 3, Reporting Accounting Changes in Interim
  Financial Statements. SFAS No. 154 requires retrospective application
  to prior periods financial statements of changes in accounting principle,
  unless it is impracticable to determine either the period-specific effects or
  the cumulative effect of the change. The Company does not expect the adoption
  of SFAS No. 154 will have any material impact on its consolidated
  financial statements.                                                                                                                                                                                                                                                                                                                                                                                                                           
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                                           | In
  November 2005, the FASB issued FSP FAS 115-1 and FAS 124-1,
  The Meaning of Other-Than-Temporary Impairment and Its Application to
  Certain Investments (FSP 115-1 and 124-1), which clarifies when an
  investment is considered impaired, whether the impairment is other than
  temporary, and the measurement of an impairment loss. It also includes
  accounting considerations subsequent to the recognition of an
  other-than-temporary impairment and requires certain disclosures about
  unrealized losses that have not been recognized as other-than-temporary
  impairments. FSP 115-1 and 124-1 are effective for all reporting periods
  beginning after December 15, 2005. At December 31, 2005, the
  Company had no unrealized investment losses that had not been recognized as
  other-than-temporary impairments in its available-for-sale securities. The
  Company does not anticipate that the implementation of these pronouncements
  will have a significant impact on its financial position or results of
  operations.
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|NOTE 3     | SHORT-TERM
  AND LONG-TERM INVESTMENTS   
|            |                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            | A.                                        | Short-term
  investments                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         

| |                                           |  |              |       |         |   |       | 
| | ----------------------------------------- |  | ------------ | ----- | ------- | - | ----- | 
| |                                           |  | December 31, |      
| |                                           |  |              |      
| |                                           |  | 2 0 0 5      |       | 2 0 0 4 |  
| |                                           |  |              |       |         |  
| | Comprised as follows:                     |  |              |       |         |   |       | 
| | Marketable securities -
  Corporate bonds |  | $            | 2,167 |         | $ | 6,381 | 
| |                                           |  |              |       |         |   |       | 

| |    |                        
| | -- | -----------------------
| | B. | Long-term
  investments

| |                                               |  |              |       |         |   |   | 
| | --------------------------------------------- |  | ------------ | ----- | ------- | - | - | 
| |                                               |  | December 31, |      
| |                                               |  |              |      
| |                                               |  | 2 0 0 5      |       | 2 0 0 4 |  
| |                                               |  |              |       |         |  
| | Comprised as follows:                         |  |              |       |         |   |   | 
| | Marketable securities -
  Corporate bonds (1) |  | $            | 1,309 |         | $ | - | 
| |                                               |  |              |       |         |   |   | 
| | Investment in affiliated
  companies:         |  |              |       |         |   |   | 
| | Microsystem Srl (2)                           |  |              | 870   |         |   | - | 
| | Other                                         |  |              | 16    |         |   | - | 
| |                                               |  |              |       |         |   |   | 
| |                                               |  |              | 886   |         |   | - | 
| |                                               |  |              |       |         |   |   | 
| |                                               |  | $            | 2,195 |         | $ | - | 
| |                                               |  |              |       |         |   |   | 

F-14

---

---



CIMATRON LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS
(in thousands, except share and per share data)

|            |                                                |                                 |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|----------- | ---------------------------------------------- | ------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 3     | SHORT-TERM
  AND LONG-TERM INVESTMENTS (Cont.)
|            |                                                |                                
|            | B.                                             | Long-term
  investments (Cont.)
|            |                                                |                                 |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|            |                                                | (1)                             | Comprised of structured
  bonds, which are debt instruments whose cash flows are linked to the movement
  in interest rates. The structured notes were issued by financial
  institutions. The notes typically contain embedded option components such as
  caps, calls, and floors. Contractual cash flows for principal from such
  structured notes can vary in timing throughout the life of the structured
  notes. Interest income resulting from investment in structured notes is
  accounted for based on the guidance provided in EITF No. 96-12, Recognition
  of Interest Income and Balance Sheet Classification of Structured Notes.
  Under this guidance the retrospective method is used for recognizing interest
  income.                                                                                                                                                                                                                                                                                                        
|            |                                                |                                 |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|            |                                                | (2)                             | In July 2005, the Company
  completed the acquisition of 27.5% of the share capital of Microsystem Srl,
  its Italian distributor, for a consideration of $694. The Company has an
  option (First Call Option) to acquire up to additional 23.5% of Microsystems
  share capital until June 30, 2007, for an additional consideration of
  approximately $600. If the Company exercises the First Call Option, it will
  have a second option (Second Call Option), at any time within a thirty days
  period (Second Exercise Period) starting at the expiration of twelve months
  from the exercise of the First Call Option to acquire up to the remaining 49%
  of Microsystems share capital, for an additional consideration of
  approximately $1,250. If the Company exercises the First Call Option, the
  then remaining other shareholders of Microsystem will have an option to sell
  to the Company at any time during the Second Exercise Period 49% of
  Microsystems share capital, for a consideration of approximately $1,250.
|            |                                                |                                 |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|            |                                                |                                 | The
  Companys investment in Microsystem is comprised as follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    

| |                                     |  |              |     |  
| | ----------------------------------- |  | ------------ | --- | -
| |                                     |  | December 31, |    
| |                                     |  |              |    
| |                                     |  | 2 0 0 5      |    
| |                                     |  |              |    
| |                                     |  |              |     |  
| | Cost (including related
  expenses) |  | $            | 878 |  
| | Equity in earnings                  |  |              | (5  | )
| | Translation adjustments             |  |              | 2   |  
| |                                     |  |              |     |  
| |                                     |  | $            | 870 |  
| |                                     |  |              |     |  

| |  |                                                                
| |  | ---------------------------------------------------------------
| |  | Aggregate maturities of
  marketable securities are as follows:

| |                |  |              |       | 
| | -------------- |  | ------------ | ----- | 
| |                |  | December 31, |      
| |                |  |              |      
| |                |  | 2 0 0 5      |      
| |                |  |              |      
| |                |  |              |       | 
| | Eight years    |  | $            | 1,068 | 
| | Thirteen years |  |              | 241   | 
| |                |  |              |       | 
| |                |  | $            | 1,309 | 
| |                |  |              |       | 

| |    |                                                                                                                                                                                      
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | C. | As of December 31, 2005
  and 2004 all the investments in marketable securities are classified in
  accordance with SFAS No. 115 as available-for-sale.                              
| |    | Unrealized gain (loss) on
  available-for-sale securities of $64 and $(222) for the year ended December
  31, 2005 and 2004, respectively, were recorded in other comprehensive loss.

F-15

---

---



CIMATRON LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS
(in thousands, except share and per share data)

|            |                             | 
|----------- | --------------------------- | 
|NOTE 4     | TRADE
  ACCOUNTS RECEIVABLE

| |                                          |  |              |        |         |   |        |  
| | ---------------------------------------- |  | ------------ | ------ | ------- | - | ------ | -
| |                                          |  | December 31, |       
| |                                          |  |              |       
| |                                          |  | 2 0 0 5      |        | 2 0 0 4 |  
| |                                          |  |              |        |         |  
| |                                          |  |              |        |         |   |        |  
| | Accounts receivable                      |  | $            | 6,235  |         | $ | 7,447  |  
| | Less - allowance for
  doubtful accounts |  |              | (1,694 | )       |   | (1,317 | )
| |                                          |  |              |        |         |   |        |  
| |                                          |  | $            | 4,541  |         | $ | 6,130  |  
| |                                          |  |              |        |         |   |        |  

|            |                                                 
|----------- | ------------------------------------------------
|NOTE 5     | OTHER
  ACCOUNTS RECEIVABLE AND PREPAID EXPENSES

| |                        |  |              |     |         |   |     | 
| | ---------------------- |  | ------------ | --- | ------- | - | --- | 
| |                        |  | December 31, |    
| |                        |  |              |    
| |                        |  | 2 0 0 5      |     | 2 0 0 4 |  
| |                        |  |              |     |         |  
| |                        |  |              |     |         |   |     | 
| | Prepaid expenses       |  |              | 241 |         |   | 346 | 
| | Derivative instruments |  |              | 5   |         |   | -   | 
| | Interest receivable    |  |              | 66  |         |   | 113 | 
| | Other                  |  |              | 462 |         |   | 253 | 
| |                        |  |              |     |         |   |     | 
| |                        |  | $            | 774 |         | $ | 712 | 
| |                        |  |              |     |         |   |     | 

|            |                         
|----------- | ------------------------
|NOTE 6     | PROPERTY
  AND EQUIPMENT

| |                                  |  |              |       |         |   |       | 
| | -------------------------------- |  | ------------ | ----- | ------- | - | ----- | 
| |                                  |  | December 31, |      
| |                                  |  |              |      
| |                                  |  | 2 0 0 5      |       | 2 0 0 4 |  
| |                                  |  |              |       |         |  
| | Cost:                            |  |              |       |         |   |       | 
| | Computers and software           |  | $            | 3,940 |         | $ | 3,965 | 
| | Office furniture and
  equipment |  |              | 926   |         |   | 961   | 
| | Vehicles                         |  |              | -     |         |   | 103   | 
| | Leasehold improvements           |  |              | 455   |         |   | 449   | 
| |                                  |  |              |       |         |   |       | 
| |                                  |  |              | 5,321 |         |   | 5,478 | 
| |                                  |  |              |       |         |   |       | 
| | Accumulated
  depreciation:      |  |              |       |         |   |       | 
| | Computers and software           |  |              | 3,373 |         |   | 3,395 | 
| | Office furniture and
  equipment |  |              | 660   |         |   | 688   | 
| | Vehicles                         |  |              | -     |         |   | 96    | 
| | Leasehold improvements           |  |              | 292   |         |   | 226   | 
| |                                  |  |              |       |         |   |       | 
| |                                  |  |              | 4,325 |         |   | 4,405 | 
| |                                  |  |              |       |         |   |       | 
| |                                  |  |              |       |         |   |       | 
| | Property
  and equipment, net    |  | $            | 996   |         | $ | 1,073 | 
| |                                  |  |              |       |         |   |       | 

F-16

---

---



CIMATRON LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)

|            |                                   | 
|----------- | --------------------------------- | 
|NOTE 7     | SOFTWARE
  DEVELOPMENT COSTS, NET

| |                                          |  |              |        |         |   |        |  
| | ---------------------------------------- |  | ------------ | ------ | ------- | - | ------ | -
| |                                          |  | December 31, |       
| |                                          |  |              |       
| |                                          |  | 2 0 0 5      |        | 2 0 0 4 |  
| |                                          |  |              |        |         |  
| |                                          |  |              |        |         |   |        |  
| | Capitalized software
  development costs |  | $            | 9,353  |         | $ | 9,160  |  
| | Government grants                        |  |              | (3,495 | )       |   | (3,495 | )
| | Accumulated amortization
  (*)           |  |              | (5,665 | )       |   | (4,461 | )
| |                                          |  |              |        |         |   |        |  
| |                                          |  | $            | 193    |         | $ | 1,204  |  
| |                                          |  |              |        |         |   |        |  

|            |                                          |                                                                                                                                                                                                                                                                                                                     
|----------- | ---------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|            | (*)                                      | All capitalized modules
  were amortized over six years. Beginning with 2006, all capitalized modules
  will be amortized over five years.                                                                                                                                                                          
|            |                                          |                                                                                                                                                                                                                                                                                                                     
|            |                                          | Amortization expenses for
  the years ended December 31, 2005, 2004 and 2003, were $401, $401 and $402,
  respectively, and were charged to operations.                                                                                                                                                             
|            |                                          |                                                                                                                                                                                                                                                                                                                     
|            |                                          | The Company released its
  newest version of Cimatron E (Version 7.0) (Cimatron E7) in August 2005.
  Cimatron E7 was developed on the basis of advanced technology and
  infrastructure that replaced the infrastructure of the older versions, and
  includes new elements that did not exist in older versions.
|            |                                          | During the fourth quarter
  of 2005 the Company evaluated its capitalized software costs and wrote off
  all the net balance of capitalized costs related to its older products in the
  amount of $803, and capitalized $193 of costs related to the development of
  Cimatron E7.                                 
|            |                                          |                                                                                                                                                                                                                                                                                                                     
|NOTE 8     | ACCRUED
  EXPENSES AND OTHER LIABILITIES

| |                                     |  |              |       |         |   |       | 
| | ----------------------------------- |  | ------------ | ----- | ------- | - | ----- | 
| |                                     |  | December 31, |      
| |                                     |  |              |      
| |                                     |  | 2 0 0 5      |       | 2 0 0 4 |  
| |                                     |  |              |       |         |  
| |                                     |  |              |       |         |   |       | 
| | Employees and related
  liabilities |  | $            | 1,951 |         | $ | 1,831 | 
| | Derivative instruments              |  |              | 158   |         |   | 154   | 
| | Accrued expenses                    |  |              | 994   |         |   | 623   | 
| | Accrued royalties                   |  |              | 718   |         |   | 367   | 
| | Taxes to government
  institutions  |  |              | 154   |         |   | 156   | 
| | Others                              |  |              | 2     |         |   | -     | 
| |                                     |  |              |       |         |   |       | 
| |                                     |  | $            | 3,977 |         | $ | 3,131 | 
| |                                     |  |              |       |         |   |       | 

F-17

---

---



CIMATRON LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS
(in thousands, except share and per share data)

|              |                                                                                                                                                                                                                                                                                                                                    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 9       | ACCRUED
  SEVERANCE PAY (DEPOSITS WITH INSURANCE COMPANIES ANDSEVERANCE PAY FUNDS)                                                                                                                                                                                                                                                
|              |                                                                                                                                                                                                                                                                                                                                    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|              | The Companys liability
  for severance pay is calculated pursuant to Israeli severance pay law based
  on the most recent salary of the employee multiplied by the number of years
  of employment as of the balance sheet date. Employees are entitled to one
  months salary for each year of employment or a portion thereof.
|              |                                                                                                                                                                                                                                                                                                                                    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|              | The Companys liability
  for all of its employees is funded by monthly deposits with severance pay
  funds and insurance policies. An accrual is set up for any unfunded amount.                                                                                                                                                 
|              | The deposited funds
  include profits accumulated up to the balance sheet date. The deposited funds
  may be withdrawn only upon the fulfillment of the obligation pursuant to Israeli
  severance pay law or labor agreements. The value of the deposited funds is
  based on the cash surrender value of the policies.          
|              |                                                                                                                                                                                                                                                                                                                                    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|NOTE
  10    | CONTINGENT
  LIABILITIES AND COMMITMENTS                                                                                                                                                                                                                                                                                          
|              |                                                                                                                                                                                                                                                                                                                                    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|              | A.                                                                                                                                                                                                                                                                                                                                 | In consideration of grants
  by the Chief Scientist of the Ministry of Industry and Trade of the
  Government of Israel (the Chief Scientist), the Company is obligated to pay
  the Chief Scientist, in respect of awarded grants, royalties of 3.5% of sales
  of products developed with funds provided by the Chief Scientist, until the
  dollar-linked amount is equal to 100% of the grants payments received by the
  Company plus Libor interest rate (the Libor interest rate applies to grants
  received since January 1999). The Companys contingent liability as of
  December 31, 2005 is approximately $3,000 contingent upon the Company
  generating revenues from sales of products developed with funds provided by
  the Chief Scientist.                                                                                                                                                                                                                                                                                                              
|              |                                                                                                                                                                                                                                                                                                                                    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|              |                                                                                                                                                                                                                                                                                                                                    | The Company believes that
  the majority of products that it has sold since January 1, 2005 are not based
  on technology developed with funds provided by the OCS and that, accordingly,
  such sales should not be subject to the payment of royalties to the OCS.
  Therefore, the royalty reports that the Company submitted to the OCS for the
  period starting January 1, 2005 and thereafter have reflected significantly
  reduced royalty obligations in comparison to its royalty reports for the
  years prior to 2005. In addition, during the second half of 2005 the Company initiated a process with
  the OCS in an attempt to obtain the agreement of the OCS with its position
  and to the cessation of its obligation to pay future royalties. Although the
  Company believes it has strong arguments to support its position, the Company
  accrued royalty expenses in its financial reports for the periods from
  January 1st, 2005 to December 31st, 2005, but has not
  paid to the OCS any royalties associated with the products mentioned above.
|              |                                                                                                                                                                                                                                                                                                                                    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|              | B.                                                                                                                                                                                                                                                                                                                                 | Regarding commitments in
  respect of the Approved Enterprise, see Note 13a.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|              |                                                                                                                                                                                                                                                                                                                                    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|              | C.                                                                                                                                                                                                                                                                                                                                 | In consideration of grants
  received from the Fund for the Encouragement of Overseas Marketing of the
  Israeli Governments Ministry of Industry and Trade (the Fund), the Company
  is obligated to pay the Fund royalties amounting to 3% to 4% of the
  incremental exports, up to a maximum of 100% of the grants received.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|              |                                                                                                                                                                                                                                                                                                                                    | The Companys contingent
  liability as of December 31, 2005 is $558, contingent upon the Companys
  incremental exports.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     

F-18

---

---



CIMATRON LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS
(in thousands, except share and per share data)

|              |                                                  |                                                                                                                                             
|------------- | ------------------------------------------------ | --------------------------------------------------------------------------------------------------------------------------------------------
|NOTE
  10    | CONTINGENT
  LIABILITIES AND COMMITMENTS (Cont.)
|              |                                                  |                                                                                                                                             
|              | D.                                               | The Company uses
  technology in respect of which it is obligated to pay minimum annual
  royalties in the amount of $774, until 2007.      
|              |                                                  |                                                                                                                                             
|              | E.                                               | Lease
  commitments                                                                                                                         
|              |                                                  |                                                                                                                                             
|              |                                                  | The premises of the
  Company and its subsidiaries are leased under various operating lease
  agreements, which expire on various dates.    
|              |                                                  | Rent expenses for the
  years ended December 31, 2005, 2004 and 2003, were approximately $627, $661
  and $722, respectively.               
|              |                                                  | The Company leases its
  motor vehicles under cancelable operating lease agreements for periods
  through 2008.                             
|              |                                                  | The minimum payment under
  these operating leases, upon cancellation of these lease agreements, amounted
  to $722 as of December 31, 2005.
|              |                                                  |                                                                                                                                             
|              |                                                  | Future minimum lease
  commitments under operating leases as of December 31, 2005 are as follows:                                           

| |                           |  |   |       | 
| | ------------------------- |  | - | ----- | 
| | Year
  ended December 31, |  |   |       | 
| | 2006                      |  | $ | 1,145 | 
| | 2007                      |  |   | 875   | 
| | 2008                      |  |   | 625   | 
| | 2009                      |  |   | 121   | 
| | 2010 and thereafter       |  |   | -     | 
| |                           |  |   |       | 
| |                           |  | $ | 2,766 | 
| |                           |  |   |       | 

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | F. | Legal
  claim                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| |    | In April 2004, Omega 
  Adem Technologies Ltd., an Israeli privately held company engaged in the
  development of software, filed a lawsuit against Cimatron, claiming that
  Cimatron caused four employees of the plaintiff located in Russia to
  terminate their employment with the plaintiff and join Cimatron. During a
  period of two years (until March 2003), the plaintiff provided certain
  services to Cimatron. The four employees were among several employees who
  provided such services to Cimatron. The plaintiff claimed, among other
  things, that Cimatron undertook not to employ Omegas employees after the
  termination of the project Omega performed for Cimatron. The plaintiff
  requested the District Court in Tel Aviv, Israel to grant an injunction and a
  permanent order that would prevent Cimatron from hiring the four employees.
  In June, 2004, the court rejected the plaintiffs request for an injunction.
  However, in September 2004, Omega initiated arbitration proceedings against
  Cimatron pursuant to the services agreement between the parties and submitted
  to an arbitrator agreed upon between the parties a statement of claim for an
  amount of $20,000,000 for damages caused to Omega due to the employment of
  the four employees in question. In November 2004, Cimatron submitted a
  statement of defense denying all of Omegas claims and asserting, among other
  things, that Cimatron engaged the -employees only following the expiration of
  a year following the conclusion of Cimatrons relationship with Omega and
  that Cimatron therefore was allowed to do so. On October 11, 2005 Omega
  submitted affidavits and on January 25, 2006 the Company submitted its
  affidavits. The parties have submitted a joint request to the District Court
  seeking to dismiss the request for an injunction. Cimatron believes that
  there is no merit to the claim and intends to oppose it vigorously, but
  nevertheless accrued in the fourth quarter of 2005 an amount of $250,000 for
  this claim.

F-19

---

---



CIMATRON LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS
(in thousands, except share and per share data)

|              |                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|------------- | ---------------------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE
  11    | SHAREHOLDERS
  EQUITY
|              |                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|              | A.                     | Share
  issuance                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|              |                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|              |                        | The
  Companys shares are traded in the United States and are listed on the Nasdaq
  SmallCap Market.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|              |                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|              | B.                     | Share Option
  Plans                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|              |                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|              |                        | In January 1996, the Companys
  Board of Directors adopted a share option plan (the 1996 Share Option Plan)
  pursuant to which 316,000 Ordinary Shares were reserved for issuance upon the
  exercise of options to be granted to directors, officers, employees and
  consultants of the Company. The 1996 Share Option Plan is administrated by a
  committee of the Board, which designates the optionees and dates of grant.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|              |                        | The exercise price of an
  option granted under the 1996 Share Option Plan may be no less than 85% of
  the fair market value of an Ordinary Share, as determined by that committee
  on the date that the option is granted. The options are for a 10-year term
  and are non-assignable except by the laws of inheritance.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|              |                        | The option committee has the
  authority to amend the terms of option grants, provided that any such
  amendment is in the best interest of the grantees. In March and April 2000,
  options to purchase 39,750 shares were exercised. As of December 31, 2005,
  options to purchase 21,000 of such shares were outstanding. All of these
  options were originally granted with an exercise price of $8.00 per share. In
  January, 1998, the Board of Directors amended the exercise price of such
  options to $5.00 per share.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|              |                        | These outstanding options
  are, subject to the continued employment of each employee, exercisable
  commencing two years after the date of grant at a rate of 25% per year. The
  grantee is responsible for all personal tax consequences of the grant and the
  exercise thereof.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|              |                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|              |                        | In April 1998, the Board
  of Directors adopted an additional share option plan (the 1998 Share Option
  Plan) pursuant to which 620,000 Ordinary Shares were reserved for issuance
  upon the exercise of options to be granted to directors, officers, employees
  and consultants of the Company. The 1998 Share Option Plan is administrated
  by a committee of the Board, which designates the optionees and dates of
  grant. The exercise price of an option granted under the 1998 Share Option
  Plan may be no less than 85% of the fair market value of an Ordinary Share,
  as determined by that committee on the date that the option is granted.
  Options granted vest over a period determined by the option committee,
  terminate three years after they become exercisable, and are non-assignable
  except by the laws of inheritance. The option committee has the authority to
  amend the terms of option grants, provided that any such amendment is in the
  best interest of the grantee.
|              |                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|              |                        | As of December 31, 2005,
  options to purchase 19,750 of such shares were outstanding at a price of
  $4.00 per share under the 1998 Share Option Plan. These options are
  exercisable commencing two years after the date of grant at a rate of 25% per
  year, subject to the continued employment of each employee. The grantee will
  be responsible for all personal tax consequences of the grant and the
  exercise thereof.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   

F-20

---

---



CIMATRON LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS
(in thousands, except share and per share data)

|            |                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|----------- | ------------------------------ | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 11    | SHAREHOLDERS
  EQUITY (Cont.)
|            |                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            | B.                             | Share
  Option Plan (Cont.)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            |                                | In October 1999, the
  option committee approved the grant of options to purchase 160,000 of the
  Companys shares at a price of $2.00 per share to the former president and
  CEO of the Company. All such options expired unexercised in 2005.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|            |                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            |                                | In March 2000, the option
  committee adopted new guidelines for the options to purchase Ordinary Shares
  reserved for issuance under both the 1996 Share Option Plan and the 1998
  Share Option Plan upon the exercise of options to be granted to directors,
  officers, employees and consultants of the Company. Such options are
  exercisable commencing two years after the date of grant at a rate of 50% on
  the second anniversary of the date of grant and 25% in each of the following
  two years, subject to the continued employment of each employee. As of
  December 31, 2005, options to purchase 45,500 of such shares were outstanding
  at a price of $4.50 per share.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            |                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            |                                | In August 2003 the Companys
  Board of Directors approved the grant of options to purchase 150,000 of the
  Companys shares at a price of $2.50 per share to two officers in the
  Company. These options are exercisable commencing one year after the date of
  grant at a rate of 25%-33.3% per year, subject to the continued employment of
  the officers. 50,000 of such options were outstanding at December 31, 2005.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            |                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            |                                | In October 2004, the Board
  of Directors adopted an additional share option plan (the 2004 Share Option
  Plan) pursuant to which 240,000 Ordinary Shares were reserved for issuance
  upon the exercise of options to be granted to directors, officers, employees
  and consultants of the Company. The exercise price of an option granted under
  the Share Option Plan may be no less than 100% of the fair market value of an
  Ordinary Share, as determined by that committee on the date that the option
  is granted. The options may be exercised over a 10-year term unless
  determined otherwise by the Board. The grantees will be responsible for all
  personal tax consequences of the grant and the exercise thereof. In February
  2005, 238,500 of such options were granted to employees of the Company at an
  exercise price of $2.20 per share, and in August 2005, the board of directors
  approved the grant of 32,000 of such options at an exercise price of $2.00
  per share to the Companys Chief Executive Officer. 239,500 of such options
  were outstanding at December 31, 2005. In December 2005 our Board of
  Directors increased the 2004 Share Option Plan reserve by an additional
  250,000 shares. The Company intends to grant additional options under the
  2004 Share Option Plan to various directors, executive officers and employees
  of the Company.
|            |                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|            |                                | At December 31, 2005
  options to purchase 255,000, 329,000 and 250,500 of Company shares were
  available for grants to directors, officers, employees and consultants of the
  Company under the 1996, 1998 and 2004 Share Option Plans, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        

F-21

---

---



CIMATRON LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS
(in thousands, except share and per share data)

|            |                                |                                                                                                                                                                               
|----------- | ------------------------------ | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 11    | SHAREHOLDERS
  EQUITY (Cont.)
|            |                                |                                                                                                                                                                               
|            | B.                             | Share
  Option Plan (Cont.)                                                                                                                                                   
|            |                                |                                                                                                                                                                               
|            |                                | A summary of the status of
  the Companys stock option plan as of December 31, 2005, 2004 and 2003, and
  changes during the years ending on those dates, is presented below:

|                                                               |  |                         |          |                                       |   |         |  |                                       |          |        |   |                                       |  |   |         |   |   |      | 
|-------------------------------------------------------------- |  | ----------------------- | -------- | ------------------------------------- | - | ------- |  | ------------------------------------- | -------- | ------ | - | ------------------------------------- |  | - | ------- | - | - | ---- | 
|                                                               |  | Year ended December 31, |         
|                                                               |  |                         |         
|                                                               |  | 2 0 0 5                 |          | 2 0 0 4                               |   | 2 0 0 3 | 
|                                                               |  |                         |          |                                       |   |         | 
|                                                               |  | (in thousands)          |         
|                                                               |  |                         |         
|                                                               |  | Shares                  |          | Weighted
  average
  exercise
  price |   | Shares  |  | Weighted
  average
  exercise
  price |          | Shares |   | Weighted
  average
  exercise
  price | 
|                                                               |  |                         |          |                                       |   |         |  |                                       |          |        |   |                                       | 
|Outstanding at beginning of year                               |  |                         | 488,250  |                                       | $ | 3.04    |  |                                       | 635,000  |        | $ | 3.33                                  |  |   | 520,000 |   | $ | 3.62 | 
|Granted                                                        |  |                         | 270,500  |                                       | $ | 2.18    |  |                                       | -        |        |   | -                                     |  |   | 150,000 |   | $ | 2.50 | 
|Exercised                                                      |  |                         | -        |                                       |   | -       |  |                                       | -        |        |   | -                                     |  |   | -       |   |   | -    | 
|Cancelled                                                      |  |                         | (383,000 | )                                     | $ | 2.72    |  |                                       | (146,750 | )      | $ | 4.28                                  |  |   | (35,000 | ) | $ | 4.07 | 
|                                                               |  |                         |          |                                       |   |         |  |                                       |          |        |   |                                       |  |   |         |   |   |      | 
|Outstanding at year end                                        |  |                         | 375,750  |                                       | $ | 2.75    |  |                                       | 488,250  |        | $ | 3.04                                  |  |   | 635,000 |   | $ | 3.33 | 
|                                                               |  |                         |          |                                       |   |         |  |                                       |          |        |   |                                       |  |   |         |   |   |      | 
|Options exercisable at year end                                |  |                         | 111,250  |                                       | $ | 4.06    |  |                                       | 392,417  |        | $ | 3.18                                  |  |   | 473,160 |   | $ | 3.56 | 
|                                                               |  |                         |          |                                       |   |         |  |                                       |          |        |   |                                       |  |   |         |   |   |      | 
|Weighted average fair value of options granted during the
year |  | $                       | 0.88     |                                       |   |         |  |                                       | -        |        |   |                                       |  | $ | 1.11    |   |   |      | 
|                                                               |  |                         |          |                                       |   |         |  |                                       |          |        |   |                                       |  |   |         |   |   |      | 

| |  |                                                                                                   
| |  | --------------------------------------------------------------------------------------------------
| |  | The following table
  summarizes information about stock options outstanding at December 31, 2005:

|                         |  |                                                           |         |                                                             |  |                                     |  |                                                           |      |                                     |  |         |  |   |      | 
|------------------------ |  | --------------------------------------------------------- | ------- | ----------------------------------------------------------- |  | ----------------------------------- |  | --------------------------------------------------------- | ---- | ----------------------------------- |  | ------- |  | - | ---- | 
|                         |  | Options outstanding                                       |         | Option exercisable                                          | 
|                         |  |                                                           |         |                                                             | 
|Range of exercise prices |  | Number of
  shares
  outstanding at
  December 31,
  2005 |         | Weighted
  average
  remaining
  contractual
  life (years) |  | Weighted
  average
  exercise price |  | Number of
  shares
  exercisable at
  December 31,
  2005 |      | Weighted
  average
  exercise price | 
|                         |  |                                                           |         |                                                             |  |                                     |  |                                                           |      |                                     | 
|$2.00 to $3.00           |  |                                                           | 289,500 |                                                             |  | 9.3                                 |  | $                                                         | 2.23 |                                     |  | 25,000  |  | $ | 2.50 | 
|$3.01 to $4.00           |  |                                                           | 19,750  |                                                             |  | 0.85                                |  | $                                                         | 4.00 |                                     |  | 19,750  |  | $ | 4.00 | 
|$4.01 to $5.00           |  |                                                           | 66,500  |                                                             |  | 1.68                                |  | $                                                         | 4.66 |                                     |  | 66,500  |  | $ | 4.66 | 
|                         |  |                                                           |         |                                                             |  |                                     |  |                                                           |      |                                     |  |         |  |   |      | 
|                         |  |                                                           | 375,750 |                                                             |  |                                     |  |                                                           |      |                                     |  | 111,250 |  |   |      | 
|                         |  |                                                           |         |                                                             |  |                                     |  |                                                           |      |                                     |  |         |  |   |      | 

F-22

---

---



CIMATRON LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS
(in thousands, except share and per share data)

|              |                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|------------- | -------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE
  12    | INCOME
  TAXES
|              |                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|              | A.             | The Law
  for Encouragement of Capital Investments, 1959 (hereafter: the law)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|              |                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|              |                | Since 1994, the Companys
  operations have approved enterprise status under the law. Reduced tax rates
  apply to the Companys income from the approved enterprise (which is
  determined in accordance with the increase in the Companys revenue during
  the first year of its having the abovementioned status as compared to the
  year before).                                                                                                                                                                                                                                                                                                                                                                       
|              |                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|              |                | In April 2001 the Company
  was granted approved enterprise status, subject to the following terms:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|              |                | Tax exemption for 2 years,
  commencing in the first year the Company generates taxable income. For the
  remainder of the benefit period - 5 years - a reduced tax rate of 25%.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|              |                | The period of tax benefits
  for this approved enterprise will expire in 2015 or earlier, depending on
  whether the Company generates taxable income from this approved enterprise.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|              |                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|              |                | Income
  derived from sources other than approved enterprise is taxable at the
  ordinary corporate tax rate. On July 25, 2005 an amendment to the Israeli tax
  law was approved by the Israeli parliament, which reduces the tax rates
  imposed on Israeli companies to 31% for 2006. This amendment states that the
  corporate tax rate will be further reduced in subsequent tax years as
  follows: in 2007 29%, in 2008 27%, in 2009 26% and thereafter 25%. This
  change does not have a material effect on the Companys financial statements.                                                                                                                                                                     
|              |                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|              |                | In
  the event of a distribution of cash dividends to shareholders of earnings
  subject to the exemption, the Company will be liable to tax at a rate
  of 25%. The Company has not provided deferred taxes on future
  distributions of tax-exempt earnings, as management and the Board of
  Directors have determined not to make any distribution that may result in a
  tax liability for the Company. Accordingly, such earnings have been
  considered to be permanently reinvested. The tax-exempt earnings may be
  distributed to shareholders without subjecting the Company to taxes only upon
  a complete liquidation of the Company.                                                                            
|              |                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|              |                | The tax benefits and
  grants described above are subject to
  fulfillment of the conditions stipulated by the Law for Encouragement of
  Capital Investments, 1959, as amended, the regulations promulgated thereunder
  and the criteria set forth in the certificate of approval. The entitlement to
  the benefits is subject to completion and final approval by the Investment
  Center, such approval being subject to fulfillment of all terms of the
  approved program. In the event of failure by an enterprise to comply with
  these conditions, the tax benefits could be cancelled, in whole or in part,
  and the enterprise would be required to refund the amount of cancelled
  benefits, including interest.
|              |                | The
  completion of the Companys first, second and third approved enterprises has
  received final approval by the Investment Center.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          

F-23

---

---



CIMATRON LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS
(in thousands, except share and per share data)

|              |                        |                      
|------------- | ---------------------- | ---------------------
|NOTE
  12    | INCOME
  TAXES (Cont.)
|              |                        |                      
|              | B.                     | Comprised as follows:

| |                                         |  |                         |        |         |   |         |   |   |        |  
| | --------------------------------------- |  | ----------------------- | ------ | ------- | - | ------- | - | - | ------ | -
| |                                         |  | Year ended December 31, |       
| |                                         |  |                         |       
| |                                         |  | 2 0 0 5                 |        | 2 0 0 4 |   | 2 0 0 3 |  
| |                                         |  |                         |        |         |   |         |  
| |                                         |  |                         |        |         |   |         |   |   |        |  
| | Income (loss) before taxes
  on income: |  |                         |        |         |   |         |   |   |        |  
| | Israel                                  |  | $                       | (3,285 | )       | $ | 807     |   | $ | 1,611  |  
| | Non-Israeli                             |  |                         | (1,337 | )       |   | (1,172  | ) |   | (1,903 | )
| |                                         |  |                         |        |         |   |         |   |   |        |  
| |                                         |  | $                       | (4,622 | )       | $ | (365    | ) | $ | (292   | )
| |                                         |  |                         |        |         |   |         |   |   |        |  
| |                                         |  |                         |        |         |   |         |   |   |        |  
| | Current taxes                           |  | $                       | (2     | )       | $ | (12     | ) | $ | (9     | )
| | Tax in respect of prior
  years         |  |                         | -      |         |   | (11     | ) |   | -      |  
| |                                         |  |                         |        |         |   |         |   |   |        |  
| |                                         |  | $                       | (2     | )       | $ | (23     | ) | $ | (9     | )
| |                                         |  |                         |        |         |   |         |   |   |        |  

| |    |                                                               
| | -- | --------------------------------------------------------------
| | C. | Deferred tax assets
  (liabilities), consist of the following:

| |                                             |  |              |        |         |   |        |   |  |  | 
| | ------------------------------------------- |  | ------------ | ------ | ------- | - | ------ | - |  |  | 
| |                                             |  | December 31, |        |         |   |       
| |                                             |  |              |        |         |   |       
| |                                             |  | 2 0 0 5      |        | 2 0 0 4 |   |        |   | 
| |                                             |  |              |        |         |   |        |   | 
| |                                             |  |              |        |         |   |        |   |  |  | 
| | Deferred tax assets:                        |  |              |        |         |   |        |   |  |  | 
| | Loss carryforwards                          |  | $            | 5,838  |         | $ | 4,251  |   |  |  | 
| | Other cumulative temporary differences, net |  |              | 223    |         |   | 666    |   |  |  | 
| |                                             |  |              |        |         |   |        |   |  |  | 
| |                                             |  |              | 6,061  |         |   | 4,917  |   |  |  | 
| |                                             |  |              |        |         |   |        |   |  |  | 
| | Deferred tax liabilities:                   |  |              |        |         |   |        |   |  |  | 
| | Software development costs                  |  |              | (66    | )       |   | (361   | ) |  |  | 
| |                                             |  |              |        |         |   |        |   |  |  | 
| |                                             |  |              |        |         |   |        |   |  |  | 
| | Valuation allowance                         |  |              | (5,995 | )       |   | (4,556 | ) |  |  | 
| |                                             |  |              |        |         |   |        |   |  |  | 
| |                                             |  |              |        |         |   |        |   |  |  | 
| |                                             |  |              |        |         |   |        |   |  |  | 
| | Deferred tax, net                           |  | $            | -      |         | $ | -      |   |  |  | 
| |                                             |  |              |        |         |   |        |   |  |  | 

| |  |                                                                                                                                                                                                                                                                                                                                                                       
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | In accordance with SFAS
  No. 109, deferred tax assets are to be recognized for the anticipated tax
  benefits associated with net operating loss carryforwards, and deductible
  temporary differences, unless it is more likely than not that some or all of
  the deferred tax assets will not be realized. The adjustment is made through
  a valuation allowance.
| |  |                                                                                                                                                                                                                                                                                                                                                                       
| |  | Since the realization of
  the net operating loss carryforwards and deductible temporary differences of
  the Company and the subsidiaries is less than likely, a valuation allowance
  has been established for the amounts of the related tax benefits.                                                                                                             

F-24

---

---



CIMATRON LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS
(in thousands, except share and per share data)

|              |                        |                                                                                                                                                                                                                                                                                                                              
|------------- | ---------------------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE
  12    | INCOME
  TAXES (Cont.)
|              |                        |                                                                                                                                                                                                                                                                                                                              
|              |                        | As of December 31, 2005,
  the Company has approximately $5,894 of Israeli net operating loss
  carryforwards. The Israeli loss carryforwards have no expiration date.                                                                                                                                                       
|              |                        |                                                                                                                                                                                                                                                                                                                              
|              |                        | Tax loss carryforwards of
  a U.S. subsidiary totaling $6,759 expire between 2011 and 2023.                                                                                                                                                                                                                                  
|              |                        |                                                                                                                                                                                                                                                                                                                              
|              | D.                     | Under the Income Tax Law
  (Adjustments for Inflation) 1985, income for tax purposes is measured in
  terms of earnings in NIS, adjusted for the changes in the C.P.I. Following is
  a reconciliation of income taxes calculated at the statutory tax rate in
  Israel to the actual income tax in the financial statements:

| |                                                                                     |  |                         |        |         |   |         |   |   |      |  
| | ----------------------------------------------------------------------------------- |  | ----------------------- | ------ | ------- | - | ------- | - | - | ---- | -
| |                                                                                     |  | Year ended December 31, |       
| |                                                                                     |  |                         |       
| |                                                                                     |  | 2 0 0 5                 |        | 2 0 0 4 |   | 2 0 0 3 |  
| |                                                                                     |  |                         |        |         |   |         |  
| |                                                                                     |  |                         |        |         |   |         |   |   |      |  
| | Loss before income taxes as reported in the consolidated statements
  of operations |  | $                       | (4,622 | )       | $ | (365    | ) | $ | (292 | )
| | Statutory tax rate                                                                  |  |                         | 34     | %       |   | 35      | % |   | 36   | %
| | Income taxes under statutory tax rate                                               |  | $                       | (1,571 | )       | $ | (128    | ) | $ | (105 | )
| |                                                                                     |  |                         |        |         |   |         |   |   |      |  
| | Increase (decrease) in taxes:                                                       |  |                         |        |         |   |         |   |   |      |  
| | Disallowed deductions, net                                                          |  |                         | 278    |         |   | 41      |   |   | 44   |  
| | Tax in respect of prior year                                                        |  |                         | -      |         |   | 11      |   |   | -    |  
| | Increase in valuation allowance                                                     |  |                         | 1,439  |         |   | 99      |   |   | 70   |  
| | Other                                                                               |  |                         | (144   | )       |   | -       |   |   | -    |  
| |                                                                                     |  |                         |        |         |   |         |   |   |      |  
| | Income taxes in the statements of operations                                        |  | $                       | 2      |         | $ | 23      |   | $ | 9    |  
| |                                                                                     |  |                         |        |         |   |         |   |   |      |  

|              |                                     |                                                                                                                                                                                                                                                                                                            
|------------- | ----------------------------------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|              | E.                                  | Tax
  assessments                                                                                                                                                                                                                                                                                          
|              |                                     |                                                                                                                                                                                                                                                                                                            
|              |                                     | The Company has been
  issued final tax assessments by the Israeli income tax authorities through
  tax year ended December 31, 2000.                                                                                                                                                                      
|              |                                     | Certain subsidiaries of
  the Company received tax assessments through the tax year ended December 31,
  2004.                                                                                                                                                                                             
|              |                                     |                                                                                                                                                                                                                                                                                                            
|NOTE
  13    | TRANSACTIONS
  WITH RELATED PARTIES
|              |                                     |                                                                                                                                                                                                                                                                                                            
|              | A.                                  | In February 2002, Koonras
  Technologies Ltd., a subsidiary of Polar Investments Ltd. (Koonras) and
  DBSI Investments Ltd. (DBSI) consummated a transaction with Zeevi Computers
  and Technology Ltd. (ZCT), by which they acquired all of Ordinary Shares of
  the Company previously held by ZCT.
|              |                                     |                                                                                                                                                                                                                                                                                                            
|              | B.                                  | The following transactions
  with Koonras and DBSI are included in the financial statements:                                                                                                                                                                                                               

| |                 |  |                         |     |         |   |         |  |   |     | 
| | --------------- |  | ----------------------- | --- | ------- | - | ------- |  | - | --- | 
| |                 |  | Year ended December 31, |    
| |                 |  |                         |    
| |                 |  | 2 0 0 5                 |     | 2 0 0 4 |   | 2 0 0 3 | 
| |                 |  |                         |     |         |   |         | 
| |                 |  |                         |     |         |   |         |  |   |     | 
| | Management fees |  | $                       | 349 |         | $ | 353     |  | $ | 359 | 

F-25

---

---



CIMATRON LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS
(in thousands, except share and per share data)

|              |                                          |         
|------------- | ---------------------------------------- | --------
|NOTE
  14    | SELECTED
  STATEMENTS OF OPERATIONS DATA
|              |                                          |         
|              | A.                                       | Revenues

| |                                                                          |           |                         |        |         |   |         |       |   |        |       | 
| | ------------------------------------------------------------------------ | --------- | ----------------------- | ------ | ------- | - | ------- | ----- | - | ------ | ----- | 
| |                                                                          |           | Year ended December 31, |       
| |                                                                          |           |                         |       
| |                                                                          |           | 2 0 0 5                 |        | 2 0 0 4 |   | 2 0 0 3 |      
| |                                                                          |           |                         |        |         |   |         |      
| | Revenue by geographical
  region:                                        |           |                         |        |         |   |         |       |   |        |      
| | Israel                                                                   |           | $                       | 1,639  |         | $ | 1,939   |       | $ | 2,084  |      
| | Europe          (1)                                                      |           |                         | 10,776 |         |   | 13,255  |       |   | 12,203 |      
| | Far
  East        (2)                                                    |           |                         | 4,624  |         |   | 4,407   |       |   | 4,394  |      
| | North America                                                            |           |                         | 3,715  |         |   | 3,409   |       |   | 2,808  |      
| | Others                                                                   |           |                         | 171    |         |   | 153     |       |   | 120    |      
| |                                                                          |           |                         |        |         |   |         |       |   |        |      
| |                                                                          |           | $                       | 20,925 |         | $ | 23,163  |       | $ | 21,609 |      
| |                                                                          |           |                         |        |         |   |         |       |   |        |      
| | (1)                                                                      | Includes: |                         |        |         |   |         |       |   |        |       | 
| |                                                                          | Italy     |                         | $      | 2,423   |   | $       | 2,703 |   | $      | 2,453 | 
| |                                                                          | Germany   |                         | $      | 6,600   |   | $       | 7,782 |   | $      | 7,065 | 
| |                                                                          |           |                         |        |         |   |         |       |   |        |       | 
| | (2)                                                                      | Includes: |                         |        |         |   |         |       |   |        |       | 
| |                                                                          | Japan     |                         | $      | 2,404   |   | $       | 2,443 |   | $      | 2,334 | 
| |                                                                          |           |                         |        |         |   |         |       |   |        |      
| | Revenue through major
  distributors, as a percentage of total revenues: |           |                         |        |         |   |         |       |   |        |      
| | Distributor (A)                                                          |           |                         | 12     | %       |   | 12      | %     |   | 11     | %    
| | Distributor (B)                                                          |           |                         | 10     | %       |   | 9       | %     |   | 9      | %    

| |    |                   
| | -- | ------------------
| | B. | Cost of
  revenues

| |                                                                      |  |                         |       |         |   |         |  |   |       | 
| | -------------------------------------------------------------------- |  | ----------------------- | ----- | ------- | - | ------- |  | - | ----- | 
| |                                                                      |  | Year ended December 31, |      
| |                                                                      |  |                         |      
| |                                                                      |  | 2 0 0 5                 |       | 2 0 0 4 |   | 2 0 0 3 | 
| |                                                                      |  |                         |       |         |   |         | 
| |                                                                      |  |                         |       |         |   |         |  |   |       | 
| | Hardware and software                                                |  | $                       | 1,442 |         | $ | 1,731   |  | $ | 1,726 | 
| | Salaries and employee benefits                                       |  |                         | 1,051 |         |   | 1,120   |  |   | 1,306 | 
| | Amortization and write-off of capitalized software development
costs |  |                         | 1,204 |         |   | 401     |  |   | 402   | 
| | Royalties to the Chief Scientist                                     |  |                         | 721   |         |   | 791     |  |   | 586   | 
| | Depreciation                                                         |  |                         | 24    |         |   | 27      |  |   | 49    | 
| | Other                                                                |  |                         | 504   |         |   | 524     |  |   | 545   | 
| |                                                                      |  |                         |       |         |   |         |  |   |       | 
| |                                                                      |  |                         | 4,946 |         |   | 4,594   |  |   | 4,614 | 
| | Decrease (increase) in inventory                                     |  |                         | (11   | )       |   | 7       |  |   | 4     | 
| |                                                                      |  |                         |       |         |   |         |  |   |       | 
| |                                                                      |  | $                       | 4,935 |         | $ | 4,601   |  | $ | 4,618 | 
| |                                                                      |  |                         |       |         |   |         |  |   |       | 

| |    |                                               
| | -- | ----------------------------------------------
| | C. | Selling,
  general and administrative expenses

| |                                     |  |                         |        |         |   |         |  |   |        | 
| | ----------------------------------- |  | ----------------------- | ------ | ------- | - | ------- |  | - | ------ | 
| |                                     |  | Year ended December 31, |       
| |                                     |  |                         |       
| |                                     |  | 2 0 0 5                 |        | 2 0 0 4 |   | 2 0 0 3 | 
| |                                     |  |                         |        |         |   |         | 
| |                                     |  |                         |        |         |   |         |  |   |        | 
| | Marketing costs                     |  | $                       | 417    |         | $ | 664     |  | $ | 690    | 
| | Selling expenses                    |  |                         | 11,674 |         |   | 10,668  |  |   | 9,054  | 
| | General and administrative expenses |  |                         | 3,356  |         |   | 2,442   |  |   | 2,702  | 
| | Depreciation                        |  |                         | 203    |         |   | 188     |  |   | 199    | 
| |                                     |  |                         |        |         |   |         |  |   |        | 
| |                                     |  | $                       | 15,650 |         | $ | 13,962  |  | $ | 12,645 | 
| |                                     |  |                         |        |         |   |         |  |   |        | 

| |  |                                                                                                                                   
| |  | ----------------------------------------------------------------------------------------------------------------------------------
| |  | Advertising
  expenses for the years ended December 31, 2005, 2004 and 2003 were
  approximately $87, $157 and $195, respectively.

F-26

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