---

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

# FORM 20-F

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

# OR

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

| | For
the fiscal year ended December 31, 2005
| | -------------------------------------------

# OR

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

| | For
the transition period from __________ to __________
| | -------------------------------------------------------

# Commission file number
0-29884

# B.V.R. Systems (1998)
Ltd.(Exact name of
Registrant as specified in its charter)

# Israel (Jurisdiction of
incorporation or organization)

# 16 Hamelacha Street,
Park Afek, Rosh Haayin 48091, Israel (Address of principal
executive offices)

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

|                    |                                          
|------------------- | -----------------------------------------
|
|
|
|
|Title of each class | Name of each exchange on which registered
|None                | None                                     

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

# Ordinary Shares, NIS
1.00 par value 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:

# 95,663,757 Ordinary
Shares, NIS 1.00 par value per share

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.

x
Yeso
No

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

x
Item 17o
Item 18



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# INTRODUCTION

B.V.R.
          Systems (1998) Ltd., (BVR) an Israeli company, was formed in
January           1998 to receive all of the assets and liabilities of the
defense-related           business of BVR Technologies Ltd. in accordance with the terms
of a           reorganization plan. The reorganization plan was consummated, and BVR
commenced           operations as an independent company in October 1998, effective
as of           January 1, 1998. BVR is controlled by Chun Holdings LP.

Except
for the historical information contained herein, the statements contained in this annual
report are forward-looking statements, within the meaning of the Private Securities
Litigation Reform Act of 1995 with respect to our business, financial condition and
results of operations. Statements that use the terms believe,
anticipate, expect, plan, intend,
estimate, anticipate, project and similar expressions
in the affirmative and the negative are intended to identify forward-looking statements.
These statements reflect our current views with respect to future events and are based on
current assumptions, expectations, estimates and projections about our business and the
markets in which we operate and are subject to risks and uncertainties. Actual events
(including our results) could differ materially from those anticipated in these
forward-looking statements as a result of various factors, including the risks discussed
in Item 3. Key Information  D. Risk Factors and elsewhere in this annual
report. Except as required by applicable law, including the securities laws of the United
States, we do not undertake any obligation nor intend to update or revise any
forward-looking statements, whether as a result of new information, future events or
otherwise.

As
used in this annual report, the terms we, us, our,
the Company and BVR mean B.V.R. Systems (1998) Ltd., and our
consolidated subsidiaries, unless otherwise indicated.

All
references herein to dollars or $ are to United States dollars,
and all references to Shekels or NIS are to New Israeli Shekels.

References
in this annual report to Chun refer to our controlling shareholder, Chun Holdings LP.

References in
this annual report to fiscal 2003 refer to our fiscal year ended December 31, 2003,
references to fiscal 2004 refer to our fiscal year ended December 31, 2004,
references to fiscal 2005 refer to our fiscal year ended December 31, 2005 and
references to fiscal 2006 refer to our fiscal year ended December 31, 2006.

References
in this annual report to the Companies Law refer to the Israel Companies Law, 5759-1999.

Ehud
is a trademark jointly owned by Israel Aircraft Industries and us; and
Atas is our wholly-owned trademark. All other trademarks and trade names
appearing in this annual report are owned by their respective holders.



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# PART I

|ITEM 1. |  | Identity of Directors, Senior Management and Advisors
|------- |  | -----------------------------------------------------

Not
applicable.

|ITEM 2. |  | Offer Statistics and Expected Timetable
|------- |  | ---------------------------------------

Not
applicable.

1

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|ITEM 3. |  | Key Information
|------- |  | ---------------

|A. | Selected
Consolidated Financial Data
|-- | ------------------------------------

We
derived the following selected consolidated financial data presented below for each of the
years ended December 31, 2003, 2004 and 2005 from our Consolidated Financial
Statements and related notes included in this annual report. The selected consolidated
financial data for the years ended December 31, 2001 and 2002 have been derived from
audited financial statements not included in this annual report. Our Consolidated
Financial Statements have been prepared in accordance with generally accepted accounting
principles in Israel, or Israel GAAP. Israel GAAP, as applicable to our financial
statements, differs in certain significant respects from generally accepted accounting
principles in the United States, or U.S. GAAP. See Note 21 to the Consolidated Financial
Statements included in this annual report for a discussion of the certain differences
between Israel and U.S. GAAP.

You
should read the selected consolidated financial data together with the section entitled
Item 5. Operating and Financial Review and Prospects and our Consolidated
Financial Statements included elsewhere in this annual report. Please see Note 2 of our
Consolidated Financial Statements for an explanation of the number of shares used in
computing per share data.

|                                           | Year Ended December 31,
|------------------------------------------ | -----------------------
|
|
|
|
|Statement of Operations Data:              |                        
|Revenues                                   |                        
|Cost of revenues:                          |                        
|Costs and expenses                         |                        
|                                           |                        
|Gross profit                               |                        
|Operating expenses:                        |                        
|Research and development expenses          |                        
|Selling and marketing expenses             |                        
|General and administrative expenses        |                        
|                                           |                        
|Total operating expenses                   |                        
|                                           |                        
|Operating profit (loss)                    |                        
|Financing expenses, net                    |                        
|Other Income (expenses), net               |                        
|                                           |                        
|Profit (loss) before income taxes          |                        
|Income tax expenses                        |                        
|                                           |                        
|Net profit  (loss)                         |                        
|                                           |                        
|Basic and diluted net profit (loss) per    |                        
|ordinary share                             |                        
|                                           |                        
|Weighted average number of Ordinary Shares |                        
|used in computing basic and diluted net    |                        
|loss per ordinary share                    |                        
|                                           |                        

2

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|                                            | Year Ended December 31,
|------------------------------------------- | -----------------------
|
|
|
|
|Reconciliation to U.S. GAAP:                |                        
|Net profit (loss)                           |                        
|Allocation of non-employee stock option     |                        
|expenses under the fair value based method  |                        
|for all amounts, net of related tax effects |                        
|Loss under U.S. GAAP                        |                        
|                                            |                        
|Basic and diluted net loss per ordinary     |                        
|share under U.S. GAAP                       |                        
|                                            |                        
|Weighted average number of Ordinary Shares  |                        
|used in computing basic and diluted net     |                        
|loss per ordinary share under U.S. GAAP .   |                        
|                                            |                        

|                                 | As of December 31,
|-------------------------------- | ------------------
|
|
|
|
|Consolidated Balance Sheet Data: |                   
|Israeli GAAP:                    |                   
|Cash and cash equivalents        |                   
|Working capital (deficit)        |                   
|Total assets                     |                   
|Short-term bank credit and loans |                   
|Shareholders equity (deficit)    |                   
|U.S. GAAP:                       |                   
|                                 |                   
|Total assets                     |                   
|                                 |                   
|Shareholders equity (deficit)    |                   

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

Not
applicable.

|C. | Reasons
for the Offer and Use of Proceeds
|-- | -----------------------------------------

Not
applicable.

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

Our
business, operating results and financial condition could be seriously harmed due to any
of the following risks. If we do not successfully address any of the risks described
below, we could experience a material adverse effect on our business, results of
operations and financial condition and our share price may decline. We cannot assure you
that we will successfully address any of these risks.

3

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# Risks Related to our
Business

We have reported
operating and net losses in the past and may report operating and net losses in the
future.

We
commenced operations in 1998. We reported a net profit of $121 thousand for the year ended
December 31, 2005, a net loss of $1.2 million for the year ended December 31, 2004, a net
loss of $6.5 million for the year ended December 31, 2003 and a net loss of $5.8
million for the year ended December 31, 2002. We can offer no assurance that we will
continue to achieve profitable operations or that any profitable operations will be
sustained. Future profitability will depend on our ability to develop new products, the
degree of market acceptance of our existing and new products and the level of competition
in the markets in which we operate.

Although we had positive
shareholders equity and positive working capital since December 31, 2004 we may
still need to raise additional funds which may not be available.

As
of December 31, 2005, our shareholders equity was $3.8 million, and we had positive
working capital amounting to $ 4million. We expect that our existing cash balance,
together with our forecasted cash flows from operating activities for fiscal 2006,
including orders forecasted in the budget approved by our Board of Directors, will be
sufficient for meeting our present working capital and capital expenditure needs. If our
operations do not generate cash to the extent currently anticipated or if any of the risk
factors discussed in this annual report materialize, we may need to raise additional funds
in the future for a number of uses, including:

| |  | implementing
further marketing and sales activities;
| | - | ----------------------------------------------------

| |  | hiring
additional qualified personnel; and
| | - | ------------------------------------------

| |  | expanding
research and development programs.
| | - | --------------------------------------------

We
may not be able to obtain additional funds on acceptable terms or at all. If we cannot
raise needed funds on acceptable terms, we may not be able to:

| |  | maintain
the level of our current operations;
| | - | ---------------------------------------------

| |  | develop
new products;
| | - | ---------------------

| |  | enhance
our existing products;
| | - | ------------------------------

| |  | remain
current with evolving defense technologies;
| | - | --------------------------------------------------

| |  | take
advantage of future opportunities; or
| | - | ------------------------------------------

| |  | respond
to competitive pressures or unanticipated requirements.
| | - | ---------------------------------------------------------------

4

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Because we receive large
product orders from a relatively small number of customers, our sales and operating
results are subject to substantial periodic variations. Our revenues and operating results
for a specific quarter may not be indicative of our future performance, making it
difficult for investors to evaluate our future prospects based on the results of any one
quarter.

Due
to the nature of our customers and products, we receive relatively large orders for our
products from a relatively small number of customers. Consequently, individual orders from
individual customers can represent a substantial portion of our sales in any one period
and significant orders by any customer during one period may not be followed by further
orders from the same customer in subsequent periods. Our sales and operating results are
subject to very substantial periodic variations. Because our quarterly performance is
likely to vary significantly, the results of our operations for any quarter are not
necessarily indicative of the results that we might achieve for any subsequent period and
consequently, quarter-to-quarter comparisons of our operating results may not be
meaningful.

We may not be able to
convert all of our backlog into revenue.

We
sell the majority of our products through individual purchase orders. Many of our
customers have the right to terminate orders by paying the cost of work in process plus a
related profit factor. Customers may cancel orders due to the cancellation of a budget or
for other reasons. As of December 31, 2005, purchase orders and contractual arrangements
decreased to approximately $12.7 million, compared with $19.4 million as of December 31,
2004. If we experience cancellations of pending contracts, terminations or reductions of
contracts in progress, we may not be able to convert our entire backlog into revenue. Any
further reduction in backlog will adversely affect our business, financial condition and
results of operations.

The loss of any of our
major customers would result in a loss of a significant amount of our revenues.

Two
of our customers, namely the government of an Asian Pacific country that awarded us
several projects and a customer located in Europe, accounted for 31% and 15% of our
revenues in fiscal 2005, respectively. We cannot be certain that these and other customers
will maintain the size of their respective purchase orders, or will not reschedule or
cancel existing purchase orders. We expect that sales of our products to relatively few
customers will account for a significant portion of our net revenues for the foreseeable
future. Consequently, the cancellation of an order from any one customer may have a
material adverse effect on our business.

5

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Because competition in
the market for our products is intense, we may lose market share, and we may be unable to
achieve or maintain profitability.

We
compete with numerous other contractors on the basis of product performance, price,
reputation, technical and managerial capability, product maintenance cost and
responsiveness to customers requirements. Our ability to successfully compete for
and retain such new projects and customers is highly dependent on technical excellence,
management proficiency, strategic alliances, cost-effective performance and the ability to
recruit and retain key personnel.

The
continuing consolidation of the global defense industry, which has decreased the number,
but increased the relative size and resources of our competitors, has resulted in
intensified competition. Some of the competitors which are the top-tier contractors for
competing products have substantially greater financial, marketing and other resources
than ours. These contractors compete with us in some cases by offering more aggressive
pricing and devoting greater resources to product marketing or development than we do.
This competition may result in lower prices or reduced demand for our products and a
corresponding reduction in our revenues that may impair our ability to maintain
profitability.

We rely on contracts with
governments and defense contractors entities that entail certain risks, all of
which may adversely affect our operations.

As
is the case with many companies that derive a substantial portion of their revenues from
government contracts for defense-related products, our business is subject to specific
risks, which include changes in governmental appropriations and national defense policies
and priorities, a change of government in the customers country, as well as
political changes or alterations in the governments policy regarding the issue of
export and import permits to various countries and the policies of specific governments to
favor local over foreign defense products suppliers. We may be negatively affected by one
or more of these factors.

Generally,
our contracts with governments may be terminated or suspended by such governments as a
result of factors which may not depend on us, including as a result of a decrease in the
defense budget, a decline in the military expenditures of governments, the cancellation or
a significant cutback of a large project in which we participate or as a result of
situations such as a state of war, force majeure or other circumstances seriously
disrupting the public safety, peace or good order of the customers country. Our
contracts with non-governmental military contractors sometimes contain similar provisions.
In cases in which we received advanced payments prior to incurring the cost of fulfilling
such contracts, we realized a positive project cash flow. Particularly, in the last
threeyears, we have received substantial advances under our contracts. In the
event of an early termination of a contract, we may be required to return a portion of
such advanced payment. Upon such early termination, we would, in most cases, be entitled
to reimbursement for our incurred contract costs and to payment of a proportionate share
of our fee or profit for the work actually performed. In order to reduce risks of
financial exposure resulting from an early termination of a contract, we attempt to
stagger funding for projects in accordance with the rate of performance and to ensure
ourselves from that risk by guaranteeing positive cash flow in the life cycle of the
program. If, however, we are not entitled to all or a portion of such compensation our
operations would be adversely affected.

6

---

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Our ability to export our
products is subject to approvals by Israeli and United States governmental agencies.

Our
export of military goods and information is subject to approval of SIBAT, the Foreign
Defense Assistance and Defense Export Organization of the Israel Ministry of Defense. To
date, we have received all required approvals from SIBAT, but there can be no assurance
that we will receive such approvals in the future or that the Israeli government will not
impose additional requirements on our manufacturing or export activities, which may
require us to incur additional substantial expenses or which may otherwise have a material
adverse effect on our operations. SIBATs policy has generally been to encourage the
export of military goods and knowledge; however, SIBAT generally does not permit sales to
countries that are in a state of war or hostility with Israel and countries which may
otherwise endanger the State of Israel.

We
purchase from manufacturers in the United States substantially all of the commercial
computers, a portion of the air combat maneuvering instrumentation pods hardware and
other off-the-shelf products, such as navigation systems, which we incorporate
into our products. The export of such components is subject to the approval of the United
States Department of Commerce and/or the United States Department of Defense, which often
restricts sales to certain countries. Following the events of September 11, 2001, we
experienced delays in the receipt of such required approvals. For example, we experienced
a delay in the delivery of several components of a system to a customer and incurred
additional costs, as a result of the need to modify such components, because of a delay in
the receipt of an export approval that has since been obtained. Further, there can be no
assurance that we will receive such approvals in the future or that the United States
Government will not impose additional requirements on our manufacturing or export
activity, which might require us to incur substantial expenses, and/or find and contract
with alternative suppliers in countries that do not impose similar export restrictions.

International political
and economic uncertainty could have an adverse impact on our business and on our operating results.

In
fiscal 2005, 94% of our total revenues came from foreign customers. We estimate that a
material portion of our revenues in 2006 will come from foreign customers. The
international political and economic uncertainty and the ongoing war on terrorism may
adversely impact our ability to maintain the level of our sales to our existing customers
located abroad and to develop new business in these and other foreign countries.

7

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We are exposed to
general, global economic and market conditions.

Our
business is subject to the effects of general economic conditions globally, and, in
particular, conditions in the market for simulation systems for military and civilian
applications. In recent quarters, our sales efforts have been adversely affected as a
result of unfavorable economic conditions. If the global economic slowdown continues, we
may continue to experience material adverse impacts on our business, operating results,
and financial condition.

Our contracts have a
fixed-price and payment thereunder is subject to timely accomplishment of milestones,
which may subject us to unfavorable terms.

The
majority of our contracts are for a fixed-price, meaning they are not subject to
adjustment for the costs incurred in the performance of the contract. Consequently, we
assume the risk that increased or unexpected costs may reduce our profits or generate a
loss. The risk can be particularly significant under a fixed-price contract involving
research and development with respect to new technologies.

The
majority of our contracts with our customers provide that after we receive an advance
payment at the commencement of a project, additional payments are payable upon progress or
achievement of specific milestones. In a majority of the projects, we are required to
provide performance guarantees in an amount equal to a specific percentage of the contract
price.

Most
agreements with our customers impose penalties or reduce the amount payable to us in the
event that the completion of a phase of a project is delayed. In addition, we are
generally responsible for the delays and defaults of our subcontractors. To mitigate our
risk, we attempt to impose liability on our subcontractors on a back-to-back
basis when such subcontractor is in delay or default which, in turn, could expose us to
liability pursuant to the main contract. However, we may not be able to obtain full
recovery for such liabilities from such subcontractors.

We
may encounter significant reduction in profits or incur losses as a result of one or more
of the above unfavorable terms.

We are controlled by Chun
Holdings LP which, in the aggregate, beneficially owns approximately of our outstanding
Ordinary Shares. Therefore, Chun is able to elect the majority of our directors and
exercise control over the outcome of matters requiring shareholders approval.

As
of March 31, 2006, Chun Holdings L.P., an Israeli limited partnership beneficially owned
an aggregate of 58,142,608 of our Ordinary Shares and an immediately exercisable warrant
to purchase an additional 10,864,444 of our Ordinary Shares (representing, assuming the
exercise of such warrant and assuming no other exercise of our convertible securities,
approximately 54.09% of our currently outstanding Ordinary Shares). As a result, Chun
controls the outcome of various actions that require our shareholder approval. For
example, Chun could elect most of our directors, delay or prevent a transaction in which
shareholders might receive a premium over the prevailing market price for their shares and
prevent changes in control or management.

8

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Because we operate in
international markets, we are subject to additional risks.

We
currently offer our products in a number of countries and a key component of our marketing
strategy is to continue to expand in foreign markets. Our business is subject to risks
which often characterize international markets, including:

| |  | economic
and political instability;
| | - | -----------------------------------

| |  | import
or export licensing requirements;
| | - | ----------------------------------------

| |  | difficulties
in collecting accounts receivable;
| | - | -----------------------------------------------

| |  | longer
payment cycles;
| | - | ----------------------

| |  | unexpected
changes in regulatory requirements and tariffs;
| | - | ----------------------------------------------------------

| |  | fluctuations
in exchange rates;
| | - | -------------------------------

| |  | potentially
adverse tax consequences; and
| | - | -----------------------------------------

| |  | potentially
weak protection of intellectual property rights.
| | - | ------------------------------------------------------------

These
risks may impair our ability to generate revenues from our overseas sales efforts, which
constitute the majority of our business.

Our profitability could
suffer if third parties infringe upon our proprietary technology.

Our
profitability could suffer if third parties infringe upon our intellectual property rights
or misappropriate our technologies and trademarks for their own businesses. To protect our
rights to our intellectual property, we rely on a combination of patent, trademark and
copyright laws, trade secret protection, confidentiality agreements and other contractual
arrangements with our employees, some of our affiliates, strategic partners and others. We
currently own five patents registered in the United States and three additional patents
registered in several other countries, along with several registered and pending
trademarks, filed in several countries. Several of these patents were also granted or
applied for in Israel and/or in several countries in Europe and worldwide. The protective
steps we have taken may be inadequate to deter misappropriation of our proprietary
information. We may be unable to detect the unauthorized use of, or take appropriate steps
to enforce, our intellectual property rights. Effective patent, trademark, copyright and
trade secret protection may not be available in every country, especially in Asia Pacific,
in which we offer, or intend to offer, our products. Any failure to adequately protect our
intellectual property could devalue our proprietary content and impair our ability to
compete effectively. Further, defending our intellectual property rights could result in
the expenditure of significant financial and managerial resources.

9

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Our products may infringe
on the intellectual property rights of others.

Third
parties may assert against us infringement claims or claims that we have violated a patent
or infringed a copyright, trademark or other proprietary right belonging to them. Any
infringement claim, even if not meritorious, could result in the expenditure of
significant financial and managerial resources.

# Risks Relating to Our
Location in Israel

Conditions in Israel
affect our operations and may limit our ability to produce and sell our products.

We
are incorporated under Israeli law and our principal offices, research and development and
manufacturing facilities are located in the State of Israel. Political, economic and
military conditions in Israel directly affect our operations. Since the establishment of
the State of Israel in 1948, a number of armed conflicts have taken place between Israel
and its Arab neighbors, and the continued state of hostility, varying in degree and
intensity, has led to security and economic problems for Israel. Since
September 2000, the violence between Israel and the Palestinians has continued with
varying levels of severity into 2006. Israel has experienced terrorist incidents within
its borders, including in the West Bank and Gaza Strip. As a result, negotiations between
Israel and representatives of the Palestinian Authority ceased. The election of
representatives of the Hamas militant group in January 2006 to a majority of seats in the
Palestinian Legislative Council may create additional unrest and uncertainty in the
region. We could be adversely affected by hostilities involving Israel, the interruption
or curtailment of trade between Israel and its trading partners, or a continuous downturn
in the economic or financial condition of Israel. In addition, several countries continue
to restrict business with Israel and with companies having operations in Israel. We could
be negatively affected by adverse developments in the peace process, including the recent
violence, or by restrictive laws or practices directed towards Israel or Israeli
exporters.

Like
all male adult citizens and permanent residents of Israel, our directors, officers and
employees who are under the age of 40, unless exempt, are obligated to perform up to 36
days of military reserve duty annually. Additionally, all such residents are subject to
being called to active duty at any time under emergency circumstances. Some of our
officers and employees are currently obligated to perform annual reserve duty. No
assessment can be made as to the full impact of such requirements on our workforce or
business if conditions in Israel should change, and no prediction can be made as to the
effect of any expansion or reduction of such military obligations on us. See Item 4. Information on the Company  B.
Business Overview Conditions in Israel.

10

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Our operations may be
affected by negative economic conditions in Israel.

In
recent years, Israel has experienced periods of recession in economic activity, resulting
in low growth rates and growing unemployment. Our operations could be adversely affected
if the economic conditions in Israel deteriorate. In addition, due to significant economic
measures proposed by the Israeli government, there have been several general strikes and
work stoppages in 2003 and 2004, affecting all banks, airports and ports. These strikes
have had an adverse effect on the Israeli economy and on business, including our ability
to deliver products to our customers or to receive raw materials from our suppliers in a
timely manner. From time to time, the Israeli trade unions threaten strikes or
work-stoppages, which may, if carried out, have a material adverse effect on the Israeli
economy and our business.

If we are considered to
be a passive foreign investment company, either presently or in the future, U.S. Holders
will be subject to adverse U.S. tax consequences.

We
will be a passive foreign investment company, or PFIC, if 75% or more of our gross income
in a taxable year, including our pro rata share of the gross income of any company, U.S.
or foreign, in which we are considered to own, directly or indirectly, 25% or more of the
shares by value, is passive income. Alternatively, we will be considered to be a PFIC if
at least 50% of our assets in a taxable year, averaged over the year and ordinarily
determined based on fair market value, including our pro rata share of the assets of any
company in which we are considered to own, directly or indirectly, 25% or more of the
shares by value, are held for the production of, or produce, passive income. If we were to
be a PFIC, and a U.S. Holder does not make an election to treat us as a qualified
electing fund, or QEF, or a mark to market election, excess
distributions to a U.S. Holder, and any gain recognized by a U.S. Holder on a
disposition or our ordinary shares, would be taxed in an unfavorable way. Among other
consequences, our dividends would be taxed at the regular rates applicable to ordinary
income, rather than the 15% maximum rate applicable to certain dividends received by an
individual from a qualified foreign corporation. The tests for determining PFIC status are
applied annually and it is difficult to make accurate predictions of future income and
assets, which are relevant to the determination of PFIC status. In addition, under the
applicable statutory and regulatory provisions, it is unclear whether we would be
permitted to use a gross loss from sales (sales less cost of goods sold) to offset our
passive income in the calculation of gross income. In light of the uncertainties described
above, we have not obtained an opinion of counsel with respect to our PFIC status and no
assurance can be given that we will not be a PFIC in any year. If we determine that we
have become a PFIC, we will then notify our U.S. Holders and provide them with the
information necessary to comply with the QEF rules. If the IRS determines that we are a
PFIC for a year with respect to which we have determined that we were not a PFIC, however,
it might be too late for a U.S. Holder to make a timely QEF election, unless the U.S.
Holder qualifies under the applicable Treasury regulations to make a retroactive (late)
election. U.S. Holders who hold ordinary shares during a period when we are a PFIC will be
subject to the foregoing rules, even if we cease to be a PFIC in subsequent years, subject
to exceptions for U.S. Holders who made a timely QEF or mark-to-market election.

11

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We benefit from
government programs and tax benefits that may be discontinued or reduced.

We
have received grants and are entitled to tax benefits under Government of Israel programs.
In order to maintain our eligibility for these programs and benefits, we must continue to
meet specified conditions, including making specified investments in fixed assets and
paying royalties with respect to grants received. In addition, some of these programs
restrict our ability to manufacture particular products or transfer particular technology
outside of Israel. If we fail to comply with these conditions in the future, the benefits
received could be cancelled and we could be required to pay increased taxes. The
Government of Israel has reduced the benefits available under these programs in recent
years, and these programs and tax benefits may be discontinued or curtailed in the future.
If the Government of Israel ends these programs and tax benefits, our business, financial
condition and results of operations could be adversely affected.

Because a substantial
portion of our revenues is generated in U.S. Dollars and a portion of our expenses is
incurred in New Israeli Shekels, our results of operations may be seriously harmed if
the rate of inflation in Israel exceeds the rate of devaluation of the New Israeli
Shekel against the U.S. Dollar.

We
generate a substantial portion of our revenues in dollars, but we incur a portion of our
expenses, principally salaries and related personnel expenses, 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 dollar or that the timing of
this devaluation lags behind inflation in Israel. In 2005, the rate of inflation together
with the devaluation of the dollar in relation to the NIS improved our dollar-linked
results of operations. In case the rate of inflation in Israel will exceed the rate of
devaluation of the NIS in relation to the dollar or that the timing of this devaluation
lags behind inflation in Israel, our dollar-linked results of operations will be adversely
affected.

12

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Provisions of Israeli law
may delay, prevent or make difficult and acquisition of us, which could prevent a change
of control and therefore decrease the price of our shares

Provisions
of Israeli corporate and tax law may have the effect of delaying, preventing or making
more difficult a merger with, or other acquisition of, us. This could cause our ordinary
shares to trade at prices below the price for which third parties might be willing to pay
to gain control of us. Third parties who are otherwise willing to pay a premium over
prevailing market prices to gain control of us may be unable or unwilling to do so because
of these provisions of Israeli law. See Management  Approval of Related Party
Transactions under Israeli Law for additional information about some anti-takeover
effects of Israeli law.

It may be difficult to
enforce a U.S. judgment against us, our officers and directors named in this annual
report or to assert United States securities laws claims in Israel or serve
process on our officers.

We
are incorporated in the State of Israel. All of our executive officers and directors named
in this annual report are not residents of the United States, and a substantial portion of
our assets and the assets of these persons are located outside the United States.
Therefore, it may be difficult to enforce a judgment obtained in the United States based
upon the civil liabilities provisions of the United States Federal securities laws against
us or any of those persons or to effect service of process upon these persons in the
United States. Additionally, it may be difficult to enforce civil liabilities under United
States federal securities laws in original actions instituted in Israel.

Your rights and
responsibilities as a shareholder will be governed by Israeli law and differ in some
respects from the rights and responsibilities of shareholders under U.S. law.

We
are incorporated under Israeli law. The rights and responsibilities of the holders of our
Ordinary Shares are governed by our articles of association and by Israeli law. These
rights and responsibilities differ in some respects from the rights and responsibilities
of shareholders in typical U.S. corporations. In particular, a shareholder of an Israeli
company has a duty to act in good faith toward the company and other shareholders and to
refrain from abusing his power in the company, including, among other things, in voting at
the general meeting of shareholders on certain matters. See Item 10. Additional
Information  B. Memorandum and Articles of Association.

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

|A. | History
and Development of the Company
|-- | --------------------------------------

B.V.R.
          Systems (1998) Ltd., an Israeli company, was formed in January 1998 to receive
          all of the assets and liabilities of the defense-related business of BVR
          Technologies Ltd., or BVR-T, in accordance with the terms of a reorganization
          plan. The reorganization plan was consummated, and BVR commenced operations as
          an independent company in October 1998, effective as of January 1,
          1998. Our principal executive offices and research and development facilities
          are located at 16 Hamelacha Street, Afek Industrial Park, Rosh Haayin
          48091, Israel, and our telephone number is 972-3-900-8000. Our manufacturing
          facilities are located in Ashdod, Israel. Our wholly-owned subsidiary, BVR-S
          Pacific PTE, which is incorporated under the laws of Singapore, is located in
          Singapore.

In
2003, there was a change in control of the Company. See Item 7  Major
Shareholders and Related Party Transactions  B. Related Party Transactions for
more information.

In
February 2006, we entered into a non-binding term sheet for the acquisition of all of the
shares of the U.S.-based corporation Blue Ridge Simulation, Inc. (BRS). BRS is a
privately-held supplier of high-performance radar simulators for the U.S. Department of
Defense, commercial and international training applications. In consideration, BVR will
pay up to five million dollars in the combined form of BVRs shares and cash
payments. The closing of this transaction is subject to our due diligence review of BRS,
the execution of definitive transaction documents and the receipt of customary third-party
and regulatory approvals.

In
March 2006, H.S.N General Managers Holdings L.P. (or HSN), an Israeli limited partnership
led by Mr. Nir Dor invested $3.6 million in our share capital in consideration for the
issuance of 20,000,000 Ordinary Shares, representing approximately 17% of our issued share
capital, at a price per share of $0.18. In connection with this investment, HSN was issued
three separate warrants for the purchase of 6,000,000 of our Ordinary Shares per each
warrant, with exercise prices of $0.36, $0.54 and $1.00, exercisable for a period of three
years, with a mandatory exercise mechanism under certain conditions. Pursuant to this
investment, Mr. Dor was appointed to serve as a member of our board of directors and shall
be entitled to continue to serve on the board, either personally or to nominate a
representative on his behalf for such time that the Israeli limited partnership holds at
least nine percent of our outstanding share capital.

Our
web site is www.bvrsystems.com. Information on our web site is not incorporated by
reference in this annual report.

# Capital Expenditures

Since
January 1, 2003, our capital expenditures amounted to approximately $0.7 million. The
focus of our capital expenditure program primarily included investment in computers and
electronic equipment.

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

BVR is engaged in the military
training and simulation industry. According tothe international business
consulting firm of Frost & Sullivan, the overall market size of our industry is
estimated to be approximately $8 billion per year. The overall market can be divided into
various training methods, including live and embedded training; virtual training
(simulators); and constructive training. Each of these training methods can be further
sub-divided into applications for air, ground and navalsystems.

# General

We
are engaged in the development, manufacture, marketing and sale of sophisticated training
and simulation systems for military and civilian applications. We are currently engaged in
the following areas:

| |  | Live
and Embedded training systems:
| | - | -----------------------------------

| |  | On-Board,
Combat Training Systems such as the "Ehud(TM);" Air Combat Maneuvering Instrumentation,
or ACMI, Naval                            Combat Instrumentation System, or NCMI; and
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Embedded
simulation systems such as Embedded Virtual Avionics or EVA, and In-Flight Electronic
Warfare Simulation, or IFEWS.
| | - | ----------------------------------------------------------------------------------------------------------------------------

| |  | Virtual
and Constructive Training systems, such as:
| | - | ---------------------------------------------------

| |  | Flight
simulators for fighter aircraft, helicopters, trainer aircraft, unmanned aerial vehicles;
| | - | ------------------------------------------------------------------------------------------------

| |  | Armored
& Gunnery Simulators and Infantry Simulators; and
| | - | ---------------------------------------------------------

| |  | Naval
Tactical Trainers, or NTT, and Action Speed Tactical Trainers, or ASTT
| | - | ----------------------------------------------------------------------------

Our
products offer advanced, highly effective and cost-efficient solutions to operational and
tactical training needs. Our products are based on a complete training philosophy, which
enables our customers to reduce the amount of actual military equipment used in training
while enhancing the quality of the training exercises, thereby significantly reducing the
risks associated with actual operations and training in a live operational scenario. In
addition, our military products improve the operational capabilities of armed forces
through enhanced command and control in the battlefield and integration between fighting
units.

# Our Product Offerings

We
continuously design, develop and market new generation technologies for live, embedded,
virtual and constructive training. The advances we made in the field reflect our vast
experience, unique approach to technological innovation and our drive to singularly
fulfill the needs of our global military customers.

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# Live and Embedded
Training

Our
live and embedded training systems are designed to improve real-time management,
monitoring, training, safety and debriefing for live training exercises and operations
carried out by modern air, naval and ground forces. The on-board training product line
includes the following systems:

Ehud ACMI

Air Combat Maneuvering
Instrumentation

The
Ehud air combat maneuvering instrumentation, or ACMI, system is a complete on-board,
autonomous training and safety suite. This system is designed to enhance the airborne
training of an aircraft crew on a wide variety of missions.

Ehud
offers a unique combination of range-less, real-time and post-flight training and
debriefing systems together with safety warnings and operational capabilities. The system
is effective for air-to-air, air-to-ground and electronics warfare pilot training with an
unlimited number of participants due to our patented datalink protocol which dynamically
auto-adapts the data exchange rate according to the actual number of participants in the
network.

The
EhudACMI system includes features such as mid-air and ground collision warning
systems, which significantly enhance training safety. The Ehud ACMI system has been
flying operationally since 1994 and has been delivered to many leading air forces around
the world.

Naval Combat
Instrumentation System

Our
naval combat maneuvering instrumentation, or NCMI, is a full-scale on-board training
system. The system enables the conduct of both live field training sessions at sea
and constructive war-gaming exercises ashore.

The
basic concept behind our NCMI is the deployment of a distributed embedded simulation
system on-board an instrumented ship and a maritime patrol aircraft.

Our
NCMI system supports the debriefing, analysis, and evaluation of naval warfare exercises
at all command levels.

Our
NCMI system supports various training levels ranging from operators training at
console level, through sub-team and team training, and up to full fleet training. Our NCMI
system provides training in tactical simulators and enhances the reality of seaborne
exercises through the use of computer generated forces integrated with live exercises.
Typically, the exercise is coordinated between the participants via a datalink system,
which supports the creation of a distributed simulation network.

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# Embedded Simulation

We
are currently marketing a wide range of embedded simulation solutions. These advanced
solutions are an outcome of the synergies gained from the combination of on-board training
and simulation technologies. With vast experience in these two fields, we believe that we
are well positioned to play a leading role in this evolving market.

Embedded Virtual Avionics
Suite, or EVA

Our
Embedded Virtual Avionics Suite, or EVA, is a state-of-the-art embedded simulation suite,
installed on basic or advanced trainer aircraft, transforms training aircraft into virtual
advanced fighter aircraft. A training aircraft equipped with EVA may offer capabilities
such as virtual sensors and weapons, in-flight live or virtual target threats, operational
scenarios of gradually increasing complexity, full debriefing capabilities and flight
safety features. Our proprietary EVA technology is based on a patent owned by us and
registered in numerous countries, including the United States and several European
countries.

An
EVA standard training aircraft is equipped or refitted to replicate the cockpit and
avionics instrumentation panel of specifically targeted advanced fighters. The refitted
trainers will resemble the behavior, displays and controls of the advanced fighter sensors
(such as air-to air radar, air to ground radar and radar warnings receiver, which is part
of the electronic warfare suite of most advanced fighters and seekers) and weapon systems.
Pilots flying the EVA-fitted trainer benefit from a real-time feel and capabilities of the
simulated advanced fighter aircraft. The system offers features such as collision
avoidance and hazard warning.

To date, we have made no sales of our
EVA system.

In-Flight Electronic
Warfare Simulation, or IFEWS

Our
in-flight electronic warfare simulator, or IFEWS, is a complete, autonomous,
on-board threat-environment training and safety suite. The system is an embedded simulator
for the training and debriefing of electronic warfare, or EW, scenarios, simulating the
real EW systems in an aircraft. IFEWS provides a virtual EW range and includes our
post-flight debriefing capabilities.

Our
IFEWS generates a wide range of on-board simulation of virtual ground and airborne
threats. The virtual range, created and managed by the IFEWS computer, authentically
simulates the characteristics, behavior and interactions of both the threatening weapon
systems and the aircrafts self protection suite. Our system is tightly coupled to
the aircrafts existing EW suite. IFEWS simulates all relevant modes of weapon
system, including optical tracking modes and other modes not received by the airborne EW
suite.

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After
landing, our PC-based ground station provides advanced After-Action Review and debriefing
with a 3D analysis of crew performance, all weapon engagements, safety events and mission
scenarios.

Based
on the legacy of the Ehud ACMI systems, IFEWS provides multiple
features including: real-time training, realistic virtual threats, safety elements and
debriefing capabilities.

In
the first quarter of 2002, we completed preliminary flight tests with the Israel Air
Force, and we conducted further demonstration flight tests with the Israel Air Force
during the remainder of 2002.

In
2005, we received a follow on order from the Israel Air Force for the installation of
IFEWS systems on its CH-53 and C-130 Fleets.

# Virtual and Constructive
Training

We
provide flight, naval and ground forces simulators for various platforms, electronics and
weapon systems. Our line of simulators covers a full range of training scale, from basic
procedural training to combat mission training and full mission training. Our simulators
support the high level architecture world-wide standard for simulators connectivity
delivering the capacity to perform sophisticated distributed mission training by
communicating and training with other simulators and training devices. Our product
offerings include:

| |  | Flight
Simulators;
| | - | ------------------

| |  | Ground
Forces Simulators;
| | - | -------------------------

| |  | Naval
Simulators; and
| | - | ---------------------

| |  | Weapon
and Electronic Systems Simulators
| | - | ----------------------------------------

Flight Simulators

Fighter
Aircraft Simulators.We have developed and manufactured fighter aircraft simulators
for numerous aircrafts, including the F-16C, F-16D, F-15, F-5, A-4 and Mirage-2000.

Full
Mission Simulators.Our full mission simulators provide training for all aspects of a
missions flight and procedures, including sophisticated weapon system simulations,
sensors and full standard and emergency procedure training. These simulators encompass a
high-fidelity cockpit replica and a large variety of visual systems covering a field of
view of up to 360°.

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We
use high-end computers and personal computers, or PCs, as image generators to provide the
trainee with a high-resolution, fully-textured outside world visual presentation, based on
satellite imagery and three dimensional targets and shapes.

Our
full mission simulators provide pilots with complex tactical training, using multiple
computer generated forces, such as air, land, or sea participants.

Trainer
Aircraft Simulators.We developed and manufactured trainer aircraft simulators for
numerous aircraft, including the PC-7, MB-339 and Fouga Magister.

AMOS
 Cadet Screening Simulator.Our AMOS cadet screening and basic flight training
simulator has been developed for the Israel Air Force Fouga Magister trainer.

Our
system provides a methodology for the analysis of cadets learning abilities, through
screening while training.

Helicopter
Full Mission Simulator.

We
developed and manufactured helicopter simulators for helicopters, including the AS-550.

Our
full mission simulators for helicopters are offered for assault and fully armed attack
helicopter simulation. The simulators are offered in a number of configurations, from a
limited front view outside world imagery to a full dome display. The full dome display
configuration includes a full-size cockpit replica for two pilots with a three channel
high-resolution full color outside world display. The resulting imagery fidelity level
enables the system to perform low flying missions and weapon deployment simulation. The
system is capable of simulating typical helicopter flights and attacks, including a full
range of malfunctions and emergency procedures. Our simulators also provide for tactical
training as the trainee can fly against user pre-programmed computer generated forces.

Unmanned Air Vehicle
Mission Simulators

We
developed and manufactured an unmanned air vehicle, or UAV, and tactical mission
simulators for tactical UAV, for both the external pilot and the internal mission crew.

Our
UAV mission simulator supports training on near-to-real-life quality imaging systems for
the entire crew. Training can be executed both individually and as a team.

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Armor and Gunnery
Simulation Systems for Ground Forces

Integrated
Tactics and Armor Combat Trainer. Our integrated tactics armor and weapon system
vehicle combat trainer, or INTACT system, fulfills the need for effective training,
debriefing and evaluation of army units. Our INTACT system was developed by experienced
army officers. INTACT is a multi-station armor and weapon vehicle tactical simulator
system. Our INTACT system provides training that ranges from individual level to combat
team multi-participant tactical exercises.

Our
INTACT system provides training levels from individual precision gunnery to combat team
multi-participant exercises and beyond. The training can include unlimited combinations of
manned and computer generated forces. The INTACT system fills the need for effective
training, debriefing and evaluation of ground forces. Our INTACT system simulates virtual
forces and integrates their actions with real forces, adding value to performance and
cost-effective training.

Naval Simulators

We
developed a diversified product line of naval simulators based on dedicated replica
workstations and sophisticated visual images provide system training for operators and
officers. We specialize in quick responses to requests for unique tailor-made systems from
a wide range of naval customers.

Naval Tactical Trainer

Our
naval tactical trainer, or NTT, is a complete tactical training system providing a
solution for all shore-based tactical training needs. Our NTT is in operational use by the
Israel Navy at its main training base. Our NTT is used for the tactical training of
principal war officers and combat information center officers. In several regions of the
world, this product is also referred to as the Action Speed Tactical Trainer or ASTT.

Our
weapon and avionic systems simulators provide a unique training device for the training of
operators in highly specialized operational tasks. Products delivered to our customers
include the LANTIRN simulator used to train pilots to fly with the LANTIRN pod, and our
weapon systems trainer used to train the weapon systems officer in the many tasks required
to operate and successfully deliver todays complex weapon to the designated target.

# Raw Materials

The
raw materials used for our on-board training systems and our embedded simulation systems
include our own software and commercial off-the-shelf, or COTS, hardware that we purchase
from various suppliers. This COTS hardware includes computer boards, navigational systems,
communication systems and antennae. Due to the competitive nature of the market for these
COTS raw materials, the prices for such raw materials are not considered volatile. In some
countries, however, such raw materials are controlled items and thus, prior to export,
require the issuance of an export license.

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The
following table sets forth, for the period indicated, our consolidated revenues by product
line expressed as a percentage of total revenues.

|                                    | 2001 | 2002 | 2003 | 2004 | 2005
|----------------------------------- | ---- | ---- | ---- | ---- | ----
|
|
|
|
|Live and Embedded Training Systems  |      |      |      | 68   | %   
|Virtual and constructive Simulators |      |      |      | 32   | %   
|Total                               |      |      |      | 100  | %   

# Strategic Relationships

Israel Aircraft
Industries Ltd

From
1992 to 1997, we developed, manufactured and marketed the Ehud ACMI systems pursuant
to a joint venture agreement entered into in 1992 with MLM Systems Engineering &
Integration, or MLM, a division of Israel Aircraft Industries Ltd., or IAI. Pursuant to this agreement, IAI and us agreed to jointly develop, manufacture and
market the Ehud ACMI systems, with IAI subcontracting some of the manufacturing and
integration work with respect to the Ehud product. Following the expiration of the
term of the agreement, various claims were alleged by both IAI and us regarding the
performance of mutual obligations pursuant to the agreement and thereafter. In an ex parte
proceeding filed by IAI, the District Court of Tel Aviv issued in February 1999 a
temporary injunction preventing us from replacing IAI as our subcontractor in a project
for the German Air Force.

In
August 1999, we entered into a cooperation agreement with MLM, which brought an end to
these legal proceedings and established terms for cooperation between the two companies
with respect to the marketing of the Ehud ACMI systems; and in August 2005, we
entered into an additional cooperation agreement with MLM to resolve all other outstanding
disagreements that had remained prior to the signing of this agreement.

The
cooperation agreement of 2005 relates to cooperation with respect to the worldwide
marketing and sale of the Ehud System, R/C and LDN systems, the NCMI System and Electronic
Warfare Training Ranges.

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Ehud
System.The agreement provides for specific territories in which either
we or MLM shall have the exclusive right to act as the leading party and the other party
shall not compete with the leading party in such territories. The leading party shall pay
royalties to the other party at a rate of 5% of the total consideration it receives for
Ehud System projects in such territories. In other territories the parties have agreed to
a cooperation arrangement pursuant to which one party shall act as the prime contractor
and the other shall act as subcontractor, and each party shall provide its own proposal
relating to its part of the project. Any difference in price above the joint proposal
shall be equally shared between the parties. The royalties arrangement shall apply in
territories not specifically mentioned and agreed upon between the parties.

R/C
and LDN.In the event of agreements in connection with our R/C system or
MLMs LDN system to a specific customer, the relevant party shall pay the other party
royalties at the rate of 5% of the total consideration. The parties have agreed not to
compete with each other with the R/C system and the LDN system in respect of such
customer.

NCMI
System. We have agreed to provide MLM, within a reasonable time after the execution of
the agreement, with our existing NCMI infrastructure as a technological base in order to
enable MLM to continue the development of the NCMI system, in consideration for royalties
at the rate of 4% of the consideration of any agreement entered into between MLM and a
customer in respect of a NCMI system. We have also granted MLM a non transferable license,
for the term of the agreement for use of our NCMI infrastructure in certain territories
provided we provide up to 30% of the scope of work in such projects. In other territories
we have agreed on a cooperation arrangement in which the prime contractor shall receive
70% of the consideration and the subcontractor 30% of the consideration and in the event
the subcontractor is granted less than 30% it is compensated at a rate of 1% of the total
consideration for each 4% of the total consideration not subcontracted to the other party.

Electronic
Warfare Training Range. It was agreed that in agreements for the supply of Electronic
Warfare Training Ranges in specific agreed territories MLM shall serve as the prime
contractor and shall enter into a subcontracting agreement with us providing us 30% of the
scope of work.

The
cooperation agreement is valid for ten years and replaced all prior agreements between the
parties relating to its subject matters.

# Other Strategic
Agreements

In
March 2003 and January 2004, we entered into a memorandum of understanding and a Teaming
Agreement with two United Kingdom-based companies, respectively, for cooperation in the
marketing and sales of our naval training systems to the UK and another European country.

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# Marketing

We
actively seek to identify and propose solutions for military training and simulation needs
of the current and prospective customers. Our research and development activities focus on
systems designed to meet specific needs we identified. We market our products, either as a
prime contractor or as a subcontractor, to various governments and defense contractors
throughout the world directly and through joint ventures, agents or representatives. We
have entered into cooperation agreements with a number of defense contractors, which
provide for joint participation in pursuit and performance of contracts in certain
countries.

In
June 1998, we formed a subsidiary in Singapore, BVR-S Pacific PTE, through which we
support our operations in Singapore.

The
following table sets forth the amount of our revenues, for the periods indicated, by
geographic regions:

|             | Year Ended December 31,
|------------ | -----------------------
|
|
|
|
|Sales        |                        
|Israel       |                        
|Asia Pacific |                        
|Europe       |                        
|America      |                        
|Africa       |                        
|             |                        
|Total        |                        
|             |                        

# Customers

Currently,
all of the end-user customers of our products are governments or major defense companies
regulated by government agencies.

Although
the composition of our customers has changed from year to year, and revenues from
individual customers are subject to material increases and decreases depending on customer
requirements, a customer located in Europe accounted for approximately 31% of our revenues
in fiscal 2005, 2% of our revenues in 2004 and 1% of our revenues in 2003 and represented
0% of our backlog. A customer located in America accounted for approximately 11% of our
revenues in fiscal 2005 and 34% of our revenues in 2004 and 6% of our revenues in 2003,
and represented approximately 3% of our backlog. One of our customers located in Asia
Pacific accounted for approximately 15% of our revenues in fiscal 2005, 27% of our
revenues in fiscal 2004 and 58% of our revenues in fiscal 2003, and represented
approximately 16% of our backlog as of December 31, 2005. Another customer located in
Asia Pacific accounted for approximately 14% of our revenues in fiscal 2005, 0% of our
revenues in fiscal 2004 and 2% of our revenues in fiscal 2003 and also represented
approximately 10% of our backlog as of December 31, 2005. We expect that sales of our
products to a small number of customers will continue to account for a substantial
percentage of our net revenue in the foreseeable future.

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# General Financial
Considerations for Projects

A
significant majority of our contracts are fixed-price contracts, as opposed to
cost-plus-type contracts. Under fixed-price contracts, the price is generally not subject
to adjustment for costs actually incurred in the performance of such contract. Under such
fixed-price contracts, we assume the risk that increased or unexpected costs may reduce
our profits or generate a loss.

There
are various types of financing terms applicable to defense contracts. In most cases, after
we receive advance payment at the commencement of a project, we receive progress or
milestone payments according to a percentage of cost incurred in performance or
achievement of a specific milestone. In these projects we are required to provide a bank
guarantee in an amount equal to the payments. In a majority of projects, we are required
to provide performance guarantees in an amount equal to a specific percentage of the
contract price. A portion of our agreements with customers contains clauses that impose
penalties or reduce the amount payable to us in the event that the completion of a phase
of work is delayed. We are generally responsible for the delays and defaults of our
subcontractors. Accordingly, we attempt to impose liability on our subcontractors on a
back-to-back basis when delay or default under a contract could expose us to
liability.

Our
contracts with governments generally may be terminated or suspended as a result of factors
which may not depend on us, such as a state of war, force majeure or other circumstances
seriously disrupting the public safety, peace or good order of the customers
country. Our contracts with non-governmental military contractors sometimes contain
similar provisions. In cases in which we receive advanced payments prior to incurring the
cost of fulfilling the contract, we realize a positive project cash flow. In the last
three years, we received substantial advances from our customers under a portion of our
contracts. In the event that a contract under which an advance or progress payment has
been paid is cancelled, we may be required to return a portion of such payments to the
customer. In general, in order to reduce risks of financial exposure resulting from an
early termination of a contract, we attempt to expend funds for projects in accordance
with the rate of performance. Upon such termination, we would, in most cases, be entitled
to reimbursement for incurred contract costs and to payment of a proportionate share of
our fee or profit for the portion of such contract that was actually performed. If,
however, we are not entitled to all or a portion of such compensation, our operations
would be adversely effected. In certain cases, when possible, we insure ourselves against
such risks.

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# Manufacturing and
Suppliers

We
develop the majority of the software and hardware for our products at research and
development facilities in two locations in Israel. We manufacture cockpit replicas, turret
replicas and other hardware components and perform hardware integration, systems assembly,
and quality assurance testing at our manufacturing facilities in Ashdod, Israel. We
purchase components for the systems manufactured, including commercial computers,
integrated circuits, circuit boards, sheet metal fabricated into subassemblies and
cabinets, power supplies, television monitors and floppy disc drives. Many of the
purchased components are manufactured based on our designs and specifications. Most
materials and purchased components are generally available from a number of different
sources.

# Competition

We
operate in a competitive environment with respect to most of our products. The defense
industry has been characterized in recent years by a consolidation of companies, which has
decreased the number, but increased the relative size and resources of competitors.
Competition is based on price, product performance, reputation, reliability, maintenance
costs and responsiveness to customer requirements, including the ability to respond to
changing technology. Some of the companies with which we compete, such as divisions of
Thales, Lockheed-Martin, L-3 Communications, Cubic, IAI (in some countries), Elbit Systems
and CAE, have substantially greater financial, marketing and other resources than ours and
have the ability to develop and market products competitive with ours. We believe that our
products favorably compete with those of our competitors based on their technological
capabilities, price/performance ratio, proven track record and common technological
platform. We also believe that our competitive advantage is in our relatively small size
that enables us to be more flexible and responsive to customer requirements than our
larger competitors. In addition, we typically have lower overhead costs than our larger
competitors.

# Research and Development

The
majority of our research and development activity is performed as an inherent part of our
various projects. In addition, we believe that continued and timely development of new
products and enhancements to existing products is necessary to compete effectively.
Accordingly, through our ongoing and extensive research, development and engineering
activities, we devote a portion of our resources to: (i) sustaining and upgrading our
existing products by improving serviceability and adding new capabilities and features,
(ii) decreasing the cost of owning and operating such products,
(iii) maintaining close relationships with our customers to identify their product
needs, (iv) developing new products with improved capabilities to address such needs
and other military training, debriefing and communications needs identified by us,
(v) adapting our products to new evolving technologies that can lower the costs of
our products; and (vi) tailoring our products to meet the specific needs of our
customers.

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Our
internally financed expenditures for all research and development programs during fiscal
2005, 2004 and 2003 totaled approximately $0.6 million, $0.3 million and $0.7 million,
respectively, and represented 3%, 2% and 5% of our revenue, respectively. Royalty-bearing
grants received in the past from the Office of the Israeli Chief Scientist, or OCS, for
research and development were offset against our research and development costs. In fiscal
2005, 2004 and 2003, we did not receive any grants from the OCS. We expect that we will
continue to commit resources to research and development in the future

# Intellectual Property

In
order to protect our proprietary rights and technology used in our products, we rely
primarily upon a combination of patent, trademark and copyright laws, trade secret
protection, confidentiality agreements and other contractual arrangements with our
employees, some of our affiliates, partners, customers and others.

BVR-T
was granted five United States patents relating to the collision warning and the data link
features incorporated in our Ehud systems, the animation technology incorporated in
our simulators and our airborne avionics simulator technology. Several of these patents
were also granted or applied for in Israel and/or in specific countries in the European
Community and worldwide. As part of the reorganization plan that controlled our spin off
from BVR-T, BVR-T granted us co-ownership rights to all patents, pending patent
applications, trademarks and other intellectual property rights held by BVR-T with respect
of its defense-related business. See Item 7  Major Shareholders and Related
Party Transactions  B. Related Party Transactions  Relationship Between BVR-T
and Us. As of the date of this report, we own all the intellectual property rights,
including the rights to all patents, pending patent applications and trademarks, held by
BVR-T with respect to its defense-related business. In January 2003, BVR-T and we entered
into a technology transfer and assignment agreement pursuant to which we purchased from
BVR-T all rights, title and interest to all patents that were jointly owned by the
parties, in consideration for $12,000.

Our
trademark Atas, was registered in Israel, Europe and Turkey. Our trademark
Ehud, jointly-owned with IAI, was recently registered in several
AsianPacific countries, and we have applied for its registration in Israel, the
European Community and several other foreign countries.

As
part of our cooperation agreement with IAI, IAI and us have each granted the other party a
license to use all patents and other intellectual property rights owned by the other party
relating to the Ehud ACMI system, as is required to enable such party to exercise
its rights under the cooperation agreement. We further agreed to jointly own with IAI the
trade name Ehud. See Item 4  Information on the Company  B.
Business Overview  Strategic Relationship.

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We
also rely on unpatented proprietary know-how, copyrights and trade secrets, and employ
various methods, including confidentiality agreements with employees, consultants and
others, to protect our trade secrets and know-how. These methods, however, may not afford
complete protection and we cannot be sure that others will not independently develop our
trade secrets and know-how or obtain access thereto.

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

We
are controlled by Chun Holdings L.P., which, assuming the exercise of its warrants to
purchase 10,864,444 Ordinary Shares and assuming no other exercise of our convertible
securities, beneficially owns 64.16% of our currently outstanding Ordinary Shares.

We
hold 100% of the issued and outstanding share capital of BVR-S Pacific PTE, which is
incorporated under the laws of Singapore.

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

Our
executive offices and research and development facilities are located in Rosh
Haayin, Israel. At this location, in 2005, we leased approximately 2,539 square
meters of office space at a monthly rent of approximately $22,825. This lease will expire
on September 14, 2009. See also Note 16B to our Consolidated Financial Statements.

We
lease approximately 875 square meters of manufacturing facilities in Ashdod, Israel for a
monthly rent of approximately $10,000. This lease will expire on October 31, 2007.

We
believe that our facilities are suitable and adequate for our operations as currently
conducted. In the event that additional facilities will be required, we believe that we
could obtain such facilities at commercially reasonable rates.

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

The
following discussion of our financial condition and results of operations should be read
in conjunction with the Consolidated Financial Statements and the related notes included
elsewhere in this annual report. This discussion contains forward-looking statements
that involve risks and uncertainties. Our actual results may differ materially from those
anticipated in these forward-looking statements as a result of certain factors, including,
but not limited to, those set forth in Item 3. Key Information D. Risk
Factors.

# General

We
are engaged in the development, manufacture and marketing of sophisticated training and
computer-based simulation systems for military applications.

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Most
of our revenues are generated in U.S. Dollars, and a significant proportion of our
expenses is incurred in U.S. Dollars, or is linked to the U.S. Dollar. Consequently, we
use the U.S. Dollar as our functional currency. Transactions and balances originally
denominated in U.S. Dollars are presented in the financial statements in their original
amounts, and non-dollar transactions and balances have been translated into U.S. Dollars
using the exchange rates in effect on the date of a transaction or balance. Our
Consolidated Financial Statements have been prepared in accordance with Israel GAAP.
Israel GAAP, as applicable to our financial statements, differs in certain significant
respects from U.S. GAAP. See Note 21 to our Consolidated Financial Statements.

We
derive a substantial portion of our revenues from government contracts, the majority of
which are fixed-price, as opposed to cost-plus type contracts. Under fixed-price
contracts, the price is generally not subject to adjustment for costs actually incurred in
the performance of the contract.

In
most of our projects, we receive advance payment at the commencement of the project and
progress or milestone payments according to our performance or achievement of specific
milestones. In these cases, the advance payments that we receive prior to incurring the
cost of fulfilling the contract create a positive project cash flow. In the last three
years, we have received substantial advances from our customers under a portion of our
contracts. Our contracts generally may be terminated or suspended as a result of factors
which may not depend on us, such as a state of war, force majeure, or other
circumstances seriously disrupting the public safety, peace or good order of the
customers country. In the event that a contract under which an advance or progress
payment has been paid is canceled, we may be required to return such payments or portion
of them to the customer.

We
generally attempt to extend funds for projects in accordance with the rate of performance
in order to reduce risks of financial exposure resulting from an early termination of a
contract. Upon such termination, we would, in most cases, be entitled to reimbursement for
our incurred contract costs and to payment of a proportionate share of our fee or profit
for the work actually performed.

Revenues
related to work in progress under long-term contracts are recognized according to the
percentage-of-completion method. The percentage of completion method is computed-based on
the projects total execution costs which reflect the progress of its completion, and
which include: salaries, material costs and subcontractor charges. Revenues ascribed to
each period are the amounts of gross profits earned on such contracts during such period
plus the costs incurred during such period, excluding cost of materials that have not yet
been used and costs incurred for subcontracted work that is still to be performed).

With
respect to the sale of products acquired from third parties as shelf products and where
the cost of adaptation thereof for a customers specific needs is not material, the
related revenue is recognized after completion and delivery. Provision for estimated
losses on uncompleted contracts are made in the period in which such losses are first
determined in the amount of the estimated loss on the entire contract. Royalty revenues
are generally recorded on a cash basis.

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In
October 2002, as part of our cost reduction measures, we implemented progressive marginal
salary reductions ranging from 2% to 12 % for all employees. Israeli law generally
requires that severance pay, for eligible employees, be based upon such employees
most recent salary rate. Nevertheless, we agreed with our eligible employees that the
severance pay for such employees shall be based upon such employees salary rates as
at the end of September 2002 with respect to the employment period ending in October 2002,
and upon the most recent salary rates with respect to any employment period thereafter. We
also agreed with our employees that these salary reductions shall be reversed should our
order backlog reach $45 million, commencing on such date.

# Critical Accounting
Policies

The
preparation of our financial statements, in conformity with Israeli GAAP, requires us to
make estimates and assumptions that affect the reported amounts of assets and liabilities
and disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amount of revenues and expenses during the reporting period.
These are our managements best estimates based on experience and historical data.
Actual results could differ from those estimates.

Certain
specific accounting policies we utilize require higher degrees of judgment than others in
their application. These include going concern, revenue recognition on long-term contract
work and income taxes. In addition, Note 2 to our Consolidated Financial Statements
includes a further discussion of our significant accounting policies.

Going Concern

The
application of the going concern basis of accounting involves a range of subjective
judgments, principally in relation to the sufficiency of our resources to allow us to
continue to operate in the ordinary course and thereby realize our assets and discharge
our liabilities in the normal course of business for a period of 12 months following the
approval date of the consolidated financial statements. These resources are derived from
working capital, cash flow, volume of orders obtained, backlog of orders, existing cash
balances together with meeting forecasted cash flows from operating activities, as well as
obtaining orders forecasted in the budget.

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Revenue Recognition

We
account for our revenues on fixed price long-term contract work on the percentage of
completion method. This method of accounting requires us to calculate project profit to be
recognized in each reporting period for each project based upon our predictions of future
outcomes which include estimates of the total cost to complete (such as assumptions
relative to future labor performance and costs, materials costs and subcontractor charges)
and estimates of project schedule and completion date.

At
the onset of each contract, we prepare a detailed analysis of our estimated cost to
complete the project. Our project personnel evaluate the estimated costs at the project
level. Significant projects are reviewed in detail by senior management at least
quarterly.

Our
estimates of revenues and expenses on long-term contracts could change periodically in the
normal course of business. Such changes would be reflected in results of operations as a
change in accounting estimate in the period the revisions are determined. For all the
contracts, provisions for estimated losses on uncompleted individual contracts are made in
the period in which such losses are first determined, in the amount of the estimated loss
on the entire contract.

Income Taxes

As
part of the process of preparing our consolidated financial statements, we are required to
estimate our income taxes in each of the jurisdictions in which we operate. This process
requires us to estimate our actual current tax exposure and make an assessment of
temporary differences resulting from differing treatment of items for tax and accounting
purposes. These differences result in deferred tax assets and liabilities, which are
included within our consolidated balance sheet. We must then assess the likelihood that
our deferred tax assets will be recovered from future taxable income and, to the extent we
believe that recovery is not likely, we must establish a valuation allowance. To the
extent that we establish a valuation allowance or increase this allowance in a period, we
must include an expense within the tax provision in the statement of operations.
Significant management judgment is required in determining our deferred tax assets and
liabilities and any valuation allowance recorded against our net deferred tax assets. We
recorded a valuation allowance of $10.5 million as of December 31, 2005, which is equal to
the value of the deferred tax asset consisting of our net operating loss carry-forwards.
This indicates our managements current assertion that because we are yet to generate
taxable income, we cannot determine whether it is likely that we will be able to use this
asset in the future. In the event that we generate taxable income in a particular
jurisdiction in which we operate and in which we have net operating loss carry-forwards,
we may be required to adjust our valuation allowance.

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

The
table below sets forth, for the periods indicated, financial data, expressed as a
percentage of total revenues that we believe to be significant in analyzing our results of
operations. The data is as follows:

|                               | For Years Ended December 31,
|------------------------------ | ----------------------------
|
|
|
|
|Revenues                       |                             
|Cost of revenues               |                             
|Gross profit (loss)            |                             
|Research and development       |                             
|Selling, general and           |                             
|administrative expenses        |                             
|Operating profit (loss)        |                             
|Financing expenses, net        |                             
|Other expenses, net            |                             
|Profit (loss) before income    |                             
|taxes                          |                             
|Income tax (expenses) benefits |                             
|Net Profit (loss)              |                             

Our
order backlog as of December 31, 2005 was $12.7 million.

# Subsequent Events

For a summary of the events
subsequent to the balance sheet date, see:

| |  | "Item
4 - Information on the Company - A. History and Development of the Company"
| | - | ---------------------------------------------------------------------------------

| |  | "Item
4 - Information on the Company - B. Business Overview - Strategic Relationships"
| | - | --------------------------------------------------------------------------------------

| |  | "Item
5 - Operating and Financial Review and Prospects - General - Income Taxes"
| | - | --------------------------------------------------------------------------------

| |  | "Item
6 - Directors, Senior Management and Employees - B. Compensation"
| | - | -----------------------------------------------------------------------

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# Year Ended December 31,
2005 Compared to Year Ended December 31, 2004

Revenues.

Revenues
in fiscal 2005 were $19.2 million, an increase of 51% compared to revenues of $12.7
million in fiscal 2004. The increase was primarily attributed to the completion of several
significant projects in 2005, particularly to the progress achieved during 2005 in one
significant project in Europe which contributed $ 6.0 million to the revenues of fiscal
2005. In addition, according to the agreement signed with IAI on August 2005, we have
received royalties from IAI amounting to $ 1.7 million. Revenues from sales of our live
and embedded training systems products in fiscal 2005 accounted for 64% compared to 55% of
our revenues in fiscal 2004. Revenues derived from our virtual and constructive simulator
products accounted for 36% of our revenues in fiscal 2005 compared to 45% of our revenues
in fiscal 2004. The geographical breakdown of our revenues in fiscal 2005 was as follows:
approximately 43% of our revenues were in Europe, 33% in Asia Pacific, 16% in America and
Latin America, 6% in Israel and 2% in Africa. In fiscal 2004, approximately 36% of our
revenues were in Asia Pacific, 21% in Europe, 36% in Latin America and 7% in Israel. The
fluctuations in the proportion of our revenues attributed to geographic areas are the
result of the completion of several contracts which we had with various countries. Our
agreements are multi-year contracts, and we generally recognize revenues on the percentage
of completion method, recognizing expenses when incurred.

In
fiscal 2005, income from royalties and commissions was $1.7 million pursuant to the
Cooperation agreement with MLM signed in August 2005.During 2004, there were certain
disagreements between the company and MLM and as a result no income from royalties and
commissions were recognize .

Gross Profit (Loss).

Gross
profit in fiscal 2005 was approximately $4.4 million, an increase of $2.0 million from a
gross profit of $2.4 million in fiscal 2004. As a percentage of revenues, gross profit
increased from a gross profit of 19% in fiscal 2004, to a gross profit of 23% in fiscal
2005. The increase in gross profit was primarily due to the increase in royalties revenues
from IAI amounting to $1.7 million, together with $0.8 million decrease in cost of revenue
as result of a reversal of certain previously accrued liabilities that are no longer
payable as a result of the new agreement signed with IAI in 2005. The increase in gross
margin was partially offset by a lower gross margin in one significant project in Europe
with a lower profitability, which contributed $6.0 million to the revenues of fiscal 2005.

Research and Development
Costs.

Gross
research and development expenditures consist primarily of salaries, subcontractors and
other personnel-related expenses related to design, development and enhancement of our
products and, to a lesser extent, depreciation and other expenditures. Gross research and
development expenses in fiscal 2005 were $0.6 million, an increase of $0.3 million or 109%
from $0.3 million in fiscal 2004. The increase in gross research and development expenses
was primarily attributed to the development of the EVA.

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Selling and Marketing
Expenses.

Selling
and marketing expenditures consist primarily of costs relating to payroll expenses, sales
commissions, subcontractors and consultants, travel expenses, demonstrations, exhibitions
and participation in trade shows. Selling and marketing expenditures in fiscal 2005 were
$1.3 million, an increase of $0.2 million, or 19%, from $1.1 million in fiscal 2004. The
increase in selling and marketing expenses was primarily attributed to the fact that we
participated in 2005 in several exhibitions including the Paris Air Show and the Indian Air
Show and from increasing our marketing activities for our Eva and IFEWS products.

General and
Administrative Expenses.

General
and administrative expenses consist primarily of salaries and related costs of welfare and
administration, finance and general management personnel, professional fees, office,
vehicle and rental expenses. General and administrative expenses in fiscal 2005 were $2.1
million, an increase of $0.3 million, or 16%, from $1.8 million in fiscal 2004. The
increase in general and administrative expenses was primarily attributed to bonuses to
employees paid only in fiscal 2005, increases in professional fees includes market
analysis of the training military market and management skills improvement and increase in
travel costs for business development. As a percentage of revenues, general and
administrative expenses in fiscal 2005 were approximately 11% compared to 14% in fiscal
2004.

Operating Profit (loss).

As
a result of the foregoing, we had an operating profit of $0.37 million in fiscal 2005
compared to an operating loss of $(0.8) million in fiscal 2004. As a percentage of
revenues, operating profit increased from an operating loss of (6%) in fiscal 2004, to an
operating profit of 2% in fiscal 2005.

Financial Expenses, Net.

Financial
expenses, net consist primarily of interest paid on loans and bank charges, net of income
from interest earned on short-term deposits and interest on non-current receivables, gains
or losses from derivatives instruments and gains or losses arising from foreign exchange
erosion of monetary balances. Financial expenses, net in fiscal 2005 were approximately
$0.19 million, a decrease of approximately $0.3 million from approximately $0.5 million in
fiscal 2004. The decrease was primarily attributed to a decrease in interest on loans
received from banks due to reduced amounts of loans because of the repayment of loans
during fiscal 2004 and fiscal 2005 and the conversion of loans to shares during 2004. The
decrease was also attributed to an increase in interest income received from cash deposits
due to higher amounts deposited during the year, a decrease in bank charges relating to
guarantees due to a decrease in the guarantee amount, gains from derivative instruments
and foreign exchange gains.

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Other Income (Expenses),
Net.

We
incurred other expenses of approximately $2 thousand in fiscal 2005, compared to
approximately $192 thousand net other income in fiscal 2004. The net income in 2004 was
primarily attributed to gain on the forgiveness of a long term loan from a former
related party in the amount of $177, 000.

# Year Ended December 31,
2004 Compared to Year Ended December 31, 2003

Revenues.

Revenues
in fiscal 2004 were $12.7 million, a decrease of 12% compared to revenues of $14.5 million
in fiscal 2003. The decrease was primarily attributed to the fact that the majority of our
orders in fiscal 2004 were received during the second half of fiscal 2004. Revenues from
sales of our instrumentation line of products in fiscal 2004 accounted for 55% compared to
46% of our revenues in fiscal 2003. Revenues derived from our line of simulator products
accounted for 45% of our revenues in fiscal 2004 compared to 54% of our revenues in fiscal
2003. The geographical breakdown of our revenues in fiscal 2004 was as follows:
approximately 36% of our revenues were in Asia Pacific, 21% in Europe, 36% in America and
7% in Israel. In fiscal 2003, approximately 72% of our revenues were in Asia Pacific, 14%
in Europe, 6% in Latin America and 8% in Israel. The fluctuations in the proportion of our
revenues attributed to geographic areas are the result of the completion of several
contracts which we had with various countries. Our agreements are multi-year contracts and
we generally recognize revenues on a percentage of completion method, recognizing expenses
when incurred.

In
fiscal 2004, no income was recorded from royalties and commissions pursuant to the
Cooperation Agreement with MLM, since there were still outstanding disagreements between
the parties. The resolving of the outstanding disagreements in August 2005 did not impact
the Companys financial results or its revenues in 2004.

Gross Profit (Loss).

Gross
profit in fiscal 2004 was approximately $2.4 million, an increase of $1.6 million, from a
gross profit of $0.8 million in fiscal 2003. As a percentage of revenues, gross profit
increased from a gross profit of 6% in fiscal 2003, to a gross profit of 19% in fiscal
2004. The increase in gross profit was primarily attributed to improved productivity
efficiency rates and meeting the contractual delivery schedule. Our gross profit is
influenced by various factors, such as the type and size of a project, and the portion of
projects performed by subcontractors.

Research and Development
Costs.

Gross
research and development expenditures consist primarily of salaries, subcontractors and
other personnel-related expenses related to design, development and enhancement of our
products and, to a lesser extent, depreciation and other expenditures. Gross research and
development expenses in fiscal 2004 were $0.3 million, a decrease of $0.4 million or 58%
from $0.7 million in fiscal 2003. The decrease in gross research and development expenses
was primarily attributed to the implementation of our general plan for reduced research
and development programs, increased efficiency, and expense reductions.

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Selling and Marketing
Expenses.

Selling
and marketing expenditures consist primarily of costs relating to payroll expenses, sales
commissions, subcontractors and consultants, travel expenses, demonstrations, exhibitions
and participation in trade shows. Net selling and marketing expenditures in fiscal 2004
were $1.1 million, a decrease of $0.7 million, or 36%, from $1.8 million in fiscal 2003.
The ongoing decrease in selling and marketing expenses was primarily attributed to a
decrease in consulting expenses, travel expenses, the portion of the salaries of our
personnel attributed to selling activities, and focusing on our strategic markets, all of
which were part of our general policy of increased efficiency and expense reduction.

General and
Administrative Expenses.

General
and administrative expenses consist primarily of salaries and related costs of welfare and
administration, finance and general management personnel, professional fees, office,
vehicle, rental expenses and fees payable. General and administrative expenses in fiscal
2004 were $1.8 million, a decrease of $2.2 million, or 55%, from $4.0 million in fiscal
2003. The decrease in general and administrative expenses was primarily attributed to the
ongoing reduction in salaries due to downsizing administrative employees, cost reductions
of employee fringe benefits a reduction in allowance for doubtful accounts and in costs
relating to our subsidiary, BVR-S Pacific PTE, due to the reduction of its personnel. As a
percentage of revenues, general and administrative expenses in fiscal 2004 were
approximately 14% compared to 28% in fiscal 2003.

Operating Profit (Loss).

As
a result of the foregoing, we had an operating loss of $(0.8) million in fiscal 2004
compared to an operating loss of $(5.6) million in fiscal 2003. As a percentage of
revenues, operating loss decreased from an operating loss of (39%) in fiscal 2003, to an
operating loss of (6%) in fiscal 2004.

Financial Expenses, Net.

Financial
expenses, net, consist primarily of interest paid on loans and bank charges, net of income
from interest earned on short-term deposits and interest on non-current receivables, gains
or losses from derivatives instruments and gains or losses arising from foreign exchange.
Financial expenses, net, in fiscal 2004 were approximately $ 0.5 million, a decrease of
approximately $0.2 million from approximately $ 0.7 million in fiscal 2003. The decrease
was primarily attributed to a decrease in bank charges relating to guarantees due to
guarantee reductions and gains from derivative instruments, net of losses from foreign
exchange.

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Other Income (Expenses),
Net.

We
incurred net income from other sources of approximately $192,000 in fiscal 2004, compared
to approximately $55,000 net expenses in fiscal 2003. Other income consists primarily of
gain on the forgiveness of a long term loan from a former related party in fiscal
2004 and gain from the sale of unrestricted stock in fiscal 2003.

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

The
dollar cost of our operations is influenced by the extent to which inflation in Israel is
or is not offset, or is offset on a lagging basis, by the devaluation of the NIS in
relation to the dollar. When the rate of inflation in Israel exceeds the rate of
devaluation of the NIS against the dollar, companies experience increases in the dollar
cost of their operations in Israel. Unless offset by a devaluation of the NIS, inflation
in Israel will have a negative effect on our profitability, as we receive payment in
dollars or dollar-linked NIS for all of our sales, while we incur a portion of our
expenses in NIS.

The
following table presents information about the rate of inflation in Israel, the rate of
devaluation of the NIS against the dollar, and the rate of inflation in Israel adjusted
for the devaluation:

|Year endedDecember 31 | Israeli Inflation % rate | NIS devaluation % rate | Israeli inflationAdjusted for
devaluation %
|--------------------- | ------------------------ | ---------------------- | -------------------------------------------
|
|
|
|
|2001                  | 1.4                      | 9.3                    | (7.9)                                      
|2002                  | 6.5                      | 7.3                    | (0.8)                                      
|2003                  | (1.9)                    | (7.6)                  | 5.7                                        
|2004                  | 1.2                      | (1.6)                  | 2.8                                        
|2005                  | 2.4                      | 6.8                    | (4.4)                                      

A
devaluation of the NIS in relation to the dollar has the effect of reducing the dollar
amount of any of our expenses or liabilities payable in NIS, unless those expenses or
payables are linked to the dollar. This devaluation also has the effect of decreasing the
dollar value of any asset that consists of NIS or receivables payable in NIS, unless the
receivables are linked to the dollar. Conversely, any increase in the value of the NIS in
relation to the dollar has the effect of increasing the dollar value of any unlinked NIS
assets and the dollar amounts of any unlinked NIS liabilities and expenses.

Because
exchange rates between the NIS and the dollar fluctuate continuously, with a historically
declining trend in the value of the NIS, exchange rate fluctuations, particularly larger
periodic devaluations, will have an impact on our profitability and period-to-period
comparisons of our results.

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We
are exposed to a variety of market risks, including changes in interest rates and foreign
currency fluctuations.

We
entered into currency future contracts and put and call option contracts to reduce our
exposure to fluctuations of specific currencies against the dollar, resulting primarily
from firm commitments in such currencies.

As
at December 31, 2005, the Company did not have any outstanding future contracts.

# Political and Economic
Conditions.

Political Conditions.

Since
the establishment of the State of Israel in 1948, a number of armed conflicts have taken
place between Israel and its Arab neighbors, and the continued state of hostility, varying
in degree and intensity, has led to security and economic problems for Israel. Since
September 2000, the violence between Israel and the Palestinians has intensified and
a material escalation in violence has occurred. Israel has experienced terrorist incidents
within its borders, including in the West Bank and Gaza Strip. As a result, negotiations
between Israel and representatives of the Palestinian Authority ceased. The election of
representatives of the Hamas militant group in January 2006 to a majority of seats in the
Palestinian Legislative Council may create additional unrest and uncertainty in the
region. We could be adversely affected by hostilities involving Israel, the interruption
or curtailment of trade between Israel and its trading partners, or a continuous downturn
in the economic or financial condition of Israel. In addition, several countries continue
to restrict business with Israel and with companies having operations in Israel. We could
be negatively affected by further adverse developments in the peace process, including the
recent violence, or by restrictive laws or practices directed towards Israel or Israeli
exporters.

Like
all male adult citizens and permanent residents of Israel, our directors, officers and
employees who are under the age of 40, unless exempt, are obligated to perform up to 36
days of military reserve duty annually. Additionally, all such residents are subject to
being called to active duty at any time under emergency circumstances. The majority of our
officers and employees are currently obligated to perform annual reserve duty. No
assessment can be made as to the full impact of such requirements on our workforce or
business if conditions in Israel should change, and no prediction can be made as to the
effect of any expansion or reduction of such military obligations on us. See Item 4.
Information on the Company  B. Business Overview  Conditions in Israel.

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Economic Conditions

Israels
economy has been subject to numerous destabilizing factors, including a period of rampant
inflation in the early to mid-1980s, low foreign exchange reserves, fluctuations in world
commodity prices, military conflicts and civil unrest. The Israeli Government has
intervened in various sectors of the economy by utilizing fiscal and monetary policies,
import duties, foreign currency restrictions and controls of wages, prices and foreign
currency exchange rates. The Israeli Government has periodically changed its policies in
all these areas.

# Effective Corporate Tax
Rate

Israeli
companies are subject to corporate tax on their income, at a rate which will be gradually
reduced from the rate of 31% in 2006, to 29% in 2007, 27% in 2008, 26% in 2009 and 25% in
2010 and thereafter.

However,
our old manufacturing facilities in Jerusalem and our new facilities in Rosh Haayin
have been granted Approved Enterprise status under the Law for the
Encouragement of Capital Investments, 1959, as amended, known as the Investment Law.
Consequently, these facilities are eligible, subject to compliance with specified
requirements, for tax exemption for a period of two years and reduced tax rate of 25% for
an additional period of five years on our increased income, if any, commencing on the day
we derive taxable income from our facilities in Rosh Haayin. We may utilize such tax
benefits until 2016. The tax benefits under the Investment Law are not available with
respect to income derived from products manufactured outside of Israel. We expect to
derive a substantial portion of our income from our Approved Enterprise facility.

# Government Grants

The
Government of Israel, through the Office of the Chief Scientist, encourages research and
development projects which result in products for export. We may receive from the Office
of the Chief Scientist up to 50% of the research and development expenditures for
particular projects. We received in the past grants from the Office of the Chief Scientist
for the development of technologies related to our simulators. Pursuant to the terms of
these grants, we were obligated to pay royalties of 3% to 6% of revenues derived from
sales of products funded with these grants. We completed payment of all royalties due with
respect to the grants we received.

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

Historically
we have met our financial requirements primarily through the private sale of equity
securities, customer payments and advances and the utilization of bank credit lines. In
addition, we raised capital through equity financings in 2004. As of December 31,
2005, we had cash and cash equivalents of approximately $3 million and a positive working
capital of approximately $4 million.

38

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On
April 20, 2004, we reached an agreement with a former related party for the repayment of
$204,000 out of an outstanding loan amounting to $381,000 resulting in the forgiveness of
a debt amounting to $177,000.

Pursuant
to these transactions, the banks agreed to postpone repayment of $1.5 million in
short-term credit, such that $0.5 million is repayable in each of the years 2005, 2006 and
2007. The first payment was paid in January 2005, the second payment was paid in January
2006 and the third payment is scheduled to be made in January 2007.

There
are no restrictions as to our use of the credit lines with our banks. The banks may
terminate our credit lines at any time, and the banks may demand repayment in full of any
indebtedness then outstanding.

In
addition, we have obtained bank guarantees to secure our performance of certain
obligations, including under our leases and contracts with customers. Of these guarantees,
which amounted to an aggregate of $9.0 million on December 31, 2005, guarantees in an
aggregate of $8.5 million are to be released by our obtaining specific performance
milestones, which are scheduled to be completed through June 2008.

In
connection with our guarantees, loans and credit lines from banks, we have placed equally
ranking, first priority fixed and floating liens on all of our assets.

Our
operating cash flow is influenced by cash provided from our customers as an advance and by
cash used in the performance of ongoing projects. Operating activities for the year 2005,
2004 and 2003, provided (or used) cash of approximately $1.0 million, ($1.9) million and
$0.5 million, respectively. For fiscal 2005, cash provided from changes in assets and
liabilities of $0.5 million primarily consisted of a decrease in trade receivables of $2.4
million. Additionally, there was a decrease in excess of advances from customers over
amounts recognized as revenues of $(2.4) million, a decrease in inventory of $1.2 million,
a decrease in trade payables of ($0.6) million and a decrease in other payables and
accrued expenses of $0.2 million.

For
fiscal 2004, changes in operating assets and liabilities of $0.9 million primarily
consisted of a decrease in trade payables of $1.06 million. Additionally, there was a
decrease in trade receivables of $0.2 million, a decrease in other receivables and prepaid
expenses of $0.4 million, a decrease in inventory of $0.16 million and a decrease in other
payables and accrued expenses of $0.3 million.

For
fiscal 2003, cash provided from changes in assets and liabilities of $6.5 million
primarily consisted of a decrease in trade receivables of $11.6 million due to collection
of payments and due to a reduction in contracts performed compared to 2002 and 2001. Such
changes in assets and liabilities also consisted of an increase in excess of advances from
customers over amount recognized as revenue of $2.3 million. Additionally, there was a
decrease in non-current receivables of $0.5 million, net of a decrease in trade payables
of $5.2 million, an increase in inventory of $1.8 million and a decrease in other payables
and accrued expenses of $1.2 million.

39

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Investing
activities for fiscal 2005, fiscal 2004 and fiscal 2003 provided (or used) cash of
approximately ($0.1) million, ($2.7) million and $4.2 million, respectively. Cash
flows used in investing activities in fiscal 2005 consisted primarily of a purchase of
fixed assets in the amount of $339,000 and a decrease in restricted bank deposits of $0.2
million. The decrease in restricted bank deposits was due to a decrease in advanced
payments and performance guarantees.

Cash
flows used in investing activities in fiscal 2004 consisted primarily of an increase in
restricted bank deposits of $2.6 million and purchase of fixed assets in the amount of
$113,000. The increase in restricted bank deposits was due to an increase in advance
payment and performance guarantees.

Cash
flows provided by investing activities in fiscal 2003 consisted primarily of a decrease in
restricted bank deposits of $4.3 million and net purchase of fixed assets in the amount of
$171,000. The decrease in restricted bank deposits was due to a reduction in advance
payment guarantees.

Financing
activities for fiscal 2005, fiscal 2004 and fiscal 2003 provided (or used) cash of
approximately ($0.5) million, $5.7 million and $(3.9) million, respectively.

Cash
flows used in financing activities in fiscal 2005 consisted primarily of the net repayment
of long-term loans from banks of $0.5 million.

Cash
flows provided by financing activities in fiscal 2004 consisted primarily of the issuance
of Ordinary Shares in consideration for $9.7 million, the exercise of $3.1 million in
stock options and the net repayments of $6.6 million, $0.4 million and $0.2 million,
respectively, with respect to a short-term bank credit, a short-term loan from Chun and
long-term loans from former shareholders.

Cash
flows used in financing activities in fiscal 2003 consisted primarily of a net repayment
of short-term bank credit of $5.0 million net of receipt of the short-term loan from Chun
of $0.4 million and receipt of long-term loans from former shareholders of $0.6 million.

Our
current assets exceed our current liabilities. We believe that the existing cash balances
together with meeting forecasted cash flows from operating activities for fiscal 2006, as
well as obtaining orders forecasted in the budget approved by the Board of Directors will
be sufficient to meet our present working capital and capital expenditure needs.

|C. | Research
and Development, Patents and Licenses
|-- | ----------------------------------------------

See
"Item 4  Information on the Company - B. Business Overview - Research and Development;
Intellectual Property."

40

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

# Periodic Variations in
Operating Results

Due
to the nature of our customers and products, our sales are often made pursuant to a
relatively small number of customers and large orders. Consequently, an individual project
from an individual customer can represent a substantial portion of our revenues in any one
period. In addition, a significant project for any customer during one period may not be
followed by further projects for the same customer in subsequent periods. Our sales and
operating results may, therefore, vary substantially from period to period. In 2003, we
experienced a significant increase in orders from Latin American countries. This would
appear to be the result of our having invested substantial amounts of our time and
resources from 2001, in developing a market that we believe to have significant commercial
potential. In 2004, we successfully entered into a significant contract with a Portuguese
entity pursuant to diligent marketing efforts. In 2005, we successfully entered into a
significant contract with an Israeli Company regarding a purchase order made by the Israel
Air Force. In the first quarter of 2006, we entered into two significant contracts with an
Italian company and another foreign customer.

# Reduction in Order
Backlog

Our
business is subject to the effect of general economic conditions globally, and, in
particular, conditions in the market for simulation systems for military and civilian
applications. In recent quarters, our sales efforts have been adversely affected as a
result of unfavorable economic conditions and reduced capital spending in Asia Pacific
where we have lately derived and anticipate continuing to derive a material portion of our
revenues. For example, we were informed by one of our customers that due to the suspension
of its budget, such customer decided not to proceed with a planned project in which we had
expected to participate. As of December 31, 2005,we had purchase orders and
contractual arrangements of approximately $12.7 million compared to a backlog of $19.4
million as of December 31, 2004. A further decline in our backlog level could result in
more variability and less predictability in our quarter-to-quarter net sales.

# Delay in the Receipt of
Required Export Approvals

We
purchase from manufacturers in the United States substantially all of the commercial
computers, a portion of the air combat maneuvering instrumentation pods hardware and
other off-the-shelf products, such as navigation systems, which we incorporate
into our products. The export of such components is subject to the approval of the United
States Department of Commerce and/or the United States Department of Defense, which often
restricts sales to certain countries. Since the events of September 11, 2001, the United
States has imposed a longer bureaucratic process on the provision of approvals and has
attached more stringent conditions; consequently, we have experienced delays in the
receipt of such required approvals.

41

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

We
do not have any off-balance sheet arrangements.

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

Our
significant financial and contractual obligations as of December 31, 2005, and the
periods in which such obligations are due are as follows:

|Payments and Amount of CommitmentExpiration Per Period(U.S. Dollars in Thousands) |  |  |  |       
|--------------------------------------------------------------------------------- |  |  |  | ------
|
|
|
|
|
|Borrowed Lines of credit(2)                                                       |  |  |  | 1,153 
|                                                                                  |  |  |  |       
|Guarantees:                                                                       |  | 
|Performance guarantees                                                            |  |  |  | 6,294 
|Advance payment guarantees                                                        |  |  |  | 2,266 
|Other bank guarantees                                                             |  |  |  | 492   
|                                                                                  |  |  |  |       
|Total Guarantees                                                                  |  |  |  | 9,052 
|                                                                                  |  |  |  |       
|Operating lease commitments                                                       |  |  |  | 1,241 
|                                                                                  |  |  |  |       
|Total commercial commitments                                                      |  |  |  | 11,446
|                                                                                  |  |  |  |       

(1)           Excludes liability for
employee severance benefits, net in the amount of $79,000           and long term payable
of $607,000.(2)           Following the approval
of our shareholders at a meeting held on March 1, 2004,           we sold 66,872,669
Ordinary Shares to the investors who participated in the           investment round that
took place between March 2004 and June 2004 at price per           share of $0.18 in the
aggregate amount of approximately $11.9 million, of which           55,206,003 Ordinary
Shares with an aggregate value of approximately $9.8 million           were issued in
exchange for cash and 11,666,667 Ordinary Shares with an           aggregate value of
$2.1 million were issued in exchange for the conversion of an           aggregate of
$2,000,000 of loans from certain of our banks and a debt in the           aggregate
amount of $100,000 owed to two of our existing shareholders. In           addition, the
banks agreed to postpone repayment of short-term credit, in the           amount $0.5
million to 2005, $0.5 million to 2006 and $0.5 million to 2007. The           Company
also received a credit line from Chun, in the amount $3.2 million.

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

Not
applicable.

42

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

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

The
following table lists the name, age and position held by each of our executive officers
and directors, as of March 31, 2006:

|Name             | Age | Position                                                     
|---------------- | --- | -------------------------------------------------------------
|
|
|
|
|Aviv Tzidon      | 50  | Director and Chairman of the Board of Directors              
|Yaron Sheinman   | 52  | Director*                                                    
|Avi Leumi        | 42  | Director                                                     
|Uri Manor        | 63  | Director                                                     
|Eric Chan        | 47  | Director**                                                   
|Avraham Gilat    | 59  | Director***                                                  
|Rimon Ben-Shaoul | 61  | Director                                                     
|Gadi Aviram      | 51  | Director                                                     
|Orit Stav        | 35  | Director****                                                 
|Amnon Harari     | 55  | Director****                                                 
|Ken Lalo         | 48  | Director*****                                                
|Nir Dor          | 42  | Director******                                               
|Ilan Gillies     | 37  | Chief Executive Officer                                      
|Reuven Shahar    | 47  | Vice President of Finance and Chief Financial Officer        
|Dekel Tzidon     | 46  | Vice President of Development and Chief Technological Officer
|Gilad Yavets     | 36  | Vice President of Marketing                                  

---

* Served as a director until December
22, 2005** Served as a director until June
28, 2005*** Appointed director as
of June 28, 2005****External Director***** Appointed director
as of February 20, 2006****** Appointed director
as of March 21, 2006

Aviv
Tzidon has been a Director and the Chairman of our Board of Directors since
November 24, 2003. Mr. Tzidon was the co-founder of BVR Technologies Ltd. (or BVR-T) and
served as its Chief Technology Officer and a director since it commenced operations in
1987. From October 1998, upon the spin-off of BVR Systems (1998) Ltd. from BVR-T, and
until April 2000, Mr. Tzidon served as Chairman of the Board of Directors and Chief
Executive Officer of BVR-T. For three years, Mr. Tzidon worked as an independent
consultant for Israel Aircraft Industries. Mr. Tzidon served as a combat pilot with the
Israel Air Force, including reserve service, for approximately 20 years.

43

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Yaron
Sheinman has been a director since the consummation of our spin-off in
October 1998. He is a founder and Chairman of the Board of Directors of BVR-T. From the
commencement of BVR-Ts operations in 1987 through 1996, Mr. Sheinman served as the
Chairman and Chief Executive Officer of BVR-T. Previously, he acted as an independent
consultant to Israel Aircraft Industries for two years for the development of avionics
systems. Mr. Sheinman served as a combat pilot with the Israel Air Force, including
reserve service for approximately 15 years. Mr. Sheinman also served as Chairman of the
Board of Directors of Nexus Telocation Systems Ltd., VizRT, Coresma Unisfair and
BrightCom. As of December 22, 2005, Mr. Sheinman no longer serves on our Board of
Directors.

Avi
Leumi has been a Director since March 1, 2004. Mr. Leumi has served as CEO,
Co-Founder and Chairman of the Board of Directors of Aeronautics Defense Systems Ltd.
since November 1997. From 1992 to 1997, Mr. Leumi served as CEO of Leumi Chemicals Ltd., a
family owned business. Mr. Leumi is a graduate of the Israel Naval Academy.

Uri
Manor has been a director since March 1, 2004. Mr. Manor has served as
Managing Director of Datus Ltd., a consulting company specializing in the marketing of
defense systems since January 1, 1996 and Managing Director of Loven Hachatzav Ltd., a
holding company specializing in high tech and defense companies since 2001. Mr. Manor is
also a member of the board of directors of Soltam Systems, Fibrotex International and
Aeronautics Defense Systems. Moreover, Mr. Manor represents Hindustan Aeronautics Limited
in Israel. From 1969 to 1996, Mr. Manor held various management positions in Israel
Aircraft Industries Ltd. including Deputy General Manager, MBT Division. Mr. Manor holds a
B.Sc. and an M.Sc. in Aeronautical Engineering from the Technion, the Israel Institute of
Technology.

Eric
Chan has been our Director since March 1, 2004. On November 10, 2003, Mr.
Chan was appointed General Manager of ST training & Simulation or STTS. Between the
years 1999 and 2003, Mr. Chan held various management positions in CET Technologies, a
subsidiary of ST Elect, including Vice President of Defense Business and Deputy General
Manager. In 1997, Mr. Chan served as Division Manager of Land Systems Division of
Singapore Engineering Software, a subsidiary of ST Elect, where he was instrumental in
winning the large-scale island-wide Police C2 program from Singapores Ministry of
Home Affairs. Mr. Chan currently serves as the Chairman of the Board of iVLab, a
subsidiary of STTS, is an alternate director of Prescient Systems & Technologies and
is a director of a number of companies including Knowledge Alive and ST Education &
Training. Mr. Chan holds a B.Sc. in engineering from the National University of Singapore.
As of June 28, 2005, Mr. Chan no longer serves on our Board of Directors.

Avraham
Gilat has been a director since June 28, 2005. Mr. Gilat serves as the
Chairman of Soltam Systems Ltd. and the Soltam Group, one of Israels prominent
defense companies and as a Director General of Mikal Ltd., a holdings company for a wide
range of commercial activities. Prior to this Mr. Gilat served in various positions in
Israel Military Industries Ltd. Mr. Gilat holds an M.B.A. from New York University and a
B.A. in Economics from Tel-Aviv University.

44

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Rimon
Ben-Shaoul has been a director since March 1, 2004. Since 2004, Mr.
Ben-Shaoul has served as President and Chief Executive Officer of Polar Communications
Ltd., an investment company investing in the technology and telecommunications sectors,
and as chairman or a member of the Board of Directors of various private and publicly
traded companies within the Polar group. Since February 2001, Mr. Ben-Shaoul has also
served as Co-Chairman, President and Chief Executive officer of Koonras Technologies Ltd.,
an investment company controlled by Polar Investments Ltd. From June 1997 to February
2001, Mr. Ben-Shaoul served as President and Chief Executive Officer of Clal Industries
and Investments Ltd., one of Israels largest holdings companies in the industrial
and high-tech sectors, and as a member of the Board of Directors of Clal (Israel) Ltd. and
various subsidiaries thereof. From 1985 to June 1997, Mr. Ben-Shaoul served as President
and Chief Executive Officer of Clal Insurance Company Ltd., was a member of its board of
directors and served as Chairman or as a member of the board of directors of various
subsidiaries of Clal Insurance Company Ltd. Mr. Ben-Shaoul holds an M.B.A. and a B.A. in
Economics from Tel-Aviv University.

Gadi
Aviram has been a director since March 1, 2004. Mr. Aviram is the founder
and Chief Executive Officer of Metro Motor Marketing Ltd., local importer and
representative of Kawasaki Heavy Industries. From 2000 to 2002, Mr. Aviram served as
director of Safecom Car Communication Ltd. and from 1999 to 2000; Mr. Aviram served as
director of Pointer (Eden Telecom Group) Ltd.

Orit
Stav has been one of our external directors since March 1, 2004. Ms. Stav
is an Investment Associate at Siemens Venture Capital. Prior to joining Siemens VC, Ms.
Stav was a partner in Platinum Neurone Ventures (PNV), an Israeli Venture Capital Fund and
has more than six years of experience in the venture capital market and the technology
industry in Israel. She led investments from seed stage to exit and worked with leading
international VCs. She gained experience with varied technology companies throughout the
Siemens investment spectrum. Ms. Stav holds a B.A. in Economics and Management from Tel
Aviv University and an M.B.A. from Hertfordshire University, UK.

Amnon
Harari has been one of our external directors since July 2002. Mr. Harari
currently serves as the Vice President of sales and service for EMEA in Lumenis Ltd. From
March 2002 until August 2004, Mr. Harari served as the chief executive officer of Advanced
Heating Technologies Ltd. From May 2000 to March2002, Mr. Harari served as Chief
Executive Officer of Partner Future Communication Ltd. From April1999 to April2000, Mr. Harari served as General Manager of Alcatel Israel. From April1997
to April1999, Mr. Harari served as Corporate Vice-President and General Manager of
the Public Switching Division of Tadiran Telecommunication Ltd that was later acquired by
Alcatel to become Alcatel Israel. From 1992 to 1996, Mr. Harari served as the head of the
Israel Air Force Material Directorate. From February1997 to February 2002, Mr.
Harari served as an External Director of Elbit Systems Ltd. Mr. Harari is a
Brigadier-General in the Israel Air Force. Mr. Harari holds a B.Sc. in Physics from the
Tel Aviv University.

45

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Ken
Lalo has been a director since February 20, 2006. Since 2004, Mr. Lalo has
served as Executive Vice President of Polar Communications Ltd., an investment company
controlled by Polar Investments Ltd. and is a member of the Boards of Directors of various
affiliates of Polar, including publicly traded and private companies. Between 2001 and
2004, Mr. Lalo served as Vice President and General Counsel of other entities within the
Polar Investments group. From 1993 to 2001, Mr. Lalo served as Vice President and General
Counsel of Clal Industries and Investments Ltd. and was a member of the Boards of
Directors of various affiliates of Clal, including publicly traded and private companies.
From 1986  1992, Mr. Lalo worked as an attorney in Maryland, USA. Mr. Lalo holds an
M.B.A. from Northwestern University / Tel- Aviv University, an M.C.L. from George
Washington University and an LL.B. from Tel-Aviv University.

Nir
Dorhas been a director since March 21, 2006. Mr. Dor currently serves as the chairman
of the board of directors of Cargal Carton Industries Ltd., Vice Chairman of the board of
directors of Global Factoring Ltd. and serves on the board of directors of The Danone
Spring of Eden BV. Mr. Dor served as the chief executive officer of Eden Springs Ltd.
between 1999 and 2004. Mr. Dor is a certified public accountant and holds a B.A. in
business management and finance from the College of Management of Tel-Aviv.

Ilan
Gillies has been our Chief Executive Officer since his appointment on
November 26, 2003. Mr. Gillies has been employed by the BVR Group since 1995 and served as
Managing Director of BVR S Pacific from November1998 to September 2003. Mr. Gillies has
served as a combat pilot with the Israel Air Force since 1989.

Reuven
Shaharhas been our Chief Financial Officer and Vice President of Finance
since his appointment on July 1, 2000. From 1995 through June 2000, he was Treasurer and
Director of Finance of Elisra Electronic Systems Ltd. From 1990 to 1995, Mr. Shahar was
the head of the economic staff in the defense division of Elisra. He previously held
various positions at Elisra as of 1984. Mr. Shahar holds a B.A. in business management
from the Hebrew University of Jerusalem and an M.B.A. from Recanati Graduate School of
Business Administration in Tel Aviv University.

Dekel
Tzidon has been our Chief Technology Officer and Vice President of Research
& Development since January 1, 2004. From 1995 to 1997, Mr. Tzidon was employed by
RTSET as an R&D engineer and IP manager. In 1997, Mr. Tzidon joined BVR as a senior
systems engineer, IP manager and head of the technology group. In 2001, Mr. Tzidon served
as a senior systems engineer in Comview. Since 2002, Mr. Tzidon has been employed as an IP
consultant for a number of hi-tech companies including BVR. Mr. Tzidon has a B.Sc. in
computer engineering. Mr. Tzidon is the brother of Mr. Aviv Tzidon, the Chairman of our
Board of Directors.

46

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---



Gilad
Yavetshas been our Vice President of Marketing since March 3, 2004. Mr.
Yavets joined BVR in 1997 and has served in different positions in the company, including
Contracts Director, Director of Business Development and Acting Vice President of
Marketing. Mr. Yavets holds an LL.B. from the Faculty of Law of the Hebrew University of
Jerusalem and an Executive M.B.A. from the Recanti Graduate School of Business
Administration in Tel-Aviv University.

Resignation of Directors
and Officers

The
following director otherwise ceased to serve on our Board of Directors during 2005 and
2006:

| |  | Mr.
Eric Chan ceased to serve on our Board of Directors as of June 28, 2005; and
| | - | --------------------------------------------------------------------------------

| |  | Mr.
Yaron Sheinman ceased to serve on our Board of Directors as of December 22, 2005.
| | - | -------------------------------------------------------------------------------------

No
officer resigned from our company during 2005 and 2006.

Expiration of Term of
Office

No
term of our external director has expired, in accordance with the provisions of the Israel
Companies Law  1999, as amended from time to time (the Companies Law). On June 28,
2005, our shareholders extended Mr. Hararis appointment to continue to serve as an
external director for an additional three-year term.

|B. | Compensation
|-- | ------------

The
aggregate remuneration we paid for the year ended December 31, 2005 to all executive
officers as a group (4 persons) was approximately $481,000 in salaries, fees, commissions
and bonuses. This amount includes approximately $58,000 set aside or accrued to provide
for pension, retirement or similar benefits provided to our directors and executive
officers.

Members
of our board of directors, other than our external directors, do not receive cash
compensation for their service on the board of directors or any committee of the board of
directors. However, all of our directors are reimbursed for their expenses for each board
of directors meeting attended. Our external directors received an aggregate of
approximately $10,300 for the year ended December 31, 2005.

At
the meeting of our shareholders held on March 1, 2004, a special majority of our
shareholders who voted at that meeting, approved the grant of an option to purchase 72,000
of our Ordinary Shares to each of our nine directors serving on our Board of Directors at
the time, with the exception of Aviv Tzidon, the Chairman of our Board of Directors. The
options vested with the following Directors upon their completion of one full year of
service on our board following the March 1, 2004 shareholders meeting: Yaron Sheinman, Avi
Leumi, Uri Manor, Eric Chan, Gadi Aviram, Rimon Ben-Shaoul, Orit Stav and Amnon Harari and
are exercisable at a price of $0.18 per share for a period of three years.

47

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At
the meeting of our shareholders held on March 1, 2004, a majority of our shareholders who
voted at that meeting also approved the grant of an option to purchase 9,000,000 of our
Ordinary Shares to Mr. Aviv Tzidon. One fifth of the options will vest upon the completion
of each full year of service on our board, which commenced on November 24, 2003, for a
period of five years and will be exercisable at a price of $0.18 per share for a period of
three years.

Taking
into account the option grants described in the preceding two paragraphs above, as of
March 31, 2006, options to purchase 11,245,000 Ordinary Shares granted to our directors
and executive officers under our option plans were outstanding. The weighted average
exercise price of these options was $0.184 per share. Of these options, options to
purchase 4,855,000 Ordinary Shares are currently exercisable or will become exercisable
within 60 days of such date.

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

Our
articles of association provide for a board of directors of not less than two and no more
than fifteen members. Each director is elected to serve until the next annual general
meeting of shareholders and until his or her successor has been elected. Officers serve at
the discretion of the board of directors. The Israeli Companies Law, which entered into
effect on February 1, 2000 and was amended most recently in March 2005 to require that, at
least one external director have financial and accounting expertise and the other external
directors are to possess professional qualifications as promulgated by regulations to the
Companies Law; these regulations provide that financial and accounting expertise require
such external director to possess a high level of understanding in business matters, such
that he or she can read and understand financial statements in depth and be able to raise
issues with respect to the manner in which the financial data is presented therein. The
companys board of directors is to determine such candidates qualifications
based on his or her education, experience and skills regarding financial and control
matters in companies of similar size and in a similar industry and knowledge of
preparation and approval of financial statements under the Companies Law and Israeli
securities laws.

Our
articles of association provide that any director may, by written notice, appoint another
person to serve as a substitute director and may cancel such appointment. According to the
Companies Law, a person may not serve as a substitute director for more than one director
and a director may not serve as a substitute director. 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 provides otherwise, and the
right to remuneration. Appointment of a substitute director for a member of a committee of
the board of directors is only permitted if the substitute is a member of the board of
directors and does not regularly serve as a member of such committee. If the committee
member being substituted is an external director, such substitute may only be another
external director possessing the same expertise as the external director being substituted
and may not be a regular member of such committee. Unless the time period or scope of any
appointment is limited by the appointing director, 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 has appointed any other person as a substitute
director.

48

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# External Directors

Under
the Companies Law, companies incorporated under the laws of Israel whose shares have been
offered to the public in or outside of Israel are required to appoint no less than two
external directors. The Companies Law provides that a person may not 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, as of the date of the persons
appointment to serve as external director, or had, during the two years preceding that
date, any affiliation with the company, any entity controlling the company or any entity
controlled by the company or by this controlling entity. 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 can serve as an external director if the persons position or other business
creates, or may create, conflict of interests with the persons responsibilities as
an external director. A person shall be qualified to serve as an external director only if
he or she possesses accounting and financial expertise or professional qualifications. At
least one external director must posses accounting and financial expertise and the other
external directors are to possess professional qualifications as promulgated by
regulations to the Companies Law; these regulations provide that financial and accounting
expertise require such external director to possess a high level of understanding in
business matters, such that he or she can read and understand financial statements in
depth and be able to raise issues with respect to the manner in which the financial data
is presented therein. The companys board of directors is to determine such
candidates qualifications based on his or her education, experience and skills
regarding financial and control matters in companies of similar size and in a similar
industry and knowledge of preparation and approval of financial statements under the
Companies Law and Israeli securities laws. These requirements do not apply to external
directors appointed before the recent amendment to the Companies Law but will apply to
their reappointment for an additional term. Until the lapse of two years from termination
of office, a company may not engage an external director to serve as an office holder and
cannot employ or receive services from that person, either directly or indirectly,
including through a corporation controlled by that person. External directors are to be
elected by a majority vote at a shareholders meeting, provided that either:

49

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| |  | the
total number of votes for the appointment of the external directors shall include the
votes of at least one third of the shares represented at the meeting in person or by
proxy, which are not held by controlling shareholders of the company; or
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the
total number of votes against the appointment of the external directors, among the
non-controlling shareholders of the company, shall not exceed 1% of the aggregate voting
rights in the company.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

When
counting the votes of the non-controlling shareholders, abstentions are not to be included
in such calculations.

An
external director is entitled to compensation as provided in regulations promulgated under
the Companies Law and is otherwise prohibited from receiving any compensation, directly or
indirectly, in connection with services provided as an external director. We compensate
our two external directors in accordance with regulations promulgated under the Companies
Law.

The
initial term of an external director is three years and may be extended for an additional
three years. Each committee of a companys board of directors, which exercises board
powers, is required to include at least one external director. However, the audit
committee should include all the external directors.

Pursuant
to the decisions of the Special General Meetings dated July 9, 2002 and March 1, 2004,
respectively, Amnon Harari and Orit Stav were each appointed as external directors of the
Company for a three-year term. On June 28, 2005, our shareholders extended Mr.
Hararis appointment to continue to serve as an external director for an additional
three-year term.

# Exculpation, Insurance
and Indemnification of Directors and Officers

Under
the Companies Law, an Israeli company may not exempt an office holder from liability with
respect to a breach of his duty of loyalty, but may exempt in advance an office holder
from his liability to the company, in whole or in part, with respect to a breach of his
duty of care, provided, that the company is so permitted under its articles of
association. The breach of such duty is governed by Israeli contract laws.

50

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Office Holder Insurance

Our
articles of association provide that, subject to the provisions of the law, we may enter
into a contract for the insurance of the liability of any of our office holders with
respect to:

| |  | a
breach of his duty of care to us or to another person;
| | - | --------------------------------------------------------

| |  | a
breach of his duty of loyalty to us, provided that the office holder acted in good faith
and had reasonable cause to assume that his act would not prejudice our interests; or
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a
financial liability imposed upon him in favor of another person concerning an act
performed by him in his capacity as an office holder.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------

Indemnification of Office
Holders

Our
articles of association provide that we may indemnify an office holder against:

| |  | a
financial liability imposed on him in favor of another person by any judgment, including
a settlement or an arbitrators award approved by a court concerning an act
performed in his capacity as an office holder; and
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | reasonable
litigation expenses, including attorneys fees, expended by the office holder or
charged to him by a court, in proceedings we institute against him or instituted on our
behalf or by another person, or in a criminal charge from which he was acquitted, or a
criminal charge in which he was convicted for a criminal offense that does not require
proof of intent, in each case relating to an act performed in his capacity as an office
holder.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Under
the Companies Law, these provisions are subject to shareholder approval.

Limitations on Insurance
and Indemnification

The
Companies Law provides that a company may not indemnify an office holder nor enter into an
insurance contract which would provide coverage for any monetary liability incurred as a
result of any of the following:

| |  | a
breach by the office holder of his duty of loyalty unless the office holder acted in good
faith and had a reasonable basis to believe that the act would not prejudice the company;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

51

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| |  | a
breach by the office holder of his duty of care if the breach was done intentionally or
recklessly;
| | - | -----------------------------------------------------------------------------------------------------

| |  | any
act or omission done with the intent to derive an illegal personal benefit; or
| | - | ----------------------------------------------------------------------------------

| |  | any
fine levied against the office holder.
| | - | ------------------------------------------

In
addition, under the Companies Law, indemnification of, and procurement of insurance
coverage for, our office holders must be approved by our Audit Committee and our Board of
Directors and, in specified circumstances, by our shareholders.

We
have obtained directors and officers liability insurance.

# Audit Committee

Under
the Companies Law, the board of directors of any public company, as defined by the
Companies Law, must appoint an audit committee comprised of at least three directors,
including all of the external directors, but excluding the chairman of the board of
directors, the general manager, the chief executive officer and a controlling shareholder
or its relative and any director employed by the company or who provides services to the
company on a regular basis. Yaron Sheinman, Amnon Harari and Orit Stav currently serve as
members of our Audit Committee. Orit Stav is the financial expert of the Committee.
Following the resignation of Yaron Sheinman, Ken Lalo was appointed to serve as a member
of our Audit Committee.

The
role of the audit committee is to examine flaws in the companys business management,
in consultation with its internal auditor and independent accountants, and suggest
appropriate courses of action.

In
addition, the approval of the audit committee is required to effect specified actions and
transactions with office holders and interested parties. An interested party is defined in
the Companies Law as a 5% or greater shareholder, any person or entity who has the right
to designate one or more directors or the general manager of the company or any person who
serves as a director or as a general manager. An audit committee may not approve an action
or a transaction with an interested party or with an office holder unless at the time of
approval the two external directors are serving as members of the audit committee and at
least one external director was present at the meeting in which such approval was granted.

52

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# Management Employment
Agreements

We
have entered into employment or consulting agreements with each of our executive officers.
These agreements contain various provisions, including provisions relating to assignment
of intellectual property rights to us and confidentiality and are in effect until
terminated by either party upon advance notice or otherwise in accordance with the terms
of the particular agreement. All of these agreements also contain non-competition
provisions. Under the Companies Law, in a public company, as defined in the Companies Law,
the chief executive officer may not serve as the companys chairman of the board.
However, the shareholders of the company may approve the service of the chairman of the
board also as the chief executive officer, for periods of up to three years each,
provided, that at least two-thirds of the votes of non-controlling shareholders present
and voting at the meeting vote affirmatively.

# Employee Share Option
Plans

We
have three employee stock option plans. Options granted under our option plans generally
vest over a period of two to five years. Options granted under each plan expire four, five
or nine years from the date of grant. Our share option plans are administered by our Board
of Directors. All of our employees are eligible to participate in our option plans. Our
board of directors has complete discretion to make all decisions relating to the
interpretation and operation of our option plans, including the discretion to determine
which eligible individuals are to receive an award, and to determine the type, number,
vesting requirements and other features and conditions of each award.

On
January 4, 2004, our board of directors adopted a new share option plan under which
options for the purchase of 5,000,000 Ordinary Shares of the Company may be granted to our
employees and consultants. Under this plan, as of March 31, 2006, 4,889,000 options were
granted to employees and consultants of the Company, at an exercise price of $0.145 
$0.65 each. These options will vest over 5 years with one-fifth vesting each year and each
increment expiring 3 years after vesting. Moreover, as of March 31, 2006, an additional
111,000 Ordinary Shares of the Company were reserved for issuance pursuant to options
issuable under this share option plan.

As
of March 31, 2006, we had outstanding options for the purchase of an aggregate of
5,245,800 Ordinary Shares of the Company.

53

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# Employees

The
following table sets forth for the last three fiscal years, the number of our employees
engaged in the specified activities:

|                                      | Year ended December 31,
|------------------------------------- | -----------------------
|
|
|
|
|Production and Research & Development |                        
|Marketing and Sales                   |                        
|Administration and Management         |                        
|                                      |                        
|Total                                 |                        
|                                      |                        

As
of, March 31, 2006, we employed approximately 56 employees in research and development
operations and productions, both internally financed and pursuant to contracts with our
customers performed an integral role in our various projects

Our
employees are required to sign a nondisclosure agreement covering all of our proprietary
information which they might possess or to which they might have access. We believe that
we have satisfactory labor relations with our employees and have never experienced a work
stoppage.

We
are subject to labor laws and regulations in Israel. We and our Israeli employees are also
subject to certain provisions of the general collective bargaining agreements between the
Histadrut, the General Federation of Labor in Israel, and the Coordination Bureau of
Economic Organizations, including the Industrialists Association, by order of the Israel
Ministry of Labor and Welfare. None of our employees are represented by a labor union and
we have not experienced any work stoppages. 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 and sales personnel are paid commissions based on
our performance in certain territories worldwide.

We
are subject, like all other Israeli employers, to Israeli labor laws and regulations. The
laws principally concern matters like paid annual vacation, paid sick days and other
conditions of employment. In addition, Israeli law generally requires severance pay, which
may be funded by managers insurance described below (or by other funds), upon the
retirement or death of an employee or termination of employment, subject to the provisions
of the law. Provisions for severance pay 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. These amounts also include payments by the employee for national health
insurance. The total payments to the National Insurance Institute are equal to
approximately 16.25% of the wages (up to a specified amount), of which the employee
contributes approximately 66% and the employer contributes approximately 34%.

54

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We
follow a practice, although not legally required, to contribute funds on behalf of all of
our 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 a lump-sum payment upon retirement 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 or her basic salary and the employer contributes
approximately 14% of the salary.

|D. | Share
Ownership
|-- | ---------------

As
of March 31, 2006, Aviv Tzidon beneficially owned an option to purchase 3,600,000 Ordinary
Shares, (for further information, see item 6B) exercisable at a price of $0.18 per share
for three years. Assuming the exercise of such options and no other exercise of our
convertible securities, Mr. Tzidon will hold 2.99% of our then outstanding Ordinary
Shares. In addition, Mr. Tzidon holds 33.3 % of Chun LP, which beneficially owned as of
March 31,2006 58,142,608 Ordinary shares and a four-year option to purchase 10,864,444
Ordinary Shares, vesting immediately and exercisable at a price of $0.18 per share.
Assuming the exercise of such options and no other exercise of our convertible securities,
Chun will hold 54.09% of our then outstanding Ordinary Shares.

Other
than Mr. Aviv Tzidon, none of our directors and officers beneficially owned more than 1%
of our outstanding equity securities.

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

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

The
following table sets forth certain information regarding the beneficial ownership of our
Ordinary Shares as of, March 31, 2006, by each person or entity known to own beneficially
more than 5% of our outstanding Ordinary Shares based on information provided to us by the
holders or disclosed in public filings with the Securities and Exchange Commission.

55

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|Name                                   | Number of OrdinaryShares Beneficially Owned(1) | Percentage ofOutstanding OrdinaryShares(2)
|-------------------------------------- | ---------------------------------------------- | ------------------------------------------
|
|
|
|
|CHUN Holdings Limited Partnership (3)  |                                                |                                           
|c/o Yigal Arnon & Co.                  |                                                |                                           
|1 Azrieli Center Tel-Aviv 67021 Israel |                                                |                                           
|                                       |                                                |                                           
|H.S.N General Managers Holdings LP     |                                                |                                           
|7 Berkowitz  St                        |                                                |                                           
|Tel Aviv Israel                        |                                                |                                           
|                                       |                                                |                                           
|Polar Investments House                |                                                |                                           
|Platinum House                         |                                                |                                           
|21 Ha'arbah St                         |                                                |                                           
|Tel Aviv 64731 Israel                  |                                                |                                           
|                                       |                                                |                                           
|Bank Leumi Le-Israel B.M               |                                                |                                           
|24-32 Yehuda Halevi St                 |                                                |                                           
|Tel Aviv 63432 Israel                  |                                                |                                           

|(1) | Except
as otherwise noted and pursuant to applicable community property laws,
               each person named in the table has sole voting and investment power with
respect                to all ordinary shares listed as owned by such person. Shares
beneficially owned                include shares that may be acquired pursuant to options
that are exercisable                within 60 days of March 31, 2006.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Ordinary
shares deemed beneficially owned by virtue of the right of any person                or
group to acquire these ordinary shares within 60 days of March 31, 2006 are
               treated as outstanding only for the purposes of determining the percent
owned by                such person or group. The percentage of outstanding ordinary
shares is based on                116,713,757 Ordinary Shares outstanding as of March 31,
2006.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Based
on information reported by Chun LP in its Schedule 13D, the general
                    partner of Chun LP is Chun Holdings Ltd., a private Israeli company
jointly held                     by Aviv Tzidon (33.3%), Aeronautics Defense System Ltd.
(33.3%) and Prescient                     System & Technologies Pte. Ltd. (33.3%).
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | Includes
three separate warrants for the purchase of 6,000,000 ordinary shares
                    per each warrant, with exercise prices of $0.36, $0.54 and $1.00,
exercisable                     for a period of three years, with a mandatory exercise
mechanism under certain                     conditions.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) | Includes
2,570,307 Ordinary Shares held by Koonras Technologies Ltd., a
               wholly-owned subsidiary of Polar Investments Ltd. It also includes a
four-year                warrant to purchase 2,158,960 (including 911,678 warrants held
by Koonras) of                our Ordinary Shares at a price of $0.18 share, exercisable
immediately.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(6) | Includes
a four-year warrant to purchase 10,864,444 of our Ordinary Shares at a
               price of $0.18 share, exercisable immediately.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------

As
of March 5, 2006, we had approximately 6 shareholders of record with a United States
address holding approximately 10,486,580 of our Ordinary Shares representing approximately
8.98% of our outstanding share capital as of such date.

53

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

# Management Services
Agreements with Elisra Electronic Systems Ltd.

On
July 27, 2000, we entered into a management services agreement with Elisra Electronic
Systems Ltd., our former controlling shareholder, pursuant to which we paid Elisra a
management services fee of $200,000. The agreement expired on December 31, 2000. On March
29, 2001, we entered into a second management services agreement with Elisra pursuant to
which Elisra provided us with management services during fiscal 2001 for an annual fee of
$200,000, which has since expired. On March 18, 2002, we entered into a third management
services agreement with Elisra pursuant to which Elisra will provide us with management
services during the year 2002 for an annual fee of $200,000. On April 6, 2003 we entered
into a fourth management services agreement with Elisra pursuant to which Elisra will
provide us with management services during the year 2003 for an annual fee of $200,000.
The fourth management agreement was approved by our audit committee and by our board of
directors. Pursuant to Elisras sale of all its holdings during the fourth quarter of
2003, the fourth management agreement was terminated and is no longer in effect as of
December 23, 2003. See Item 10. Additional Information  Transactions Requiring
Special Approval.

# One-Time Acquisition
through our Subsidiary

During
2003, our subsidiary, BVR-S Pacific, purchased on behalf of Elisra, certain hardware
products from a Singaporean company. BVR-S Pacific sold such products to Elisra
thereafter. BVR-S Pacific received a 10% commission from Elisra on this sale amounting to
approximately $50,000.

# Transaction with a
Subsidiary of Elisra

We
have made purchases of a specific component that is incorporated into our on-board
training systems from Tadiran Spectalink Ltd., a wholly owned subsidiary of Elisra, our
former controlling shareholder. Purchases from Tadiran Spectalink were approximately
$45,000, $244,000 and $1.7 million for fiscal 2003, fiscal 2002 and fiscal 2001,
respectively. We believe that the terms of our transactions with Tadiran Spectalink were
no less favorable to us from those we could have obtained from an unaffiliated third party
supplier. In November 2002, Elta, a division of IAI, acquired from Koor Industries Ltd.
30% of the outstanding shares of Elisra at such time and pursuant to which, we treat IAI
as a related party. See Item 4  Information on the Company  B. Business
Overview  Strategic Relationships. In 2003, we recorded approximately $1.4
million as revenues and approximately $0.5 million in expenses as cost of sales from
transactions with IAI.

# Loan from Major
Shareholders

On
October 1, 2003, our major shareholders, during such time, loaned us an aggregate amount
of $601,000, in order to finance our operations. This loan does not bear interest and is
comprised of: (i) a $381,000 loan from Elisra, which was subsequently repaid in April
2004; (ii) a $120,000 loan from Clal Industries and Investments Ltd., which matured in
October 2005 yet has not been repaid as of the date of this annual but was agreed Clal may
demand its repayment at any time; (iii) a $62,000 loan from Polar Investment Ltd., which
was subsequently converted into shares  see below); and (iv) a $38,000 loan from
Koonras Technologies Ltd., which was subsequently converted into shares  see below.

57

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# Short-Term Loan from Chun

In
December 2003, we received a loan from Chun in the amount of $430,000 linked to the US
Dollar and bearing no interest. In March 1, 2004, we repaid the aforementioned loan.

# Agreement with Consult
Wise Pte Ltd.

On
January 1, 2004, we entered into an agreement with Consult Wise Pte Ltd., a Singaporean
company. Maayan Tzidon, the brother of Aviv Tzidon, the Chairman of our Board of
Directors, holds 50% of the issued and outstanding shares of Consult Wise. Our audit
committee and board of directors in their meetings on March 3, 2004 approved this
agreement. Pursuant to this agreement, we agreed to pay Consult Wise $3,000 per month for
the provision of its marketing services of our products and services in Korea and
Singapore, for a period of three years commencing January 1, 2004. In lieu of cash, we
agreed to pay the monthly fee in our Ordinary Shares based on a per share price of $0.18.
In order to facilitate the payment of shares, a trustee was issued 600,000 of our Ordinary
Shares and was instructed to release 16,667 of our Ordinary Shares to Consult Wise each
month during the term of the agreement. Should the agreement be terminated prior to the
completion of the three-year term, no more shares will be issued to Consult Wise pursuant
to the agreement.

For further information see:

| |  | Sale
of Shares and Issue of Warrants to Investors below.
| | - | ----------------------------------------------------------

| |  | Note
20 to the Consolidated Financial Statements included in this annual report.
| | - | --------------------------------------------------------------------------------

| |  | Agreement
with Affiliate of Dekel Tzidon.
| | - | -----------------------------------------

| |  | On
March 1, 2004, the Company entered into a consulting agreement with Eyepoint Ltd., an
Israeli company wholly owned by Mr. Dekel Tzidon, brother of Mr. Aviv Tzidon, the
Chairman of our Board of Directors. Pursuant to this consulting agreement, Mr. Tzidon
continues to serve as the Companys Vice President of Research & Development and
Chief Technological Officer. The terms of this agreement were approved by the Companys
Audit Committee in July 2004.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

58

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# Sale of Shares to
Principal Shareholders

Sale of Shares to and Issue of
Warrants to H.S.N General Managers Holdings L.P.

In
March 2006, H.S.N General Managers Holdings L.P. (or HSN), an Israeli limited partnership
led by Mr. Nir Dor invested $3.6 million in our share capital in consideration for the
issuance of 20,000,000 Ordinary Shares, representing approximately 17% of our issued share
capital, at a price per share of $0.18. In connection with this investment, HSN was issued
three separate warrants for the purchase of 6,000,000 of our Ordinary Shares per each
warrant, with exercise prices of $0.36, $0.54 and $1.00, exercisable for a period of three
years, with a mandatory exercise mechanism under certain conditions. As of March 2006, Mr.
Dor serves as a member of our board of directors.

Sale of Shares to and
Issue of Warrants to Chun

On
November 21, 2003, Chun Holdings Ltd., or Chun, issued a tender offer to purchase all of
our outstanding shares for a purchase price of $0.18 per share. Pursuant to the tender
offer, which expired on December 30, 2003, some of our shareholders, including Clal
Industries Ltd. and our former controlling shareholder Elisra Electronics Systems Ltd., or
Elisra, tendered an aggregate of 7,142,608 of their shares, constituting 67% of our issued
and outstanding share capital. Upon the request of Chun, all of the tendered shares were
registered in the name of its affiliate Chun Holdings L.P., or Chun LP which became our
controlling shareholder. As of, March 31, 2006 Chun was holding an aggregate of 49.82% of
our outstanding shares and 54.09 % including options that are exercisable within 60 days
of March 31, 2006.

Following
the expiration of the tender offer, Elisra no longer held any of our share capital.

On
March 3, 2004, Chun entered into an agreement to purchase 33,333,333 of our Ordinary
Shares at a price per share of $0.18 for an aggregate purchase price of $6,000,000. This
transaction was approved by our Audit Committee, Board of Directors and by a special
majority of our shareholders who did not have a personal interest in the transaction and
who voted at our Shareholders Meeting held on March 1, 2004.

Chun
also agreed on such date to provide our company with a credit line in the amount of $3.2
million. In consideration for this credit line our Audit Committee and our Board of
Directors agreed, subject to shareholder approval, to grant Chun a four-year warrant to
purchase an additional 40,000,000 of our Ordinary Shares for an exercise price of $0.18
per share. A special majority of our shareholders who did not have a personal interest in
the transaction and who voted at our shareholders meeting held on March 1, 2004, approved
the grant of the warrant. Chun, however, waived its right to receive warrants for the
purchase of 10,000,000 of our Ordinary Shares and agreed that such warrants be granted to
other investors as disclosed below.

59

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Options issued to the
Chairman of the Board of Directors

On
January 1, 2004, Aviv Tzidon received an option to purchase 9,000,000 of our Ordinary
Shares issued for services rendered as Chairman of our Board of Directors. One fifth of
the options will vest upon completion of each full year of service on our Board of
Directors, which commenced on November 24, 2003. Each option is exercisable for three
years following vesting and is exercisable at a price per share of $0.18. This transaction
was approved by our Audit Committee, our Board of Directors and a special majority of our
shareholders who did not have a personal interest in the transaction and who voted at our
shareholders meeting held on March 1, 2004.

Sale of Shares and
Issuance of Warrants to Investors

On
March 3, 2004, a group of investors entered into an investment agreement to purchase
22,428,225 of our Ordinary Shares at a price per share of $0.18 for an aggregate purchase
price of $4,037,080. Two of the investors, Polar Communications Ltd. and Koonras
Technologies Ltd., who were also existing security holders of the Company prior to the
March 2004 investment, were issued additional shares in consideration for their agreement
to convert an aggregate debt owed to them of $100,000 into 555,556 of our Ordinary Shares
at a price per share of $0.18. Pursuant to this investment agreement, the investors were
also issued four-year warrants to purchase an aggregate of 10,000,000 of our Ordinary
Shares with an exercise price of $0.18 per share; Chun LP was initially granted these
warrants, but subsequently waived its rights to receive such warrants in favor of the
investors, pro rata to their investments. This transaction was approved by our Audit
Committee, our Board of Directors and a special majority of our shareholders who did not
have a personal interest in the transaction and who voted at our Shareholders Meeting held
on March 1, 2004.

Convertible Loan
Agreements

On
March 3, 2004, three of our banks, namely Bank Leumi Le-Israel B.M., Bank Hapoalim B.M.
and the Industrial Development Bank Ltd., agreed to convert existing loans in the amount
of $1.1 million, $700,000 and $200,000, respectively, into 6,111,111; 3,888,889; and
1,111,111 of our Ordinary Shares, respectively.

# Employment Agreements

We
have entered into employment agreements with each of our executive officers. See
Item 6  Directors, Senior Management and Employees  C. Board
PracticesManagement Employment Agreements.

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

Not
applicable.

60

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|ITEM 8. |  | Financial Information
|------- |  | ---------------------

|A. | Consolidated
Statements and Other Financial Information
|-- | -------------------------------------------------------

The
Financial Statements required by this item are found at the end of this Annual Report,
beginning on page F-1.

# Legal Proceedings

We
are not a party to any material legal proceedings.

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

There
have been no material changes in our financial position since December 31, 2005,except
from the March 2006 financing round; see Item 4  Information on the Company 
A. History and Development of the Company.

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

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

Our
Ordinary Shares have traded on the Over The Counter Bulletin Board under the symbol
BVRSF.OB since February 2003 and previously traded on the Nasdaq SmallCap Market from
March 2001. From October 1998 until March 2001 our shares were traded on the Nasdaq
National Market.

The
following table sets forth, for the periods indicated, the range of high and low sales
prices of our Ordinary Shares:

|2001                          | High | Low
|----------------------------- | ---- | ---
|
|
|
|
|Year ending December 31, 2001 |      |    
|                              |      |    
|2002                          |      |    
|Year ending December 31, 2002 |      |    
|                              |      |    
|2003                          |      |    
|Year ending December 31, 2003 |      |    
|                              |      |    
|2004                          |      |    
|First Quarter                 |      |    
|Second Quarter                |      |    
|Third Quarter                 |      |    
|Fourth Quarter                |      |    
|                              |      |    
|2005                          |      |    
|First Quarter                 |      |    
|Second Quarter                |      |    
|Third Quarter                 |      |    
|Fourth Quarter                |      |    
|October                       |      |    
|November                      |      |    
|December                      |      |    
|                              |      |    
|2006                          |      |    
|January                       |      |    
|February                      |      |    
|March                         |      |    

61

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

Not
applicable.

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

Our
Ordinary Shares traded on the Nasdaq Capital Market until February 13, 2003. Our Ordinary
Shares were delisted from the Nasdaq Capital Market after we failed to comply with its
required listing standards. Since February 14, 2003, our Ordinary Shares have been traded
on the Over-the-Counter Bulletin Board under the symbol BVRSF.OB.

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

Not
applicable.

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

Not
applicable.

|F. | Expenses
of the Issue
|-- | ---------------------

Not
applicable.

62

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|ITEM 10. |  | Additional Information
|-------- |  | ----------------------

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

Not
applicable.

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

# Objects and Purposes

We
were first registered under Israeli law on January 6, 1998. Our registration number with
the Israel Registrar of Companies is 52-004362-1. Our objectives and purposes include the
development, design, manufacture and marketing of advanced training systems for military
objectives and a wide variety of other business purposes.

# Transactions Requiring
Special Approval

An
office holder is defined in the Companies Law as a director, general manager,
chief business manager, deputy general manager, vice general manager and any person
assuming the responsibilities of any of the foregoing positions without regard to such
persons title and any other manager who is directly subject to the general manager.

The
Companies Law imposes a duty of care and a duty of loyalty on all office holders of a
company. The duty of care 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 breach of such duty is governed by Israeli contract laws. The duty of
care includes a duty to use reasonable means to obtain:

| |  | information
on the appropriateness of a given action brought for his approval or performed by him by
virtue of                            his position; and
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | all
other important information pertaining to the previous actions.
| | - | -------------------------------------------------------------------

The
duty of loyalty requires an office holder to act in good faith for the interests of the
company and includes a duty to:

| |  | refrain
from any conflict of interest between the performance of his duties in the company and
his personal                            affairs;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------

| |  | refrain
from any activity that is competitive with the company;
| | - | ---------------------------------------------------------------

| |  | refrain
from exploiting any business opportunity of the company to receive a personal gain for
himself or                            others; and
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------

| |  | disclose
to the company any information or documents relating to a companys affairs which
the office holder has received due to his position as an office holder.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------

Each
person listed in the table under Item 6  Directors, Senior Management and
Employees  A. Directors and Senior Management is an office holder.

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The
Companies Law requires that an office holder disclose to the company 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. The disclosure is
required to be made promptly and in any event, no later than the board of directors
meeting in which the transaction is first discussed. A personal interest of an office
holder includes an interest of a company in which the office holder is, directly or
indirectly, a 5% or greater shareholder, director or general manager or in which he or she
has the right to appoint at least one director or the general manager. If the transaction
is an extraordinary transaction, the office holder must also disclose any personal
interest held by his or her relative.

Under
the Companies Law, an extraordinary transaction is a transaction:

| |  | not
in the ordinary course of business;
| | - | ---------------------------------------

| |  | not
on market terms; or
| | - | -----------------------

| |  | likely
to have a material impact on the company's profitability, assets or liabilities.
| | - | ---------------------------------------------------------------------------------------

Under
the Companies Law, once an office holder complies with the above disclosure requirement,
the board of directors may approve the transaction, unless the companys articles of
association provide otherwise. A transaction that is adverse to the companys
interest may not be approved. If the transaction is an extraordinary transaction, then it
also must be approved by the audit committee, before the board approval, and under certain
circumstances, by the shareholders of the company. A director who has a personal interest
in a matter which is considered at a meeting of the board of directors or the audit
committee may not be present at this meeting or vote on this matter. If a majority of the
directors has a personal interest in a transaction, these directors are permitted to be
present and vote, but shareholder approval is also required.

Under
the Companies Law, the disclosure requirements which apply to an office holder also apply
to a controlling shareholder of a public company. A controlling shareholder includes a
shareholder that holds 25% or more of the voting rights in a public company if no other
shareholder owns more than 50% of the voting rights in the company. Extraordinary
transactions of a public company with a controlling shareholder or in which a controlling
shareholder has a personal interest, and the terms of compensation of a controlling
shareholder who is an office holder, require the approval of the audit committee, the
board of directors and the shareholders of the company. The shareholder approval must
satisfy either of the following criteria:

| |  | the
majority of the votes for the approval includes the votes of at least one-third of the
total votes of shareholders who are present at the meeting and who have no personal
interest in the transaction; the votes of abstaining shareholders shall not be included
in the number of the said total votes; or
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | the
total number of votes against the approval, among the shareholders who are present at the
meeting and who have no personal interest in the transaction shall not exceed 1% of the
aggregate voting rights in the company.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

For
information concerning the direct and indirect personal interests of certain of our office
holders and principal shareholders in certain transactions with us, see Item 7
 Major Shareholders and Related Party Transactions  B. Related Party
Transactions.

# Directors
Compensation

Under
the Companies Law, all arrangements as to compensation of office holders who are not
directors require approval of the board of directors. Arrangements as to compensation of
directors also require audit committee approval, before board approval, and shareholder
approval. Nevertheless, pursuant to our articles of association, our directors who are not
our employees or professional services providers shall not be paid any remuneration for
their services unless it was approved by the general meeting of our shareholders.

# Directors Borrowing
Powers

Our
board of directors may from time to time, in its discretion, cause the Company to borrow
or secure the payment of any sum or sums of money for the purposes of the Company. Such
borrowing powers may be exercised by a majority of the board in accordance with our
articles of association.

# Rights attached to our
Shares

Dividend
Rights. Our articles of association provide that our shareholders at a general meeting
and upon the recommendation of our board of directors may from time to time, declare such
dividend as may appear to be justified but not in excess of our board of directors
recommendation. Subject to the rights of the holders of shares with preferential or other
special rights that may be authorized in the future, holders of Ordinary Shares are
entitled to receive dividends according to their rights and interest in our profits.

Voting
Rights. Holders of Ordinary Shares have one vote for each ordinary share held on all
matters submitted to a vote of shareholders. These voting rights may be affected by the
grant of any special voting rights to the holders of a class of shares with preferential
rights that may be authorized in the future. The Ordinary Shares do not have cumulative
voting rights in the election of directors. As a result, holders of Ordinary Shares that
represent more than 50% of the voting power have the power to elect all the directors to
the exclusion of the remaining shareholders.

65

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Liquidation
Rights. In the event of our liquidation, after satisfaction of liabilities to
creditors, our assets will be distributed to the holders of Ordinary Shares in proportion
to their respective holdings. This liquidation right may be affected by the grant of
preferential dividends or distribution rights to the holders of a class of shares with
preferential rights that may be authorized in the future.

Redemption
Provisions. We may, subject to applicable law, issue redeemable preference shares and
redeem the same.

Capital
Calls. Under our memorandum of association and the Companies Law, the liability of our
shareholders is limited to the par value of the shares held by them.

Preemptive,
First Refusal and Co-Sale Rights. All outstanding Ordinary Shares are validly issued,
fully paid and non-assessable and do not have preemptive rights, rights of first refusal
or co-sale rights.

Transfer
of Shares. Fully paid Ordinary Shares are issued in registered form and may be
transferred pursuant to our articles of association, unless such transfer is restricted or
prohibited by another instrument and subject to applicable securities laws.

# Modification of Rights

Unless
otherwise provided by our articles of association, rights attached to any class may be
modified or abrogated by a resolution adopted in a general meeting approved by a majority
of 75% of the voting power represented at the meeting in person or by proxy and voting
thereon, subject to the sanction of a resolution passed by majority of the holders of 75%
a majority of the shares of such class present and voting as a separate general meeting of
the holders of such class.

# Shareholders
Meetings and Resolutions

The
quorum required for an ordinary meeting of shareholders consists of at least two
shareholders present in person or by proxy, who hold or represent between them at least
33-1/3% of the outstanding voting shares, unless otherwise required by applicable rules. A
meeting adjourned for lack of a quorum generally is adjourned to the same day in the
following week at the same time and place or any time and place as the chairman of the
board may designate. At such reconvened meeting the required quorum consists of any two
shareholders present in person or by proxy.

Under
the Companies Law, each shareholder of record will be provided at least 21 calendar
days prior notice of any general shareholders meeting.

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Under
the Companies Law and our articles of association, all resolutions of our shareholders
require a simple majority of the shares present, in person or by proxy, and voting on the
matter, subject to certain exceptions provided for under the Companies Law, which require
a majority of at least 75% of the shares present. However, the Companies Law requires that
any amendment to the articles of association of a company incorporated prior to February
1, 2000, shall be approved by holders of at least 75% of the voting rights represented at
the meeting, in person or by proxy, and voting thereon, unless the articles are amended to
the effect of requiring a different majority.

Under
the Companies Law, each and every shareholder has a duty to act in good faith in
exercising his rights and fulfilling his obligations towards us and other shareholders,
such as in voting in the general meeting of shareholders on the following matters:

| |  | any
amendment to the articles of association;
| | - | ---------------------------------------------

| |  | an
increase of our authorized share capital;
| | - | --------------------------------------------

| |  | a
merger; or
| | - | ------------

| |  | approval
of certain actions and transactions that require shareholder approval.
| | - | -------------------------------------------------------------------------------

In
addition, each and every shareholder has the general duty to refrain from depriving other
shareholders of their rights.

Our
annual general meetings are held once in every calendar year at such time (within a period
of not more than fifteen months after the last preceding annual general meeting) and at
such place determined by our board. All general meetings other than annual general
meetings shall be called extraordinary general meetings. Our board may, whenever it thinks
fit, convene an extraordinary general meeting at such time and place as it determines, and
shall be obligated to do so upon a requisition in writing in accordance with the Companies
Law.

# Limitation on Owning
Securities

The
ownership of our Ordinary Shares by nonresidents of Israel is not restricted in any way by
our memorandum of association and articles of association or the laws of the State of
Israel, except for citizens of countries, which are in a state of war with Israel, who may
not be recognized as owners of our Ordinary Shares.

# Mergers and Acquisitions
under Israeli Law

The
Companies Law includes provisions that allow a merger transaction and requires that each
company that is a party to a merger have the transaction approved by its board of
directors and a vote of at least 75% of its shares, at a shareholders meeting called
on at least 21 days prior notice. For purposes of the shareholders vote, unless a
court rules otherwise, the merger will not be deemed approved if a majority of the shares
held by parties other than the other party to the merger, or by any person who holds 25%
or more of the shares of the other party, or the right to appoint 25% or more of the
directors of the other party, vote against the merger. Upon the request of a creditor of
either party of the proposed merger, the court may delay or prevent the merger if it
concludes that there exists a reasonable concern that as a result of the merger, the
surviving company will be unable to satisfy the obligations of any of the parties to the
merger. In addition, a merger may not be completed unless at least 50 days have passed
from the time that a proposal for the approval of the merger has been filed with the
Israel Registrar of Companies and 30 days have passed from the time that the approval of
the merging parties shareholders has been received.

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The
Companies Law also provides that an acquisition of shares of a public company 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 and there is no existing 25% or greater shareholder in the
company. If there is no existing 45% or greater shareholder in the company, the Companies
Law provides that an acquisition of shares of 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. Regulations adopted under the Companies Law provide that these
tender offer requirements do not apply to companies whose shares are listed for trading
outside of Israel if, according to the laws of the country in which the shares have been
offered to the public or in which the shares are listed for trading on an exchange,
including the rules and regulations of such exchange, there is either a restriction upon
any acquisition of control to any extent, or the acquisition of control to any extent
requires the purchaser to make a tender offer to the public.

If
following any acquisition of shares, the acquirer will hold 90% or more of the
companys shares or of a class of shares, the acquisition may not be made other than
through a tender offer to acquire all of the shares of such class. If the shareholders who
declined the tender offer hold 5% or less of the companys outstanding share capital
or class of shares, all the shares that the acquirer offered to purchase will be
transferred to it. However, the tendered shareholders may seek to alter the consideration
by court order.

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

In
September 2001, we entered into an agreement with Aermacchi S.p.A., a leading manufacturer
and producer of modern military training aircraft in Europe, for the supply of a MB339
training aircraft full mission simulator and three years of logistical support. The
contract price is $7.1 million, which, as in substantially all of our contracts, is
payable in accordance and subject to timely achievement of specific milestones during the
lifetime of the project. We completed this project during the second quarter of 2003 and
enter into the logistical support period. As of March 31, 2006, we received $0.1 million
under this contract.

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In
April 2003, we entered into a contract with the air force of a Latin American country for
the development and supply of an F-16 training facility. The contract price is
approximately $5.0 million, which, as in substantially all of our contracts, is payable in
accordance and subject to timely achievement of specific milestones during the lifetime of
the project. We completed this project during the third quarter of 2005.

In
October 2003, we entered into a contract with the armed forces of a Latin American country
for the development and supply of a tank training center. The contract price is
approximately $2.7 million, which, as in substantially all of our contracts, is payable in
accordance with and subject to timely achievement of specific milestones during the
lifetime of the project. We completed this project during the fourth quarter of 2005.

In
November 2003, we entered into a contract, together with a European company, with the navy
of a European country for the development and supply of a naval tactical trainer. The
contract price is approximately $1.5 million (a significant portion of which will be
payable to us), which, as in substantially all of our contracts, is payable in accordance
with and subject to timely achievement of specific milestones during the lifetime of the
project. We completed this project during the first quarter of 2005.

In
December 2003, we entered into a leasing contract with the Israel Air Force for the use
and maintenance of an ACMI system. The contract price is approximately $0.7 million, and
is payable on a monthly basis. We completed this contract during the third quarter of
2005.

In
July 2004, we entered into a follow on contract with a customer in Asia for the provision
of integrated logistic support services for a period of three years for a training system
that was previously provided by us. The contract price is approximately $1.6 million. We
expect to complete this project during the first quarter of 2007. As of March 31, 2006, we
received $0.9 million under this contract.

In
August 2004, we entered into a contract with a NATO Member for the provision of EHUD
Air Combat Maneuvering Instrumentation (ACMI) systems. The contract price is approximately
$6.0 million, which, as in substantially all of our contracts, is payable in accordance
and subject to timely achievement of specific milestones during the lifetime of the
project. We completed this project during the fourth quarter of 2005.

In
October 2004, we entered into a contract with Boeing for the integration of EHUD
ACMI systems on Boeings new F-15K aircraft, to be supplied to the Republic of Korea
Air Force. The contract price is approximately $1.5 million, which, as in substantially
all of our contracts, is payable in accordance and subject to timely achievement of
specific milestones during the lifetime of the project. We expect to complete this project
during the second quarter of 2006. As of March 31, 2006, we received $1.5 million under
this contract.

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In
November 2004, we entered into a contract with Systex Corporation, a leading Asian system
integration company for the supply of an infantry multi-weapon firing simulation system.
The contract price is approximately $2.6 million, which, as in substantially all of our
contracts, is payable in accordance and subject to timely achievement of specific
milestones during the lifetime of the project. We expect to complete this project during
the first quarter of 2007. As of March 31, 2006, we received $1.1 million under this
contract.

In
January 2005, we entered into an additional contract with Systex Corporation for the
supply of a tank simulation system. The contract price is approximately $1.4 million,
which, as in substantially all of our contracts, is payable in accordance and subject to
timely achievement of specific milestones during the lifetime of the project. We expect to
complete this project during the second quarter of 2006. As of March 31, 2006, we received
$1.0 million under this contract.

In
September 2005, we entered into a contract with Elbit Systems for the supply of work-share
in a new F-16I simulator for the Israel Air Force. The contract price is approximately
$2.2 million, which, as in substantially all of our contracts, is payable in accordance
and subject to timely achievement of specific milestones during the lifetime of the
project. We expect to complete this project during the first quarter of 2008. As of March
31, 2006, we received $0.3 million under this contract.

In
January 2006, we entered into an agreement with Aermacchi S.p.A., a leading manufacturer
and producer of modern military training aircraft in Europe, for the upgrade of two MB339a
training aircraft simulators. The contract price is approximately $4.5 million, which, as
in substantially all of our contracts, is payable in accordance and subject to timely
achievement of specific milestones during the lifetime of the project. We expect to
complete this project during the third quarter of 2007.

In
March 2006, we entered into a contract with an international customer for the provision of
an F-16 MLU Improved Unit Line Trainer.  The contract price is $2.7 million,
which, as in substantially all of our contracts, is payable in accordance and subject to
timely milestones during the lifetime of the project.  We expect to complete this
project during the first quarter of 2008. As of March 31, 2006, we received $0.4 million
under this contract.

For
a summary of our other material contracts, see:

| |  | "Item
4 - Information on the Company - A. History and Development of the Company," including a
description of                            the Share Purchase Agreement entered into in
March 2006 with H.S.N General Managers Holdings                            L.P., an
Israeli limited partnership led by Mr. Nir Dor.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | Item
4  Information on the Company  B. Business Overview Strategic
Relationships, including a description of the Cooperation Agreement entered into
with MLM in August 2005.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | "Item
6 - Directors, Senior Management and Employees - B. Compensation"
| | - | -----------------------------------------------------------------------

| |  | "Item
7 - Major Shareholders and Related Party Transactions - B. Related Party Transactions."
| | - | ---------------------------------------------------------------------------------------------

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

Under
current Israeli regulations, we may pay dividends or other distributions in respect of our
Ordinary Shares either in non-Israeli or Israeli currencies. If we make these payments in
Israeli currency, they will be freely converted into non-Israeli currencies at the rate of
exchange prevailing at the time of conversion. Because exchange rates between the NIS and
the dollar continuously fluctuate, a U.S. shareholder will be subject to the risk of
currency fluctuations between the date when we declare NIS-denominated dividends and the
date when we pay them in NIS. See Item 3. Key
Information  D. Risk Factors.

Non-residents
of Israel may freely hold and trade our securities pursuant to the general permit issued
under the Israeli Currency Control Law, 1978. Neither our memorandum of association nor
the laws of the State of Israel restrict in any way the ownership of our Ordinary Shares
by non-residents, except that these restrictions may exist with respect to citizens of
countries which are in a state of war with Israel.

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

# Israeli Tax
Considerations and Government Programs

The
following is a summary of the current tax structure applicable to companies in Israel,
with special reference to its effect on us. The following also contains a discussion of
certain Israeli and United States tax consequences to purchasers of our Ordinary Shares
and certain Israeli Government programs benefiting us. To the extent that the discussion
is based on new 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.

HOLDERS
OF OUR ORDINARY SHARES SHOULD CONSULT THEIR OWN TAX ADVISORS AS TO THE UNITED STATES,
ISRAELI OR OTHER TAX CONSEQUENCES OF THE PURCHASE, OWNERSHIP AND DISPOSITION OF ORDINARY
SHARES, INCLUDING, IN PARTICULAR, THE EFFECT OF ANY FOREIGN, STATE OR LOCAL TAXES.

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General Corporate Tax
Structure

Israeli
companies are subject to corporate tax at the rate of 31% of taxable income. Under current
law, the corporate tax rates are scheduled to be reduced to 29% in January 2007, and are
expected to be further reduced to 27% in 2008, 26% in 2009 and 25% in 2010 and
thereafter.. However, the effective tax rate payable by a company which derives income
from an Approved Enterprise (as further discussed below) may be considerably less.

Tax Benefits under the Law for the
Encouragement of Capital Investments, 1959

On
March 30, 2005, the Knesset approved a reform of the Encouragement of Capital Investments
Law  1959 (the Encouragement Reform).

Following
in Section A is the outline of The Investment Law before the Encouragement Reform. Section
B notes several of the significant changes in the Investment Law which are relevant to our
company.

The
Investment Law provides that terms and benefits included in any certificate of approval
that was granted before the Encouragement Reform came into effect will remain subject to
the provisions of the Investment Law as they were on the date of such approval. Therefore
the Encouragement Reform will not apply to any of our programs already approved under the
Investment Law.

|A. | The
Investment Law before the Encouragement Reform
|-- | --------------------------------------------------

The
Investment Law provides that a proposed capital investment in eligible facilities may,
upon application to the Investment Center of the Ministry of Industry and Commerce of the
State of Israel, be designated as an Approved Enterprise. Each certificate of
approval for an Approved Enterprise relates to a specific investment program delineated
both by its financial scope, including its capital sources, and by its physical
characteristics, e.g., the equipment to be purchased and utilized pursuant to the program.
The tax benefits derived from any such certificate of approval relate only to taxable
income attributable to the specific Approved Enterprise. If a company has more than one
approval or only a portion of its capital investments are approved, its effective tax rate
is the result of a weighted combination of the applicable rates. The tax benefits under
the law are not generally available with respect to income derived from products
manufactured outside of Israel.

Taxable
income of a company derived from an Approved Enterprise is subject to corporate tax at a
maximum rate of 25% (rather than the ordinary corporate tax rate) for the benefit
period. The benefit period is seven years (and under certain
circumstances, as further detailed below, ten years) commencing with the year in which the
Approved Enterprise first generates taxable income, and is limited to twelve years from
commencement of production or 14 years from the date of approval, whichever is earlier.
The Investment Law also provides that a company that has an Approved Enterprise is
entitled to accelerated depreciation on its property and equipment that are included in an
approved investment program.

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

Our
requests for designation of our capital investment at our facility in Rosh Haayin as
an Approved Enterprise program were approved under the Investment Law. For
this Approved Enterprise, we elected the alternative package of benefits.

A
company that has elected the alternative package of benefits and that subsequently pays a
dividend out of income derived from the Approved Enterprise during the tax exemption
period will be subject to tax in respect of the amount distributed (including the tax
thereon) at the rate which would have been applicable had it not elected the alternative
package of benefits (generally 10%-25%, depending on the extent of foreign shareholders
holding its ordinary shares). In addition, the dividend recipient is taxed at the reduced
rate applicable to dividends from Approved Enterprises (15%), if the dividend is
distributed during the tax exemption period or within a specified period thereafter. We
must withhold this tax at source, regardless of whether the dividend is converted into
foreign currency. See Taxation of Ordinary SharesTaxation of Dividends
Paid On Ordinary Shares and Note 18 to the Consolidated Financial Statements.

Subject
to certain provisions concerning income under the alternative package of benefits, all
dividends are considered to be attributable to the entire enterprise and the effective tax
rate on the dividends is the result of a weighted combination of the various applicable
tax rates. We are not obliged to distribute exempt retained profits under the alternative
package of benefits, and we may generally decide from which years profits to declare
dividends. We currently intend to reinvest the amount of our tax-exempt income and not to
distribute such income as a dividend.

The
Investment Center bases its decision as to whether or not to approve an application on the
criteria set forth in the Investment Law and regulations, the then prevailing policy of
the Investment Center, and the specific objectives and financial criteria of the
applicant. Accordingly, there can be no assurance that any such application will be
approved. In addition, the benefits available to an Approved Enterprise are conditional
upon the fulfillment of conditions stipulated in the Investment Law and its regulations
and the criteria set forth in the specific certificate of approval, as described above. In
the event that a company does not meet these conditions, it would be required to refund
the amount of tax benefits, with the addition of the consumer price index linkage
adjustment and interest.

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We
have derived, and expect to continue to derive, a substantial portion of our income from
our Approved Enterprise facilities. Subject to compliance with applicable requirements,
income derived from our Approved Enterprise facilities will be tax exempt for a period of
two years after we have taxable income and will be subject to a reduced rate of corporate
tax of up to 25% depending on the extent of foreign shareholders holding our ordinary
shares for the following five years.

|B. | Outline
of the primary changes of the Encouragement Reform
|-- | ----------------------------------------------------------

The
Encouragement Reform provides that Approved Enterprise status will continue to
be granted by the Investment Center to qualifying investments. However, the Amendment
limits the scope of enterprises which may be approved by the Investment Center by setting
criteria for the approval of a facility as an Approved Enterprise, such as provisions
generally requiring that at least 25% of the Approved Enterprises income will be
derived from export.

The
Encouragement Reform also provides that Approved Enterprise status will only be necessary
for receiving grants from the Investment Center. As a result, it is no longer necessary
for a company to acquire Approved Enterprise status in order to receive the tax benefits
previously available under the alternative package of benefits. Rather, a company may
claim the tax benefits offered by the Investment Law as amended directly in its tax
returns, provided that its facilities meet the criteria for tax benefits set out by the
Amendment. Such companies are also no longer required to file reports with the Investment
Center. Companies are entitled to approach the Israeli Tax Authority for a pre-ruling
regarding their eligibility for benefits under the Encouragement Reform.

Tax
benefits are available under the Encouragement Reform to production facilities (or other
eligible facilities), which are generally required to derive more than 25% of their
business income from export. In order to receive the tax benefits, the Encouragement
Reform states that the company must make an investment which meets all the conditions set
out in the Amendment for tax benefits and exceeds a minimum amount specified in the Law.
Such investment allows the company to receive a Benefited Enterprise status,
and may be made over a period of no more than three years ending on the end of the year in
which the company requested to have the tax benefits apply to the Benefited Enterprise
(the Year of Election). Where the company requests to have the tax benefits
apply to an expansion of existing facilities, only the expansion will be considered to be
a Benefited Enterprise and the companys effective tax rate will be the weighted
average of the applicable rates. In this case, the minimum investment required in order to
qualify as a Benefited Enterprise is required to exceed a certain percentage of the value
of the companys production assets before the expansion, as follows:

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|Production assets          | % of required investment | Required investment      
|-------------------------- | ------------------------ | -------------------------
|
|
|
|
|Up to NIS 140 million      | 12%                      | Up to NIS 16.8 million   
|From NIS 140 - 500 million | 7%                       | From NIS 9.8 - 35 million
|Over NIS 500 million       | 5%                       | From NIS 25 million      

The
extent of the tax benefits available under the Amendment to qualifying income of a
Benefited Enterprise are determined by the geographic location of the Benefited
Enterprise. The location will also determine the period for which tax benefits are
available.

Dividends
paid out of income derived by a Benefited Enterprise will be treated similarly to payment
of dividends by an Approved Enterprise under the alternative package of benefits.
Therefore, dividends paid out of income derived by a Benefited Enterprise (or out of
dividends received from a company whose income is derived from a Benefited Enterprise) are
generally subject to withholding tax at the rate of 15% (deductible at source). The
reduced rate of 15% is limited to dividends and distributions out of income derived from a
Benefited Enterprise during the benefits period and actually paid at any time up to 12
years thereafter. A company qualifying for tax benefits under the Amendment which pays a
dividend out of income derived by its Benefited Enterprise during a period in which the
Benefited Enterprise was exempt from tax will be subject to tax in respect of the gross
amount of the dividend at the otherwise applicable rate of 25%, (or lower in the case of a
qualified company owned by a certain percentage of non-Israeli residents). The dividend
recipient would be subject to tax at the rate of 15% on the amount received which tax
would be deducted at source.

Grants under the Law for the
Encouragement of Industrial Research and Development, 1984

Under
the Law for the Encouragement of Industrial Research and Development, 1984, research and
development programs which meet certain criteria and are approved by the Research
Committee, a governmental committee of the Office of the Chief Scientist are eligible for
grants of up to 50% of the projects expenditure, as determined by the Research
Committee, in return for the payment of royalties from the sale of the product developed
in accordance with the program. Regulations promulgated under the Research Law generally
provide for the payment of royalties to the Chief Scientist ranging from 3% to 5% or in
some cases, such as ours, ranging from 4% to 6%, on revenues from products developed using
such grants until 100-150% of the dollar-linked grant is repaid. Following the full
repayment of the grant, there is no further liability for payment. See Item
5Operating and Financial Review and Prospects and Note 18 to the Consolidated
Financial Statements.

75

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The
terms of the Israeli government participation also require that the manufacture of
products developed with government grants be performed in Israel. However, under the
regulations promulgated under the Research Law, in the event that any of the manufacturing
is performed outside Israel by any entity other than us, if approval is received from the
Office of the Chief Scientist for such foreign manufacturing and the identity of the
foreign manufacturers, we may be required to pay increased royalties. If the manufacturing
volume that is performed outside of Israel is less than 50%, the total amount to be repaid
to the Office of the Chief Scientist may be adjusted to 120% of the grant. If the
manufacturing volume that is performed outside of Israel is between 50% and 90% the total
amount may be adjusted to 150% of the grant and if it is more than 90%, the total amount
may be adjusted to 300% of the grant. Since our manufacturing activities are performed by
subcontractors outside of Israel, the consent of the Office of the Chief Scientist is
required for these activities and additional consents will be required in connection with
the manufacturing of products developed in the future with Office of the Chief Scientist
grants. The letters of approval under which we received the grants do not specifically
refer to our manufacturing activities outside of Israel; however, we believe that the
Office of the Chief Scientist has adequately expressed its consent to such activities.
There can be no assurance that the consents granted to date by the Office of the Chief
Scientist will be deemed to be adequate under applicable laws and regulations or that such
consents will not be reversed or modified in any way or that we will obtain consents for
such activities at all from the Office of the Chief Scientist in the future. Failure to
comply with the requirements for consents for manufacturing outside of Israel could result
in penalties, cancellation of grants and denial of any future applications for grants or
for these consents. If the consents obtained from the Office of the Chief Scientist to
manufacture our products outside of Israel are terminated or if we are unable to obtain
similar consents in the future, our business could be harmed. A transfers of the
technology developed pursuant to the terms of these grants may be transferred outside of
Israel only subject to the payments promulgated under the Research Law and subject to the
prior approval of the Research Committee; technology transfers within Israel are also
subject to the prior approval of the Research Committee. Such approval is not required for
the export of any products resulting from such research or development. Approval of the
transfer of technology in Israel may be granted only if the recipient abides by all the
provisions of the Research Law and regulations promulgated thereunder, including the
restrictions on the transfer of know-how and production and the obligation to pay
royalties in an amount that may be increased. There can be no assurance that such consent,
if requested, will be granted under reasonable commercial terms. See Item
5Operating and Financial Review and ProspectsGovernment Grants.

Effective
for grants received from the Office of the Chief Scientist under programs approved after
January 1, 1999, the outstanding balance of such grants will be subject to interest
equal to the 12 months LIBOR rate applicable to dollar deposits that is published on
the first business day of each calendar year.

As
governmental incentives, the funds generally available for grants from the Office of the
Chief Scientist may be reduced in the future and there is no assurance that the government
will not abolish such grants in the future. Even if these grants are maintained, there is
no assurance we will receive Office of the Chief Scientist grants in the future. In
addition, each application to the Office of the Chief Scientist is reviewed separately,
and grants are based on the program approved by the Research Committee. Generally,
expenditures supported under other incentive programs of the State of Israel are not
eligible for grants from the Office of the Chief Scientist. There is no assurance that
applications to the Office of the Chief Scientist will be approved and, until approved,
the amounts of any such grants are not determinable.

76

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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. Such 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

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

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

Under
the Industry Encouragement Law, Industrial Companies are entitled to the following
preferred tax benefits:

(a)        deduction
of purchases of know-how and patents over an eight-year period for           tax
purposes;

(b)        right
to elect under certain conditions to file a consolidated tax return with
          additional related Israeli Industrial Companies;

(c)        accelerated
depreciation rates on equipment and buildings;

(d)        deduction
over a three-year period of expenses related to the issuance and           listing of
shares on a stock exchange;

Eligibility
for the benefits under the Industry Encouragement Law is not subject to receipt of prior
approval from any governmental authority. No assurance can be given that we qualify or
that we will continue to qualify as an Industrial Company or that the benefits
described above will be available in the future.

77

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Special Provisions
Relating to Taxation Under Inflationary Conditions

The
Income Tax Law (Inflationary Adjustments), 1985, generally referred to as the
Inflationary Adjustments Law, represents an attempt to overcome the problems
presented to a traditional tax system by an economy undergoing rapid inflation. The
Inflationary Adjustments Law is highly complex. Its features which are material to us can
be described as follows:

(a)       
          There is 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). If the depreciated cost of fixed assets exceeds a
          companys equity, then such excess multiplied by the applicable annual rate
          of inflation is added to taxable income.

(b)       
          Subject to certain limitations, depreciation deductions on fixed assets and
          losses carried forward are adjusted for inflation based on the increase in the
          consumer price index.

Capital Gains Tax on
Sales of Our Ordinary Shares

Israeli
law generally imposes on residents and non-residents capital gains tax on the sale of
capital assets in Israel, including our ordinary shares, unless a specific exemption is
available or unless a tax treaty between Israel and the shareholders country of
residence provides otherwise.  The law distinguishes between the inflationary surplus
and the real gain.  The inflationary surplus is a portion of the total capital gain
which is equivalent to the increase of the relevant assets purchase price that is
attributable to the increase in the Israeli consumer price index or, in certain
circumstances, a foreign currency exchange rate, between the date of purchase and the date
of sale.  The real gain is the excess of the total capital gain over the inflationary
surplus.

On
January 1, 2006 an amendment to the Israeli tax regime became effective (the 2006
Tax Reform). The 2006 Tax Reform significantly changed the tax rates applicable to
income derived from shares.

According
to the 2006 Tax Reform, an individual is subject to a 20% tax rate on real capital gains
derived from the sale of shares, as long as the individual is not a substantial
shareholder (generally a shareholder with 10% or more of the right to profits, right
to nominate a director and voting rights) of the company issuing the shares. There will
generally be no capital gains tax on the inflationary surplus. The rate on the gains from
publicly traded shares applicable to gains that were realized before January 1, 2006 was
15%.

78

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A
substantial shareholder will be subject to tax at a rate of 25% in respect of real capital
gains derived from the sale of shares issued by the company in which he or she is a
substantial shareholder. The determination of whether the individual is a substantial
shareholder will be made on the date that the securities are sold. In addition, the
individual will be deemed to be a substantial shareholder if at any time during the 12
months preceding this date he had been a substantial shareholder.

With
respect to gains accrued before January 1, 2003, regulations promulgated under the Israeli
Income Tax Ordinance provided for an exemption from Israeli capital gains tax on gains
that were derived from the sale of shares of an Industrial Company, as defined
by the Industry Encouragement Law. This exemption only applied to shares that were traded
on specified non-Israeli markets, including the NASDAQ National Market, provided that the
sellers purchased their shares either in the companys initial public offering or in
public market transactions thereafter. The exemption did not apply to shareholders who are
in the business of trading securities, or to shareholders that are Israeli resident
companies and subject to the Income Tax Law (Inflationary Adjustments)  1985. We
believe that we are currently an Industrial Company, as defined by the Industry
Encouragement Law. There can be no assurance that the Israeli tax authorities will not
deny our status as an Industrial Company, possibly with retroactive effect.

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

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

Pursuant
to the treaty between the Governments of the United States and Israel with respect to
taxes on income, or the U.S.-Israel tax treaty, the sale, exchange or disposition of our
ordinary shares by a person who qualifies as a resident of the United States under the
treaty and who is entitled to claim the benefits afforded to him by the treaty, will
generally not be subject to Israeli capital gains tax. This exemption shall not apply to a
person who held, directly or indirectly, shares representing 10% or more of the voting
power in our company during any part of the 12-month period preceding the sale, exchange
or disposition, subject to certain conditions. A sale, exchange or disposition of our
shares by a U.S. resident qualified under the treaty, who held, directly or indirectly,
shares representing 10% or more of the voting power in our company at any time during the
preceding 12-month period would be subject to Israeli tax, to the extent applicable;
however, under the treaty, this U.S. resident would be permitted to claim a credit for
these taxes against the U.S. income tax with respect to the sale, exchange or disposition,
subject to the limitations in U.S. laws applicable to foreign tax credits.

79

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# Taxation of Dividends

Non-residents
of Israel are subject to income tax on income accrued or derived from sources in Israel.  These
sources of income include passive income such as dividends, royalties and interest, as
well as non-passive income from services rendered in Israel.  On distributions of
dividends other than bonus shares, or stock dividends, to Israeli individuals and foreign
resident individuals and corporations we would be required to withhold income tax at the
rate of 20%.  If the income out of which the dividend is being paid is attributable
to an Approved Enterprise under the Law for the Encouragement of Capital Investments,
1959, the rate is 15%.  A different rate may be provided for in a treaty between
Israel and the shareholders country of residence.  Under the U.S.-Israel tax
treaty, if the income out of which the dividend is being paid is not attributable to an
Approved Enterprise, then income tax with respect to shareholders that are U.S.
corporations holding at least 10% of our voting power in the twelve-month period
preceding the distribution of such dividends, is required to be withheld at the rate of
12.5%.

Foreign Exchange Regulations

Dividends
(if any) paid to the holders of our Ordinary Shares and any amounts payable upon our
dissolution, liquidation or winding up, as well as the proceeds of any sale in Israel of
the Ordinary Shares to an Israeli resident, may be paid in non-Israeli currency or, if
paid in Israeli currency, may be freely converted into dollars at the rate of exchange
prevailing at the time of conversion. Because exchange rates between the NIS and the
dollar fluctuate continuously, a U.S. shareholder will be subject to the risk of currency
fluctuations between the date when we declare NIS-denominated dividends and the date when
we pay them in NIS.

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

Not
applicable.

|G. | Statements
by Experts.
|-- | ----------------------

Not
applicable.

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

We
are subject to the informational requirements of the Securities Exchange Act of 1934, as
amended, applicable to foreign private issuers and fulfill the obligation with respect to
such requirements by filing reports with the Securities and Exchange Commission. You may
read and copy any document we file with the Securities and Exchange Commission without
charge at the Securities and Exchange Commissions public reference room at 450 Fifth
Street, N.W., Washington, D.C. 20549. Copies of such material may be obtained by mail from
the Public Reference Branch of the Securities and Exchange Commission at such address, at
prescribed rates. Please call the Securities and Exchange Commission at l-800-SEC-0330 for
further information on the public reference room.

80

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As a foreign private issuer, we are
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 short-swing profit recovery provisions contained in Section
16 of the Exchange Act. In addition, we are not required under the Exchange Act to file
periodic reports and financial statements with the Securities and Exchange Commission as
frequently or as promptly as United States companies whose securities are registered under
the Exchange Act. A copy of each report submitted in accordance with applicable United
States law is available for public review at our principal executive offices.

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

Not
applicable.

|ITEM 11. |  | Quantitative and Qualitative Disclosures About Market Risk
|-------- |  | ----------------------------------------------------------

Market
risk represents the risk of changes in the value of a financial instrument caused by
fluctuations in interest rates, equity prices and foreign exchange rates.

# Interest Rate Risk

We
are exposed to interest rate volatility primarily relating to interest rate changes
applicable to our withdrawals under our credit lines. Our credit lines bear interest at
rates, which vary with changes in LIBOR. We do not speculate on the future direction of
such interest rates. On March 2004, the Company reached an agreement with its principal
bank lenders for the repayment of $6.55 million and the deferral of repayment of long-term
loans totaling $1.5 million until the years 2005, 2006 and 2007. As of December 31,
2005, current maturities of long  term loans, $ 0.5 million bore interest at
variable rates. The weighted average interest rates on short-term bank credit (linked to
the U.S. dollar) as at December 31, 2005, 2004 and 2003 are 5.4%, 3.85% and 3.6%,
respectively. As of December 31, 2005, the interest expenses we attributed to the
utilization of our credit lines amounted to $54,000. Interest risk is estimated as the
potential increase in interest expenses from a hypothetical 10% increase in the interest
rates. Assuming a hypothetical 10% increase, our interest expenses would increase by
$5,000.

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# Equity Price Risk

As
of December 31, 2005, we did not have any marketable securities that were recorded at a
fair value; hence, there was no exposure to equity price risk.

# Foreign Currency
Exchange Risk

As
of December 31, 2005, we had cash and cash equivalents in New Israeli Shekels (NIS) or in
funds linked thereto in the amount of $657,000 (out of $3.1 million in cash and cash
equivalents that we had in total). Market risk is estimated as the potential decrease in
fair value resulting from a hypothetical 10% increase in the year-end Dollar exchange
rate. Assuming such increase in the Dollar exchange rate, the fair value of our cash and
cash equivalents would decrease immaterially by $60,000. As of December 31, 2005,
we had accounts receivable in New Israeli Shekels (NIS) or in funds linked thereto in the
amount of $229,000. Market risk is estimated as the potential decrease in fair value
resulting from a hypothetical 10% increase in the year-end Dollar exchange rate. Assuming
such increase in the Dollar exchange rate, the fair value of our accounts receivable would
decrease by $21,000.As of December 31, 2005, we had accounts payable in New
Israeli Shekels (NIS) or in funds linked thereto in the amount of $591,000. Market risk is
estimated as the potential increase in fair value resulting from a hypothetical 10%
decrease in the year-end Dollar exchange rate. Assuming such a decrease in the Dollar
exchange rate, the fair value of our accounts payable would increase by $54,000. As of
December 31, 2005, we had other payable in New Israeli Shekels (NIS) or in funds linked
thereto in the amount of $1,344,000. Market risk is estimated as the potential increase in
fair value resulting from a hypothetical 10% decrease in the year-end Dollar exchange
rate. Assuming such a decrease in the Dollar exchange rate, the fair value of our accounts
payable would increase by $122,000.

As
of December 31, 2005, we had cash and cash equivalents in Singapore dollars or SGD or in
funds linked thereto in the aggregate amount of $260,000. Market risk is estimated as the
potential decrease in fair value resulting from a hypothetical 10% increase in the
year-end Dollar/SGD exchange rate. Assuming such an increase in the Dollar/SGD exchange
rate, the fair value of our SGD accounts receivable would decrease by $24,000. As of
December 31, 2005 we had accounts receivable in SGD or in funds linked thereto in the
aggregate amount of $180,000. Market risk is estimated as the potential decrease in fair
value resulting from a hypothetical 10% increase in the year-end Dollar/SGD exchange rate.
Assuming such an increase in the Dollar/SGD exchange rate, the fair value of our SGD
accounts receivable would decrease by $16,000. As of December 31, 2005 we had other
receivable and other payable in SGD or in funds linked thereto in the aggregate amount of
$20,000 and $9,000, respectively. Market risk is estimated as the potential decrease in
fair value resulting from a hypothetical 10% increase in the year-end Dollar/SGD exchange
rate. Assuming such an increase in the Dollar/SGD exchange rate, the results of operations
of the Company would not have any material effect.

82

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As
of December 31, 2005, we had cash and cash equivalents in Euro or in funds linked thereto
in the aggregate amount of $172,000. Market risk is estimated as the potential increase in
fair value resulting from a hypothetical 10% decrease in the year-end Dollar/Euro exchange
rate. Assuming such a decrease in the Dollar/Euro exchange rate, the fair value of our
other payables in Euro would increase by $16,000. As of December 31, 2005, we had account
payables in Euro or in funds linked thereto in the aggregate amount of $125,000. Market
risk is estimated as the potential increase in fair value resulting from a hypothetical
10% decrease in the year-end Dollar/Euro exchange rate. Assuming such a decrease in the
Dollar/Euro exchange rate, the fair value of our other payables in Euro would increase by
$11,000.As of December 31, 2005, we had other payables in Euro or in funds linked thereto
in the aggregate amount of $327,000. Market risk is estimated as the potential increase in
fair value resulting from a hypothetical 10% decrease in the year-end Dollar/Euro exchange
rate. Assuming such a decrease in the Dollar/Euro exchange rate, the fair value of our
other payables in Euro would increase by $30,000.

# PART II

|ITEM 12. |  | Description of Securities Other Than Equity Securities
|-------- |  | ------------------------------------------------------

Not
applicable.

|ITEM 13. |  | Defaults, Dividend Arrearages And Delinquencies
|-------- |  | -----------------------------------------------

Not
applicable.

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

Not
applicable.

|ITEM 15. |  | Controls and Procedures
|-------- |  | -----------------------

We
have established and maintain disclosure controls and procedures that are designed to
ensure that material information relating to us that we file or submit under the
Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within
the time periods specified in the Securities and Exchange Commissions rules and
forms, and that such information is accumulated and communicated to the companys
management, including its Chief Executive Officer and Chief Financial Officer, as
appropriate to allow timely decisions regarding required disclosure.

83

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As
of the end of the period covered by this report, we carried out an evaluation, under the
supervision and with the participation of management, including the Chief Executive
Officer and Chief Financial Officer, of the effectiveness of the design and operation of
disclosure controls and procedures. Based on that evaluation of these disclosure controls
and procedures, the Chief Executive Officer and Chief Financial Officer concluded that our
disclosure controls and procedures were effective as of December 31, 2005.

The
Chief Executive Officer and Chief Financial Officer have also concluded that there were no
significant changes in the our internal controls or in other factors that could
significantly affect the internal controls subsequent to the date that the evaluation was
completed, including any corrective actions with regard to significant deficiencies and
material weaknesses.

|ITEM 16A |  | Audit Committee Financial Expert
|-------- |  | --------------------------------

Our
board of directors has determined that Orit Stav is our audit committee financial expert.

84

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|ITEM 16B |  | Code of Ethics
|-------- |  | --------------

On
May 13, 2004, our company adopted a code of ethics, which applies to all of our employees,
officers and directors, including our chief executive officer, our chief financial officer
and our principal accounting officer or controller or other persons performing similar
functions.

Copies
of our code of ethics will be available at our executive offices upon request.

|ITEM 16C |  | Principal Accountant Fees and Services
|-------- |  | --------------------------------------

The
following table presents fees for professional audit services rendered by Somekh Chaikin,
a member of KPMG International (independent auditors) for the audit of the Companys
consolidated annual financial statements for the years ended December 31, 2005 and
2004, and fees billed for other services rendered by Somekh Chaikin, a member of KPMG
International (independent auditors).

|                      | 2005 | 2004
|--------------------- | ---- | ----
|
|
|
|
|Audit Fees(1)         |      |     
|Audit-Related Fees(2) |      |     
|Tax Fees(3)           |      |     
|All Other Fees(4)     |      |     

|(1) | Audit
fees consist of fees for professional services rendered for the audit of the Companys
Consolidated Financial Statements and review of financial statements and services
normally provided by the independent auditor in connection with statutory and regulatory
filings or engagements.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Audit-related
fees are fees principally for assurance and related services that are not reported under
Audit Fees.
|--- | ------------------------------------------------------------------------------------------------------------------

|(3) | Tax
fees consist of tax compliance fees for the preparation of original and
               amended tax returns, claims for refunds and tax advice.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | All
other fees not included in paragraph (1) through (3) above.
|--- | ---------------------------------------------------------------

85

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Pre-approval Policies and
procedures

The
audit committee approves all audit, audit-related services, tax services and other
services provided by KPMG. Any services provided by KPMG that are not specially included
within the scope of the audit must be pre-approved by our audit committee prior to any
engagement.

|ITEM 16D |  | Exemptions from the Listing and Standards of Audit Committees
|-------- |  | -------------------------------------------------------------

Not
applicable.

|ITEM 16E |  | Purchases of Equity Securities by the Issuer and Affiliated Purchasers
|-------- |  | ----------------------------------------------------------------------

For
information relating to the purchase of our securities by Chun LP see Item 7 
Major Shareholders and Related Party Transactions  B. Related Party
Transactions.

# PART III

|ITEM 17 |  | Financial Statements
|------- |  | --------------------

The
Financial Statements required by this item are found at the end of this Annual Report,
beginning on page F-1.

|ITEM 18 |  | Financial Statements
|------- |  | --------------------

We have responded to Item 17 in lieu
of this item

86

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|ITEM 19 |  | EXHIBITS
|------- |  | --------

The
exhibits filed with or incorporated into this annual report are listed on the index of
exhibits below.

|Exhibit No. |  | Description
|----------- |  | -----------

|1.1* |  | Memorandum
of Association of Registrant
|---- |  | ---------------------------------------

|1.2* |  | Form
of Articles of Association
|---- |  | -------------------------------

|4.1** |  | Management
Services Agreement, dated March 18, 2002, between the Registrant and Elisra
                   Electronic System Ltd. (an English summary accompanied by Hebrew
original)
|----- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.2*** |  | Management
Services Agreement, dated April 6, 2003, between the Registrant and Elisra
                   Electronic System Ltd. (an English summary accompanied by Hebrew
original)
|------ |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.3 |  | Lease
Agreement, dated September 14, 1999, as amended, between BVR Technologies Ltd.
                   and Minrav Holdings Ltd. (an English summary accompanied by Hebrew
original)
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.4 |  | Lease
Agreement, dated August 29, 1999, between the Registrant and Electra Real Estate
                   Ltd.(an English summary accompanied by Hebrew original)
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.5 |  | Share
Purchase Agreement, dated March  2004 between the Registrant and the
                   purchasers identified therein
|--- |  | ---------------------------------------------------------------------------------------------------------------------------

|4.6 |  | Cooperation
Agreement, dated August 11, 2005, between the Registrant and Israel
                   Aircraft Industries on behalf of MLM. As this addendum is written in
Hebrew, a                    translation is attached hereto.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.7 |  | Share
Purchase Agreement, dated March 5, 2006 between the Registrant and Nir Dor on
                   behalf of H.S.N General Managers Holdings L.P., an Israeli Limited
Partnership.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|8 |  | Subsidiaries
of the Registrant
|-- |  | ------------------------------

|10.1 |  | Consent
of Independent Registered Public Accounting firm.
|---- |  | ---------------------------------------------------------

|12.1 |  | Certification
by Chief Executive Officer pursuant to section 302 of the Sarbanes-Oxley
                   Act of 2002
|---- |  | ---------------------------------------------------------------------------------------------------------------------

|12.2 |  | Certification
by Chief Financial Officer pursuant to section 302 of the Sarbanes-Oxley
                   Act of 2002
|---- |  | ---------------------------------------------------------------------------------------------------------------------

|13.1 |  | Certification
by Chief Executive Officer pursuant to 18 U.S.C., Section 1350, as
                   adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

87

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|13.2 |  | Certification
by Chief Financial Officer pursuant to 18 U.S.C., Section 1350, as
                   adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

---

* Incorporated by reference to the
Registration Statement on Form 20-F (Commission File No. 0-29884).** Incorporated by reference to the
annual report on Form 20-F for the year ended December 31, 2001.*** Incorporated by reference to the
annual report on Form 20-F for the year ended December 31, 2002. Incorporated by reference to
the annual report on Form 20-F for the year ended December 31, 2000.

88

---

---



SIGNATURE

The
registrant hereby certifies that it meets all of the requirements for filing on Form 20-F
and that it has duly caused and authorized the undersigned to sign this annual report on
its behalf.

| |  | B.V.R. SYSTEMS (1998) LTD.By: /s/ Ilan Gillies
Ilan GilliesChief Executive Officer
| |  | ------------------------------------------------------------------------------------------------

| |  | By: /s/ Reuven Shahar
Reuven ShaharChief Financial Officer
| |  | ------------------------------------------------------------------------

Date: April 27, 2006

89

---

---



# B.V.R. Systems (1998)
Ltd.

# Financial Statements
As of December 31, 2005



---

---



|B.V.R. Systems (1998) Ltd                                
|---------------------------------------------------------
|                                                         
|Consolidated Financial Statements as of December 31, 2005
|                                                         

Contents

|                                                                     | Page      
|-------------------------------------------------------------------- | ----------
|
|
|
|
|Report of Independent Registered Public Accounting Firm              | F-2       
|                                                                    
|Consolidated Balance Sheets as of December 31, 2005 and 2004         | F-3       
|                                                                    
|Consolidated Statements of Operations for the years                 
|ended December 31, 2005, 2004 and 2003                               | F-4       
|                                                                    
|Statement of Changes in Shareholders' Equity (Deficit) for the years
|ended December 31, 2005, 2004 and 2003                               | F-5       
|                                                                    
|Consolidated Statements of Cash Flows for the years                 
|ended December 31,2005, 2004 and 2003                                | F-6 - F-7 
|                                                                    
|Notes to Consolidated Financial Statements                           | F-8 - F-42



---

---



Report of Independent Registered Public Accounting Firm
To the Shareholders of B.V.R. Systems (1998) Ltd.

We have audited the accompanying
consolidated balance sheets of B.V.R. Systems (1998) Ltd. (the Company) and its subsidiary
as of December 31, 2005 and 2004, and the related consolidated statements of operations,
changes in shareholders equity (deficit) and cash flows for each of the years in the
three-year period ended December 31, 2005. These consolidated financial statements are the
responsibility of the Companys Board of Directors and of its Management. Our
responsibility is to express an opinion on these consolidated financial statements based
on our audits.

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

In our opinion, the consolidated
financial statements referred to above present fairly, in all material respects, the
consolidated financial position of the Company and its subsidiary as of December 31, 2005
and 2004, and the consolidated results of operations, changes in shareholders equity
(deficit) and its cash flows for each of the years in the three-year period ended December
31, 2005, in conformity with accounting principles generally accepted in Israel.

Accounting principles generally
accepted in Israel vary in certain significant respects from accounting principles
generally accepted in the United States of America. Information relating to the nature and
effect of such differences is presented in Note 21 to the consolidated financial
statements.

Somekh ChaikinCertified Public Accountants (Isr.)Member Firm of KPMG International

April 27, 2006Tel Aviv,
Israel



---

---



|B.V.R. Systems (1998) Ltd                    
|---------------------------------------------
|                                             
|Consolidated Balance Sheets as of December 31
|                                             

|                                       |  | 2005 | 2004
|-------------------------------------- |  | ---- | ----
|
|
|
|
|Assets                                 |  |      |     
|                                       |  |     
|Current assets                         |  |     
|Cash and cash equivalents              |  |      |     
|Restricted bank deposits               |  |      |     
|Trade receivables                      |  |      |     
|Other receivables and prepaid expenses |  |      |     
|Inventories                            |  |      |     
|                                       |  |      |     
|                                       |  |     
|Total current assets                   |  |      |     
|                                       |  |      |     
|                                       |  |     
|Other non-current assets               |  |      |     
|                                       |  |      |     
|                                       |  |     
|Fixed assets                           |  |      |     
|Cost                                   |  |      |     
|Less - accumulated depreciation        |  |      |     
|                                       |  |      |     
|                                       |  |     
|Fixed assets, net                      |  |      |     
|                                       |  |      |     
|                                       |  |     
|                                       |  |     
|Total assets                           |  |      |     
|                                       |  |      |     

|
Aviv TzidonChairman of the Board of Directors | 
Ilan GilliesPresident and ChiefExecutive Officer | 
Reuven ShaharCFO
|------------------------------------------------------------ | --------------------------------------------------------------- | -------------------------------

Approval date of the financial statements:  April 27, 2006



---

---



|B.V.R. Systems (1998) Ltd                    
|---------------------------------------------
|                                             
|Consolidated Balance Sheets as of December 31
|                                             

|                                                              |  | 2005 | 2004
|------------------------------------------------------------- |  | ---- | ----
|
|
|
|
|Liabilities and Shareholders' equity                          |  |      |     
|                                                              |  |     
|Current liabilities                                           |  |     
|Current maturities of long-term bank loans                    |  |      |     
|Short-term loans                                              |  |      |     
|Trade payables                                                |  |      |     
|Excess of advances from customers over amounts                |  |     
|recognized as revenue                                         |  |      |     
|Other payables and accrued expenses                           |  |      |     
|                                                              |  |      |     
|                                                              |  |     
|Total current liabilities                                     |  |      |     
|                                                              |  |      |     
|                                                              |  |     
|Long-term liabilities                                         |  |     
|Long-term bank loans                                          |  |      |     
|Long-term payables                                            |  |      |     
|Liability for employee severance benefits, net                |  |      |     
|                                                              |  |      |     
|                                                              |  |     
|Total long-term liabilities                                   |  |      |     
|                                                              |  |      |     
|                                                              |  |     
|Commitments and contingencies                                 |  |      |     
|                                                              |  |     
|Shareholders' equity                                          |  |      |     
|Share capital:                                                |  |     
|Ordinary shares, NIS 1.00 par value                           |  |     
|200,000,000 shares authorized; 95,800,210 and                 |  |     
|95,863,757 shares issued and 95,400,210 and 95,663,757 shares |  |     
|outstanding as at December 31,2004 and 2005, respectively)    |  |      |     
|Additional paid-in capital                                    |  |      |     
|Accumulated deficit                                           |  |      |     
|                                                              |  |      |     
|                                                              |  |     
|                                                              |  |      |     
|                                                              |  |      |     
|                                                              |  |     
|Total liabilities and shareholders' equity                    |  |      |     
|                                                              |  |      |     

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

F - 3

---

---



|B.V.R. Systems (1998) Ltd                                            
|---------------------------------------------------------------------
|                                                                     
|Consolidated Statements of Operations for the years ended December 31
|                                                                     

|                                            |  | 2005 | 2004 | 2003
|------------------------------------------- |  | ---- | ---- | ----
|
|
|
|
|Revenues:                                   |  |      |      |     
|Sales                                       |  |      |      |     
|Royalties and commissions                   |  |      |      | 16A 
|                                            |  |      |      |     
|                                            |  |     
|Total revenues                              |  |      |      | 19A 
|                                            |  |      |      |     
|Cost of revenues                            |  |      |      | 19B 
|                                            |  |      |      |     
|                                            |  |     
|Gross profit                                |  |      |      |     
|                                            |  |      |      |     
|                                            |  |     
|Operating expenses:                         |  |     
|Research and development                    |  |      |      |     
|Selling and marketing                       |  |      |      |     
|General and administrative                  |  |      |      |     
|                                            |  |      |      |     
|                                            |  |     
|Operating profit (loss)                     |  |      |      |     
|                                            |  |     
|Financial expenses, net                     |  |      |      | 19C 
|Other income (expenses), net                |  |      |      | 19D 
|                                            |  |      |      |     
|                                            |  |     
|Profit (loss) before income taxes           |  |      |      |     
|Income tax expense                          |  |      |      | 17  
|                                            |  |      |      |     
|                                            |  |     
|Net profit (loss) for the year              |  |      |      |     
|                                            |  |      |      |     
|Profit (loss) per share:                    |  |     
|Basic and diluted profit (loss) per share   |  |     
|(in US $)                                   |  |      |      |     
|                                            |  |      |      |     
|                                            |  |     
|Weighted-average number of Ordinary         |  |     
|Shares of nominal NIS 1.00 par value        |  |     
|outstanding (in thousands) used in          |  |     
|calculation of the basic and diluted profit |  |     
|(loss) per share                            |  |      |      |     
|                                            |  |      |      |     

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

F - 4

---

---



|B.V.R. Systems (1998) Ltd                             
|------------------------------------------------------
|                                                      
|Statement of Changes in Shareholders' Equity (Deficit)
|                                                      

|                            | Number of
Ordinary Shares
(NIS 1
par value) | Share capital | Additional
paid-in capital | Retained
earnings
(accumulated
deficit) | Total
shareholders'
equity
(deficit)
|--------------------------- | ------------------------------------------- | ------------- | -------------------------- | --------------------------------------- | ------------------------------------
|
|
|
|
|Balance as at               |                                             |               |                            |                                         |                                     
|January 1, 2003             |                                             |               |                            | 10,660,874                              |                                     
|                            |                                             |               |                            |                                         |                                     
|                            |                                             |              
|Changes during 2003         |                                             |              
|Net loss for the year       |                                             |               |                            | -                                       |                                     
|                            |                                             |               |                            |                                         |                                     
|                            |                                             |              
|Balance as at               |                                             |              
|December 31, 2003           |                                             |               |                            | 10,660,874                              |                                     
|                            |                                             |              
|Changes during 2004         |                                             |              
|Issuance of ordinary shares |                                             |               |                            | 67,072,669                              |                                     
|Exercise of stock options   |                                             |               |                            | 17,666,667                              |                                     
|Net loss for the year       |                                             |               |                            | -                                       |                                     
|                            |                                             |               |                            |                                         |                                     
|                            |                                             |              
|Balance as at               |                                             |              
|December 31, 2004           |                                             |               |                            | 95,400,210                              |                                     
|                            |                                             |              
|Changes during 2005         |                                             |              
|Issuance of shares          |                                             |              
|in respect of services      |                                             |               |                            | 263,547                                 |                                     
|Net profit for the year     |                                             |               |                            | -                                       |                                     
|                            |                                             |               |                            |                                         |                                     
|                            |                                             |              
|Balance as at               |                                             |              
|December 31, 2005           |                                             |               |                            | 95,663,757                              |                                     
|                            |                                             |               |                            |                                         |                                     

* Including issuance expenses of US$
243 thousand

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

F - 5

---

---



|B.V.R. Systems (1998) Ltd            
|-------------------------------------
|                                     
|Consolidated Statements of Cash Flows
|                                     

|                                                             | Year ended December 31
|------------------------------------------------------------ | ----------------------
|
|
|
|
|Cash flows from operating activities                         |                       
|Net profit (loss) for the year                               |                       
|Adjustments to reconcile net profit (loss) to net cash flows |                       
|from operating activities (A)                                |                       
|                                                             |                       
|                                                             |                       
|Net cash provided by (used in) operating activities          |                       
|                                                             |                       
|                                                             |                       
|Cash flows from investing activities                         |                       
|Purchases of fixed assets                                    |                       
|Proceeds from sale of fixed assets                           |                       
|Proceeds from sale of available for sale securities          |                       
|Decrease in long-term deposits                               |                       
|Decrease (increase) in restricted bank deposits              |                       
|Changes in loans to employees                                |                       
|                                                             |                       
|                                                             |                       
|Net cash provided by (used in) investing activities          |                       
|                                                             |                       
|                                                             |                       
|Cash flows from financing activities                         |                       
|Short-term bank credit, net                                  |                       
|Receipt (repayment) of short-term loan from related party    |                       
|Receipt (repayment) of long-term loans from related parties  |                       
|Repayment of long-term loans from banks                      |                       
|Issuance of Ordinary Shares                                  |                       
|Exercise of stock options                                    |                       
|                                                             |                       
|                                                             |                       
|Net cash provided by (used in) financing activities          |                       
|                                                             |                       
|                                                             |                       
|Increase in cash and cash equivalents                        |                       
|Cash and cash equivalents at the beginning of the year       |                       
|                                                             |                       
|                                                             |                       
|Cash and cash equivalents at the end of the year             |                       
|                                                             |                       

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

F - 6

---

---



|B.V.R. Systems (1998) Ltd                     
|----------------------------------------------
|                                              
|Consolidated Statements of Cash Flows (cont'd)
|                                              

|                                                           | Year ended December 31
|---------------------------------------------------------- | ----------------------
|
|
|
|
|A.   Adjustments to reconcile net income to net            |                       
|cash from operating activities                             |                       
|                                                           |                       
|Income and expenses not involving cash flows:              |                       
|Loss (gain) on sale of fixed assets                        |                       
|Gain on sale of available for sale securities              |                       
|Depreciation and amortization                              |                       
|Increase (decrease) in liability for employee              |                       
|severance benefits, net                                    |                       
|Forgiveness of debt                                        |                       
|Services in exchange for shares issuance                   |                       
|                                                           |                       
|                                                           |                       
|                                                           |                       
|                                                           |                       
|Changes in operating asset and liability items:            |                       
|Decrease in trade receivables (current and non-current)    |                       
|Decrease in other receivables and                          |                       
|prepaid expenses                                           |                       
|Increase (decrease) in excess of advances from customers   |                       
|over amount recognized as revenue                          |                       
|Decrease (increase) in inventory (current and non-current) |                       
|Decrease in trade payables                                 |                       
|Decrease in other payables and accrued expenses            |                       
|                                                           |                       
|                                                           |                       
|                                                           |                       
|                                                           |                       
|                                                           |                       
|                                                           |                       
|B.   Non-cash transactions                                 |                       
|                                                           |                       
|Accounts payable in respect of fixed assets                |                       
|                                                           |                       
|                                                           |                       
|Conversion of short-term bank credit and long-term         |                       
|loans from related parties into share capital and          |                       
|additional paid-in capital                                 |                       
|                                                           |                       
|                                                           |                       

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

F - 7

---

---



|B.V.R. Systems (1998) Ltd                                             
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as of December 31, 2005
|                                                                      

# Note 1  General

| | A. | B.V.R.
Systems (1998) Ltd. (The Company), an Israeli incorporated
               company, was formed on January 6, 1998 in order to receive all of the
assets and                liabilities of the defense-related business of B.V.R.
Technologies Limited                (BVR Tech), a company formed in 1986
which were spun off to the                Company on October 23, 1998 in exchange for
Companys shares issued to the                then shareholders of BVR Tech.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company is engaged in the development, manufacturing and marketing of advanced training
and computer-based simulation systems for military applications.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Companys business is exposed to numerous risks including product development,
technological advancement and the introduction of these products to the worlds
markets. Companies engaged in this field are required to invest significant resources and
constantly update products. The future success of the Company is dependent upon the
technological sophistication, price and quality of its products, and the provision of
solutions to meet customers needs in comparison to competitors. The principal
markets for the Companys products are mainly Europe and the Far East. Most of the
Companys customers are either government institutions or entities controlled by
governments.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | B. | In
December 2003, Chun Holding L.P. (Chun), a limited partnership
               controlled by Aviv Tzidon, Aeronautics Defense Systems Ltd. and Prescient
               Systems & Technologies Pte. Ltd., gained control of the Company by
               purchasing the Companys shares through a tender offer, from other
               shareholders and through share issuance in March 2004 (see Note 15C for
more                details). As of December 31, 2005, Chun holds approximately 60.78% of
the                outstanding shares of the Company.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | C. | At
December 31, 2005, the Company has working capital of $ 4.0 million, and a
               cash and cash equivalents balance of $ 3.1 million, compared to cash and
cash                equivalents balance of $2.6 million at December 31, 2004. In
addition, during                the year ended December 31, 2005, the Companys
total income from sales,                commissions and royalties totaled $19.2 million
compared to $12.7 million during                2004, with a positive cash flow from
operations during 2005 of $1.0 million.                Management has met its recent
historical cash flow needs by managing its working                capital and utilizing
proceeds from the share issuance in 2004. Based on current                forecasts,
management believes that the company has sufficient liquidity to                finance
operations for the next twelve months.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | D. | Subsequent
to the balance sheet date, on February 22, 2006, the Company signed a
               non-binding term sheet for the acquisition of 100% of the shares of a
               privately-held US-based corporation that designs and markets radar
simulators                for the US Department of Defense, commercial and international
training                applications. In consideration, the Company will pay up to $5.0
million, through                a combination of issuing Companys shares and cash.
The closing of the                transaction is subject to a due diligence examination
by the Company, the                execution of a definitive agreement and the receipt of
customary third-party and                regulatory approvals.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | E. | Subsequent
to the balance sheet date, on March 21, 2006, the Company issued to a
               group of new investors 20,000,000 ordinary shares, for a total
consideration of                $3.6 million, together with three separate warrants for
the purchase of                6,000,000 ordinary shares per each warrant, with exercise
prices of $0.36, $0.54                and $1.00, exercisable for a period of three years,
with a mandatory exercise                mechanism under certain conditions.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 8

---

---



|B.V.R. Systems (1998) Ltd                                             
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as of December 31, 2005
|                                                                      

# Note 2 
Significant Accounting Policies

| | The
financial statements have been prepared in accordance with generally accepted accounting
principles in Israel. See Note 21 for a reconciliation to generally accepted accounting
principles in the United States.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | A. | Use
of estimates
| | -- | ----------------

| | The
preparation of financial statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amount of revenues and expenses
during the reporting period. These are managements best estimates based on
experience and historical data. Actual results could differ from those estimates.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | B. | Financial
statements in U.S. dollars
| | -- | ------------------------------------

| | The
currency of the primary economic environment in which the operations of the Company and
its subsidiary are conducted is the U.S. dollar (dollar; $).
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
majority of the Companys sales are made outside Israel in dollars, and a
substantial portion of the Companys costs are incurred in dollars. Accordingly, the
Company has determined that the dollar is the currency of its primary economic
environment and thus its functional currency.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Companys transactions and balances denominated in dollars are presented at their
original amounts. Transactions denominated in currencies other than dollars are
translated into dollars using current exchange rates. All foreign currency transaction
gains and losses are reflected in the Statements of Operations as financial income or
expenses, as appropriate.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | C. | Principles
of consolidation
| | -- | ---------------------------

| | The
consolidated financial statements include the accounts of the Company and its wholly
owned subsidiary. All intercompany transactions and balances were eliminated in
consolidation
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | D. | Cash
equivalents and Restricted bank deposits
| | -- | ---------------------------------------------

| | The
Company considers all highly liquid investments with a maturity of three months or less
at date of purchase, to be cash equivalents.
| | ----------------------------------------------------------------------------------------------------------------------------------------

| | Restricted
bank deposits are comprised of cash deposited in banks in respect of bank guarantees
granted to the Companys customers as partial collateral for the continued
performance of work and advances received from the customers. The withdrawal of these
deposits is based on the progress of the work and is subject to customer approval. The
Company recorded liens on these deposits in favor of the banks that granted the
guarantees. The deposits are linked to the U.S. dollar and bear annual interest of 3.55%.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 9

---

---



|B.V.R. Systems (1998) Ltd                                             
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as of December 31, 2005
|                                                                      

# Note 2 
Significant Accounting Policies (contd)

| | E. | Inventories
| | -- | -----------

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

| |                              |                                               
| | ---------------------------- | ----------------------------------------------
|
|
|
|
| | Raw materials and components |    On the "first-in, first-out" method       
| | Finished products:          
| | Raw materials and components |    On the "first-in, first-out" method       
| | Labor and overhead component |    On the basis of actual manufacturing cost.

| | F. | Trade
receivables
| | -- | -----------------

| | Open
accounts include amounts billed to customers and various amounts due from transactions
arising in the ordinary course of business. Customers of the Company in the context of
long-term contracts are billed in accordance with milestones determined in the
agreements. In respect of the majority of the contracts, advances are paid upon the
signing of the contract.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | G. | Allowance
for doubtful accounts
| | -- | -------------------------------

| | The
financial statements include an allowance which Management believes adequately reflects
the loss inherent in receivables for which collection is in doubt. In determining the
adequacy of the allowance Management based its estimate on information at hand about
specific debtors, including their financial situation, the volume of their operations,
aging of the receivable and evaluation of the security received from them or their guarantors.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | H. | Fixed
assets
| | -- | ------------

| | Fixed
assets are stated at cost less accumulated depreciation. Depreciation is calculated using
the straight-line method over the estimated useful lives of the assets.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Annual
rates of depreciation are as follows:
| | --------------------------------------------

| |                                | %                         
| | ------------------------------ | --------------------------
|
|
|
|
| | Computers                      | 20 - 33.3                 
| | Motor vehicles                 | 15                        
| | Manufacturing equipment        | 10 - 15                   
| | Office furniture and equipment | 6 - 15                    
| | Leasehold improvements         | Over the term of the lease
| |                                |                           

F - 10

---

---



|B.V.R. Systems (1998) Ltd                                             
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as of December 31, 2005
|                                                                      

# Note 2 
Significant Accounting Policies (contd)

| | I. | Provision
for warranties
| | -- | ------------------------

| | The
Company provides warranties on sales of systems to certain customers for periods of up to
24 months, based on managements estimation and in accordance with the Companys
prior experience.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | J. | Revenue
recognition
| | -- | -------------------

| | (1) | Recognition
of revenues and costs from long-term contracts
| | --- | ----------------------------------------------------------

| | Revenue
and costs from work in progress under long-term contracts are recognized in accordance
with Israeli Accounting Standard No. 4 as follows:
| | -------------------------------------------------------------------------------------------------------------------------------------------------

| | a. | Revenues
and costs from work performed under long-term contracts are recognized
          according to the percentage-of-completion method, if all of the
          following conditions are fulfilled: the revenues are known or capable of being
          reliably estimated, collection of the revenues is expected, the costs involved
          with execution of the work are known or capable of being reliably estimated,
          there is no material uncertainty regarding the ability to complete the work and
          comply with the contractual terms with the customer and the rate of completion
          can be reliably estimated. If the conditions enumerated above are not met,
          income is recognized at the level of the costs incurred and expected to be
          recovered (zero margin).
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | The
percentage of completion is measured on the basis of cost (the ratio of the
          costs incurred to the total estimated costs). Work in progress under long-term
          contracts is stated at cost less amounts charged to cost of revenues in the
          statement of operations and associated with revenue recognized on the basis of
          the percentage of completion method. Cost includes direct costs of
          materials, labor, subcontractor and other direct costs and allocated indirect
          manufacturing costs.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | Anticipated
losses on contracts are provided for in full when determined to be           expected.
| | -- | --------------------------------------------------------------------------------------------------

| | d. | Estimated
profit or loss from long-term contracts may change due to changes in           estimates
resulting from differences between actual performance and original           forecasts.
The effect of such changes in estimates are recognized in the           statement of
operations at the time of their identification.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (2) | Revenue
from royalties and commissions
| | --- | --------------------------------------

| | Royalties
and commission revenues resulting from the cooperation agreement with Israel Aircraft
Industries Ltd. (IAI) (see Note 16A for more details), are being recognized
when the related payments are received by IAI. The Company determines such revenues by
receiving confirmation of payments subject to royalties and commissions from IAI. During
2004 royalties and commission revenues were recorded on a cash basis as result of
uncertainties regarding the collection of such revenues.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 11

---

---



|B.V.R. Systems (1998) Ltd                                             
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as of December 31, 2005
|                                                                      

# Note 2 
Significant Accounting Policies (contd)

| | K. | Research
and development costs
| | -- | ------------------------------

| | Research
and development costs are charged to the Statement of Operations, as incurred.
| | ---------------------------------------------------------------------------------------

| | L. | Selling
and marketing costs
| | -- | ---------------------------

| | Selling
and marketing costs which can be identified clearly and unmistakably with the individual
project and with it alone, are charged to the costs of work in progress.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Costs
that cannot be so identified are charged to selling and marketing expenses in the
statement of operations.
| | ----------------------------------------------------------------------------------------------------------------

| | M. | Income
taxes
| | -- | ------------

| | Taxes
on income for all periods presented have been computed on the basis of income tax rates
applicable to the Company and its subsidiary as separate stand-alone entities.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company accounts for income taxes under the liability method of accounting for income
taxes.
| | ------------------------------------------------------------------------------------------------

| | Under
the liability method, deferred tax assets and liabilities are determined based on
differences between financial reporting and tax bases of assets and liabilities as well
as losses carried forward, and are measured using the prevailing tax rates and laws that
will be in effect when the differences are expected to be utilized. The main factors, in
respect of which deferred taxes were not calculated is the realization of investment in a
subsidiary that management intends to retain. Similarly, deferred taxes have not been
provided for future taxable distribution from a subsidiary, since it is group policy not
to initiate a distribution of dividend that involves additional tax liability.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Deferred
tax assets for future tax benefits from realization are not included where their
realization is less than probable. As such, the Company has recorded a full valuation
allowance in regard of all is tax losses carried forward as well as for other temporary
differences (see Note 17F).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 12

---

---



|B.V.R. Systems (1998) Ltd                                             
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as of December 31, 2005
|                                                                      

# Note 2 
Significant Accounting Policies (contd)

| | N. | Impairment
in value of assets
| | -- | -----------------------------

| | The
Company applies Accounting Standard No. 15  Impairment in Value of Assets
(hereinafter  the standard). The standard provides procedures which a company must
apply in order to ensure that its assets in the consolidated balance sheet (to which the
standard applies), are not presented at an amount which is in excess of their recoverable
value, which is the higher of the net selling price and the use value (the present value
of the estimated future cash flows expected to be derived from use and disposal of the
asset).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
standard applies to all the assets in the consolidated balance sheet, except inventory,
tax assets and monetary assets (excluding monetary assets which are investments in
investee companies that are not subsidiaries). In addition, the standard provides rules
for presentation and disclosure with respect to assets whose value has been impaired.
When the value of an asset in the consolidated balance sheet is higher than its
recoverable value, the company recognizes a loss from the impairment in value in the
amount of the difference between the book value of the asset and its recoverable value.
The loss thus recognized will be cancelled only in the event of changes occurring in the
estimates that were used to determine the recoverable value of the asset since the date
on which the most recent loss from the impairment in value was recognized.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | O. | Basic
and diluted income (loss) per share
| | -- | -----------------------------------------

| | Basic
income (loss) per share is computed based on the weighted average number of shares of
nominal NIS 1.00 par value outstanding during each year, plus the effect of options and
warrants outstanding at year-end the exercise of which is probable. Diluted profit (loss)
per share is computed based on the weighted average number of Ordinary Shares used for
computing the basic loss per share plus options and warrants which were not included in
the basic loss per share calculation and which do not have an anti-dilutive effect.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | P. | Accounting
for stock-based compensation
| | -- | ---------------------------------------

| | The
Company records expenses with respect to stock options granted to employees and service
providers, that provide similar services to those that are provided by employees, in
accordance with the intrinsic value method that is prescribed by APB 25, Accounting for
Stock Issued to Employees. Shares issued to service providers are recorded based on the
fair value at the grant date of the shares issued.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 13

---

---



|B.V.R. Systems (1998) Ltd                                             
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as of December 31, 2005
|                                                                      

# Note 2 
Significant Accounting Policies (contd)

| | Q. | Concentration
of credit risk
| | -- | ----------------------------

| | Financial
instruments that potentially subject the Company to concentration of credit risk consist
mainly of cash and cash equivalents, restricted bank deposits and trade receivables.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | At
December 31, 2005 and 2004, the Company had cash and cash equivalents, and restricted
bank deposits which were deposited with major Israeli banks. 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.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Trade
receivables include amounts billed to customers. Management periodically evaluates the
collectability of these trade receivables and adjusts the allowance for doubtful accounts
to reflect the amounts estimated to be doubtful of collection.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company operates on the basis of agreements it signs with its customers. The Company
manages a limited number of projects at the same time, so that a delay in the execution
of a project may have a material effect on the financial results. Furthermore, the
majority of the Companys transactions in progress are with major customers, see
Note 19A.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | R. | Fair
value of financial instruments
| | -- | -----------------------------------

| | The
fair market value of the Companys financial instruments, which are cash and cash
equivalents, loan from related party, accounts receivable, and short and long-term debt
approximate their carrying value as of December 31, 2005 and 2004. The carrying amounts
of the Companys borrowings under its loan agreements approximate their fair value,
since they bear interest that changes according to the LIBOR rate.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | S. | Derivative
financial instruments
| | -- | --------------------------------

| | Derivative
financial instruments, held for hedging, are deferred and recognized when the hedged
transactions occur.
| | -------------------------------------------------------------------------------------------------------------------

| | Derivative
financial instruments, not held for hedging, are stated in the financial statements at
their fair value. Changes in fair value are recognized as they occur.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
fair value of derivative financial instruments is determined based on their market value
and, when there is no market value, then according to a valuation model.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 14

---

---



|B.V.R. Systems (1998) Ltd                                             
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as of December 31, 2005
|                                                                      

# Note 2 
Significant Accounting Policies (contd)

| | T. | Disclosure
of effect of new accounting standards in the period prior to their
               implementation
| | -- | -----------------------------------------------------------------------------------------------------------

| | (1) | In
July 2005, the Israel Accounting Standards Board (IASB) published
               Accounting Standard No. 22, Financial Instruments: Disclosure and
               Presentation (hereinafter  the Standard). The Standard
provides                rules for presenting financial instruments in the financial
statements and                specifies the proper disclosure required in respect
thereto. Furthermore, the                Standard provides the method for classifying
financial instruments as financial                liabilities and as shareholders equity,
for classifying the interest,                dividends, losses and gains related to them
and the circumstances in which                financial assets should be offset from
financial liabilities.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
new standard will apply to financial statement for periods beginning on January 1, 2006
or thereafter. The Standard provides that it is to be adopted on a prospective basis.
Implementation of the new Standard is not anticipated to have material effect on the
Companys results of operation and financial position.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (2) | In
September 2005, the IASB published Accounting Standard No. 24,                Share-Based
Payments (hereinafter  the Standard). The Standard                requires
that share-based payment transactions, including transactions with
               employees or other parties that are to be settled by equity instruments,
cash or                other assets, be recognized in the financial statements. In
accordance with the                Standard, share-based payment transactions in which
goods or services are                received will be recognized at their fair value.
Furthermore, the Standard                provides various disclosure requirements
regarding the nature and extent of the                share-based payment arrangements
that existed during the period, and regarding                the method by which the fair
value of such arrangements was determined.
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Standard will apply to financial statements for periods beginning as from January 1, 2006
and early implementation is recommended. The instructions of the Standard should be
applied to each share-based payment transaction executed after March 15, 2005 that has
not yet vested until the effective date of the Standard. With respect to share-based
payments classified as liabilities (such as phantom plans) that exist on the effective
date of the Standard and for share-based payments granted after March 15, 2005, the
Standard is to be implemented retroactively and the comparative data is to be restated.
Changes in the terms of a share-based payment transaction being settled by means of
equity instruments and executed after March 15, 2005 are to be treated in accordance with
the instructions of the new Standard, and comparative data relating to share-based
payment granted after March 15, 2005 is to be restated. Implementation of the new
standard is expected to have a material effect on the Companys results of
operations and financial position with respect to future share-based transactions.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (3) | In
February 2006 the IASB published Accounting Standard No. 25,                Revenues (hereinafter
 the Standard). The Standard provides                the required accounting
treatment (recognition, measurement, presentation and                disclosure
principles) of revenues deriving from the selling of goods, the                rendering
of services, and the use of the entitys assets by others, which
               generate interest, royalties and dividends. The Standard provides that an
entity                is to measure its revenues according to the fair value of the
proceeds received                and/or the proceeds the entity is entitled to receive.
The Standard will apply                to financial statements for periods beginning on
January 1, 2006 or thereafter.                Implementation of the new standard is not
anticipated to have a material effect                on the Companys results of
operations and financial position.
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 15

---

---



|B.V.R. Systems (1998) Ltd                                             
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as of December 31, 2005
|                                                                      

# Note 2 
Significant Accounting Policies (contd)

| | T. | Disclosure
of effect of new accounting standards in the period prior to their
               implementation
| | -- | -----------------------------------------------------------------------------------------------------------

| | (4) | In
February 2006 the IASB published Accounting Standard No. 21, Earnings
               per Share (hereinafter  the Standard). The Standard provides that an
               entity should calculate basic earnings per share with respect to the
earnings or                loss attributable to the ordinary shareholders of the
reporting entity and that                the entity should calculate basic earnings per
share with respect to the                earnings or loss from continuing operations
attributable to the ordinary                shareholders of the reporting entity if such
earnings or loss is presented. The                basic earnings per share will be
calculated by dividing the earnings or loss                attributable to the ordinary
shareholders outstanding during the period. In                order to calculate the
diluted earnings per share an entity will adjust the                earnings or loss
attributable to the ordinary shareholders of the reporting                entity, and the
weighted average number of outstanding ordinary shares in                respect of the
effects of all the dilutive potential ordinary shares. The                Standard will
apply to financial statements for periods beginning on January 1,                2006 or
thereafter. The instructions of the Standard are to be implemented
               retroactively on comparative earnings per share data for prior periods.
The                implementation of the Standard is not anticipated to have a material
effect on                the Companys results of operations and financial position.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# Note 3  Cash and
Cash Equivalents

| |  | December 31,
| |  | ------------
|
|
|
|
| |  |             
| |  |             
| |  |             
| |  |             
| |  |             
| |  |             
| |  |             

F - 16

---

---



|B.V.R. Systems (1998) Ltd                                             
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as of December 31, 2005
|                                                                      

# Note 4  Trade
Receivables

| |                                                 | December 31
| | ----------------------------------------------- | -----------
|
|
|
|
| | Open accounts                                   |            
| | Unbilled revenue *                              |            
| | Receivables from related parties (see Note 20A) |            
| | Receivables from IAI (see Note 16A)             |            
| |                                                 |            
| |                                                 |            
| |                                                 |            
| |                                                 |            
| |                                                 |            
| | * Unbilled revenue is comprised as follows:     |            
| |                                                 |            
| | Accumulated amounts recognized as revenues      |            
| | Less - advances from customers                  |            
| |                                                 |            
| |                                                 |            
| | Other income receivable                         |            
| |                                                 |            
| |                                                 |            
| | Unbilled revenue                                |            
| |                                                 |            

| | Information
on contracts for long-term projects
| | -----------------------------------------------

| |                                                | December 31
2005 and the
year then ended | December 31
2004 and the
year then ended
| | ---------------------------------------------- | ---------------------------------------- | ----------------------------------------
|
|
|
|
| | Amount of contracts for long-term projects     |                                          |                                         
| | signed during the year                         |                                          |                                         
| |                                                |                                          |                                         
| |                                                |                                          |                                         
| | Portion of the accumulated amount of contracts |                                          |                                         
| | for long-term projects not yet recognized as   |                                          |                                         
| | income at the year end                         |                                          |                                         
| |                                                |                                          |                                         

F - 17

---

---



|B.V.R. Systems (1998) Ltd                                             
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as of December 31, 2005
|                                                                      

# Note 5  Other
Receivables and Prepaid Expenses

| |                                            | December 31,
| | ------------------------------------------ | ------------
|
|
|
|
| | Government authorities                     |             
| | Prepaid expenses                           |             
| | Receivables in respect of work in progress |             
| | Others                                     |             
| |                                            |             
| |                                            |             
| | Less - allowance for doubtful accounts     |             
| |                                            |             
| |                                            |             
| |                                            |             
| |                                            |             

# Note 6  Inventories

| |                                      | December 31,
| | ------------------------------------ | ------------
|
|
|
|
| | Finished products*                   |             
| | Components for systems manufacturing |             
| | Raw materials                        |             
| |                                      |             
| |                                      |             
| |                                      |             
| |                                      |             
| |                                      |             

| | * | At
December 31, 2004, additional inventory that was held for an operating lease which
expired during 2005, in the net amount of $1.1 million was presented as part of other
non-current assets (see Note 7).
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# Note 7  Other
Non-Current Assets

| |                                         | December 31,
| | --------------------------------------- | ------------
|
|
|
|
| | Non-current restricted bank deposits    |             
| | Inventory held for operating lease, net |             
| | Other long-term deposit                 |             
| |                                         |             
| |                                         |             
| |                                         |             
| |                                         |             

F - 18

---

---



|B.V.R. Systems (1998) Ltd                                             
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as of December 31, 2005
|                                                                      

# Note 8  Fixed Assets

| |                                    | December 31
| | ---------------------------------- | -----------
|
|
|
|
| | Computers and electronic equipment |            
| | Manufacturing equipment            |            
| | Motor vehicles                     |            
| | Office furniture and equipment     |            
| | Leasehold improvements             |            
| |                                    |            
| |                                    |            
| |                                    |            
| | Less - accumulated depreciation    |            
| |                                    |            
| |                                    |            
| | Net book value                     |            
| |                                    |            

| | Depreciation
expenses recorded for the years ended December 31, 2005, 2004 and 2003 were US$ 364
thousand, US$ 690 thousand and US$ 659 thousand, respectively.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------

# Note 9  Short-Term
Loan

| | On
October 1, 2003 shareholders of the Company (at that date) granted loans in the total
amount of $601 thousand, for a period of two years, bearing no interest. On March 2,
2004, loans in the amount of US$ 100 thousand were converted into shares of the Company,
at a price of US$ 0.18 per share. On April 20, 2004, the Company reached an agreement for
the repayment of US$ 204 thousand and a waiver of US$ 177 thousand out of the then
outstanding loans amount.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
at December 31, 2005 a loan in the amount of US$120 thousand is outstanding, bearing no
interest, the Company expects to repay this loan during 2006.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------

# Note 10  Trade
Payables

| |                                | December 31,
| | ------------------------------ | ------------
|
|
|
|
| | Payables to IAI (see Note 16A) |             
| | Post-dated checks              |             
| | Open accounts                  |             
| | Sub-contractor payables        |             
| |                                |             
| |                                |             
| |                                |             
| |                                |             
| |                                |             

F - 19

---

---



|B.V.R. Systems (1998) Ltd                                             
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as of December 31, 2005
|                                                                      

# Note 11  Excess of
Advances from Customers over Amounts Recognized as Revenue

| |                                                  | December 31,
| | ------------------------------------------------ | ------------
|
|
|
|
| | Advances from customers                          |             
| | Less - accumulated amounts recognized as revenue |             
| |                                                  |             
| |                                                  |             
| |                                                  |             
| |                                                  |             

# Note 12  Other
Payables and Accrued Expenses

| |                                        | December 31,
| | -------------------------------------- | ------------
|
|
|
|
| | Payroll and related accruals           |             
| | Provision for warranty and completion  |             
| | Government authorities                 |             
| | Accrued expenses to IAI (see Note 16A) |             
| | Other accrued expenses                 |             
| |                                        |             
| |                                        |             
| |                                        |             
| |                                        |             

# Note 13  Long-Term
Bank Loans

| | A. | Balances
according to linkage basis and rates of interest
| | -- | ---------------------------------------------------------

|                          | LinkageBasis | Rates ofInterest | December 31
|------------------------- | ------------ | ---------------- | -----------
|
|
|
|
|Long-term bank loans      |              |                  | US dollar  
|Less - current maturities |              |                  |            
|                          |              |                  |            
|                          |              |                 
|                          |              |                  |            
|                          |              |                  |            

| | B. | During
the second quarter of 2004, the Company reached an agreement with its
               principal bank to reschedule the repayment of short-term loans in the
amount of                US$ 1,550 thousand in three equal annual installments for the
years 2005, 2006                and 2007. (See Note 15C).
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 20

---

---



|B.V.R. Systems (1998) Ltd                                             
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as of December 31, 2005
|                                                                      

# Note 14  Liability
for Employee Severance Benefits, Net

| | A. | Under
Israeli law, the Company is required to make severance payments to
               dismissed employees and to employees terminating employment under certain
other                circumstances. The Companys liability for severance pay is
fully provided                for through insurance policies and by accrual.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Due
to a reduction in salaries effective from October 1, 2002 and in accordance with an
agreement between the Company and its employees, the liability for severance pay
calculation is divided into two periods, until the salary reduction and subsequently.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
calculation was based on the number of years of employment until September 30, 2002
multiplied by the latest salary paid as of September, 2002, plus the number of years of
employment commencing October 1, 2002 multiplied by the latest salary paid.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                        | December 31,
| | ---------------------- | ------------
|
|
|
|
| | Severance pay          |             
| | Less - amounts funded* |             
| |                        |             
| |                        |             
| |                        |             
| |                        |             

| | * | The
Company may only withdraw amounts funded for the purpose of severance pay disbursement.
| | - | -------------------------------------------------------------------------------------------

| | B. | Severance
pay expenses (income) recorded for the years ended December 31, 2005,                2004
and 2003 were US$ 8 thousand, US$ (78) thousand and US$ 116 thousand,
               respectively.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# Note 15 
Shareholders Equity

| | A. | The
Companys Ordinary Shares are traded on the Over the Counter Bulletin
               Board (OTCBB) under the symbol BVRSF.OB.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------

| | B. | 
| | -- | 

| |                    | Issued | Outstanding
| | ------------------ | ------ | -----------
|
|
|
|
| | Ordinary Shares of |        |            
| | NIS 1.00 par value |        |            
| |                    |        |            

| | On
March 1, 2004, the Companys shareholders approved to increase the share capital of
the Company by NIS 180,000,000 divided into 180,000,000 ordinary shares, nominal value
NIS 1.00 each. The authorized share capital of the Company following the share capital
increase is of NIS 200,000,000 divided into 200,000,000 shares.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 21

---

---



|B.V.R. Systems (1998) Ltd                                             
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as of December 31, 2005
|                                                                      

# Note 15 
Shareholders Equity (contd)

| | C. | On
March 1, 2004, and during 2004, the Company completed the issuance of
               66,872,669 shares, in the amount of US$ 11.9 million, of which US$ 9.8
million                was issued in exchange for cash and $2.1 million was issued in
exchange for the                conversion of loans from banks and a controlling interest
into shares.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
addition, Chun (see Note 1B) was granted an option (the Options) to purchase
40,000,000 ordinary shares of the Company, for an additional investment amount of up to
US$7.2 million at an exercise price per share of US$ 0.18, for a period of four years.
The options will expire in March 2008.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Chun
has resolved, and instructed the Company accordingly, that even though the shareholders
of the Company have voted for the grant of all the Options to itself, Chun shall only be
entitled to 30,000,000 of the Options and the remaining 10,000,000 Options shall be
distributed among the Investors, pro-rata to the cash invested by them during 2004.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | During
the third quarter of 2004, Chun exercised 17,666,667 options into shares for the amount
of US$ 3,180 thousand. At December 31, 2005, there are 22,333,333 options outstanding.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | D. | Shares
based compensation
| | -- | -------------------------

| | 1. | In
June 2000, the Board of Directors of the Company approved a plan to grant
               options for the purchase of up to 1,200,000 ordinary shares to the
               Companys employees. Each option is exercisable into one Ordinary
Share of                the Company at an exercise price equal to the market price of the
share on the                date of issuance. At December 31, 2005, 18,000 options are
outstanding and                exercisable under this plan at a price of US$ 2.5 per
share. No other options                are available for additional grants under this
plan.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | In
August 2001, the Board of Directors of the Company approved an option plan to
               grant options for the purchase of up to 707,900 Ordinary Shares to the
               Companys employees, directors and subcontractors. Each option is
               exercisable into one Ordinary Share of the Company at exercise prices of
US$ 0.9                 US$ 2.69, equal to the market price of the share on the
date of issuance.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
aforesaid options are exercisable in two increments, one third after one year from the
date of issuance and two thirds after two years from the date of issuance. The options
will expire after three years from the vesting date of each increment. At December 31,
2005, there are 380,300 options outstanding under this plan. No other options are
available for additional grants under this plan.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 22

---

---



|B.V.R. Systems (1998) Ltd                                             
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as of December 31, 2005
|                                                                      

# Note 15 
Shareholders Equity (contd)

| | D. | Shares
based compensation (contd)
| | -- | ----------------------------------

| | 3. | In
2004, the Company granted Aviv Tzidon, the Chairman of the Board of
               Directors, an option to purchase 9,000,000 ordinary shares of the Company
vested                in five equal increments subject to him serving as an active
Chairman of the                Board of Directors. The exercise price per share shall be
US$ 0.18. The options                will expire after three years from the vesting date
of each installment. As at                December 31, 2005 there are 9,000,000 options
outstanding, 3,600,000 of them are                exercisable immediately.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company also granted to each of the Companys directors (not including Aviv Tzidon),
options to purchase 72,000 shares of the Company (total of 648,000 shares), at an
exercise per share of US$ 0.18. The options were subject to the completion of a full year
of service. As at December 31, 2005 there are 576,000 options outstanding and
exercisable, after the cancellation of 72,000 options of one director who did not
complete a full year of service.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4. | In
January 2004, the Companys Board of Directors approved the grant of up
               to 5,000,000 options to the Companys employees and service
providers. Each                option is exercisable into one Ordinary Share of the
Company. At December 31,                2005, there are 3,657,000 options outstanding for
employees and there are                1,064,000 options outstanding for service
providers.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
options are exercisable at prices of US$ 0.145 to US$ 0.65 per share, and are exercisable
in five equal increments (one fifth per year) commencing one year after their issuance.
The options will expire after three years from the vesting date of each increment.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 5. | In
January 2004, the Company signed a three-year consulting agreement with Wise
               Pte Ltd. (Wise), a company owned and controlled by the brother
of                Aviv Tzidon, the Companys Chairman of the Board of Directors.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | According
to the agreement Wise will provide the Company marketing services in the Far East, in
consideration of a monthly payment of US$ 3,000 each month by way of issuance of 16,667
of the Companys ordinary shares each month.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | During
each of the years 2004 and 2005, the Company issued 200,000 ordinary shares in respect of
this agreement. A further 200,000 ordinary shares will be issued in respect of this
agreement during 2006.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 6. | On
June 8, 2005, the Company issued to Tact Computers and Systems Ltd.                (Tact)
63,547 ordinary shares of the Company in consideration for                the services
provided by Tact under a service agreement signed on February 2004.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 7. | Subsequent
to the balance sheet date, on January 1, 2006 the Company issued to
               Electra Real-Estate Ltd. (Electra) 1,000,000 ordinary shares
of the                Company in consideration for part of the lease payments of the
premises occupied                by the Company under an operating leasing agreement
signed with Electra during                August 1999.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 23

---

---



|B.V.R. Systems (1998) Ltd                                             
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as of December 31, 2005
|                                                                      

# Note 15 
Shareholders Equity (contd)

| | D. | Shares
based compensation (contd)
| | -- | ----------------------------------

| | 8. | Data
in respect of the option plans
| | -- | -----------------------------------

| | As
of December 31, 2005, 14,695,300 options were outstanding. The options are each
exercisable for one Ordinary Share at exercise prices ranging between US$ 0.18 and US$
7.125 per share.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | a. | A
summary of the status of the Companys stock option plans as of December
          31, 2005, 2004 and 2003, and changes during the years then ended, is as
follows:
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                         | As at December 31,
|------------------------ | ------------------
|
|
|
|
|Options outstanding at   |                   
|the beginningof the year |                   
|Granted                  |                   
|Forfeited and cancelled  |                   
|                         |                   
|Outstanding at the       |                   
|end of the year          |                   
|                         |                   
|Options exercisable at   |                   
|year-end                 |                   
|                         |                   

F - 24

---

---



|B.V.R. Systems (1998) Ltd                                             
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as of December 31, 2005
|                                                                      

# Note 15 
Shareholders Equity (contd)

| | Data
in respect of the option plans (contd)
| | --------------------------------------------

| | b. | The
following table summarizes information relating to stock options at           December 31,
2005:
| | -- | ----------------------------------------------------------------------------------------------------

| | Exercise price (US$) | Optionsoutstanding | Optionsexercisable
| | -------------------- | ------------------ | ------------------
|
|
|
|
| | 2.69                 |                    |                   
| | 2.6                  |                    |                   
| | 2.5                  |                    |                   
| | 2.36                 |                    |                   
| | 2.06                 |                    |                   
| | 2.03                 |                    |                   
| | 0.9                  |                    |                   
| | 0.65                 |                    |                   
| | 0.55                 |                    |                   
| | 0.18                 |                    |                   
| | 0.17                 |                    |                   
| | 0.23                 |                    |                   
| | 0.145                |                    |                   
| |                      |                    |                   
| |                      |                    |                   
| |                      |                    |                   
| |                      |                    |                   

| | c. | Outstanding
options as at December 31, 2005 may be exercised as follows:
| | -- | ------------------------------------------------------------------------

| |                           | Numberof options | Weightedaverageexerciseprice (US$)
| | ------------------------- | ---------------- | ----------------------------------
|
|
|
|
| | Immediately               |                  |                                   
| | First year or thereafter  |                  |                                   
| | Second year or thereafter |                  |                                   
| |                           |                  |                                   
| |                           |                  |                                   
| |                           |                  |                                   
| |                           |                  |                                   

F - 25

---

---



|B.V.R. Systems (1998) Ltd                                             
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as of December 31, 2005
|                                                                      

Note 16 
Commitments and Contingent Liabilities

| | A. | Cooperation
agreement
| | -- | ---------------------

| | The
Company developed, manufactured and marketed the Ehud system pursuant to a
joint venture agreement entered into in 1992 with the MLM division of Israel Aircraft
Industries Ltd. (IAI) (the IAI Agreement). Pursuant to the IAI
Agreement, the Company and IAI agreed to jointly develop, manufacture and market the
Ehud, with IAI subcontracting certain of the manufacturing and integration
work with respect to the Ehud product to the Company. The IAI Agreement
expired pursuant to its terms in October 1997.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | During
August 1999, the Company signed a new agreement with IAI (the 1999 Agreement)
which governs a joint venture between the parties and which also provides guidelines for
fair competition between the parties, this without adversely impacting existing
agreements previously signed with third parties.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
parties have agreed that the Ehud system will be marketed by each of the
parties, in various territories, in consideration of the payment of various royalties to
the other party. As part of the 1999 Agreement, the following worldwide territories have
been delineated:
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 1. | A
territory in which one party operates exclusively while paying the other party
               royalties at the rate of 4.75%  12.5% of the contract consideration
with                respect to contracts executed in such countries until 2008. The party
receiving                the royalty shall not operate in this territory in any manner
whatsoever.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | A
territory in which the parties may compete, with the successful party paying
               the other party royalties at the rate of 4%-8% of the contract
consideration,                with respect to contracts executed in such countries until
2008.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | Countries
not included in a. and b., above, shall be covered by a separate
               arrangement.
| | -- | ------------------------------------------------------------------------------------------------------

| | Pursuant
to the 1999 Agreement, IAI has the exclusive right to market and sell the Ehudsystems
in countries in West Europe.
| | -----------------------------------------------------------------------------------------------------------------------------

| | The
agreement, whose terms are set forth above, shall apply to the sale of the Ehud systems.
With regard to other product, separate royalty payment instructions were set up.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
August 11, 2005, the Company and IAI signed a new agreement (the 2005 Agreement)
which continues and expands the 1999 Agreement. The 2005 Agreement expands cooperation
between the parties in the marketing of Naval Combat Maneuvering Instrumentation Systems
in various countries worldwide through the transfer of work share from the leading party
to the other. The 2005 Agreement also set the rate of royalties in all territories to 5%
with respect to Ehud Systems. In addition, the 2005 Agreement resolved all
disagreements between the parties prior to January 1, 2005. The term of the 2005
Agreement is for 10 years. As result of the resolution of the disagreements between the
parties, the Company released during 2005, certain previously accrued liabilities in the
amount of $780 thousand that are no longer payable as a result of the new agreement
signed with IAI in 2005, this amount was credited to the cost of revenues during 2005.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
2005, the Company recognized royalties revenue from IAI in the amount of US$ 1.7 million.
| | --------------------------------------------------------------------------------------------

F - 26

---

---



|B.V.R. Systems (1998) Ltd                                             
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as of December 31, 2005
|                                                                      

# Note 16 
Commitments and Contingent Liabilities (contd)

| | B. | Lease
commitments
| | -- | -----------------

| | The
premises occupied by the Company are rented under various operating leases expiring at
the end of September 2009. The future minimum annual rental payments as of December 31,
2005 are as follows:
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Year ending December 31, | US$ thousand
| | ------------------------ | ------------
|
|
|
|
| | 2006                     |             
| | 2007                     |             
| | 2008                     |             
| | 2009 and after           |             
| |                          |             
| |                          |             
| |                          |             
| |                          |             

| | C. | Spin-off
| | -- | --------

| | In
connection with the 1998 spin-off (see Note 1) the Company and BVR Tech entered into
several agreements for the purpose of giving effect to the spin-off and defining the
Companys and BVR Techs working relationship, as follows:
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 1. | The
Company and BVR Tech each undertook to indemnify and/or compensate the other
               (the Injured Party) for any amount, damage or expense that the
               Injured Party incurs in consequence of a third-party claim relating to a
field                of activity of the indemnifying party, concerning events occurring
before the                effective date of the spin-off, provided that the Injured Party
notified the                indemnifying party of the third-party claim and allowed the
indemnifying party                to manage and defend such claim. As at December 31,
2005 the Company has no                information that would indicate that any material
payments will be required in                respect of this agreement.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | The
Company and BVR Tech entered into an agreement concerning technology
               transfers and cross licenses between each of the parties. Under this
agreement,                BVR Tech transferred to the Company the rights to co-ownership
of BVR                Techs intellectual property as related to the defense-related
operations                transferred to the Company pursuant to the spin-off agreement.
In January                2003 the Company and BVR Tech entered into a Technology
Transfer and Assignment                Agreement pursuant to which the Company purchased
from BVR Tech all rights,                title and interest to all patents that were in
the co-ownership of the parties,                in consideration for US$12 thousand.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | BVR
Tech will only be entitled to exploit such intellectual property rights for
               its activities that do not conflict with the Companys activities as
               conducted at the time of consummation of the Plan other than with respect
to                applications relating to simulation and training systems for commercial
               applications which shall be exploited solely by the Company. The Company
and BVR                Tech further agreed not to compete with each others business
activities.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 27

---

---



|B.V.R. Systems (1998) Ltd                                             
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as of December 31, 2005
|                                                                      

# Note 16 
Commitments and Contingent Liabilities (contd)

| | D. | Liabilities
and guarantees
| | -- | --------------------------

| | 1. | In
order to provide security for the credit received from banks and for the bank
               guarantees provided in favor of the Company, the Company registered first
degree                fixed and floating liens on money deposits, a floating lien on all
its property,                assets and related insurance benefits and a floating lien on
its unpaid share                capital, its goodwill and its plant, assets and rights.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | On
certain occasions the Company deposits cash and cash equivalents with certain
               financial institutions that have issued guarantees on behalf of the
Company in                favor of its customers. In order to fulfill the above-mentioned
commitments, the                Company places a charge on its bank deposits (including
the insurance rights                attached thereto). At the balance sheet date there
are US$ 2,364 thousand                restricted bank deposits (as at December 31, 2004
 US$ 2,563 thousand                restricted bank deposits).
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | Guarantees
issued by banks in favor of the Company are as follows:
| | -- | ------------------------------------------------------------------

| |                            | December 31
| | -------------------------- | -----------
|
|
|
|
| | Performance guarantees     |            
| |                            |            
| |                            |            
| | Advance payment guarantees |            
| |                            |            
| |                            |            
| | Other bank guarantees      |            
| |                            |            

| | The
expiration dates of the guarantees are up to June 30, 2008. Bank charges on those
guarantees are attributed to financial expenses.
| | --------------------------------------------------------------------------------------------------------------------------------------

| | E. | Liability
for warranty
| | -- | ----------------------

| | The
Company has made provision for warranty for some of its completed projects, in accordance
with management judgment and based on past experience.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------

| | The
changes in this provision during 2005 are as follows:
| | ---------------------------------------------------------

| |                                       | US$ thousands
| | ------------------------------------- | -------------
|
|
|
|
| | Balance at December 31, 2002 utilized |              
| | Accrued                               |              
| | Utilized                              |              
| |                                       |              
| |                                       |              
| | Balance at December 31, 2003          |              
| | Utilized                              |              
| |                                       |              
| |                                       |              
| | Balance at December 31,2004           |              
| | Accrued                               |              
| | Utilized                              |              
| |                                       |              
| |                                       |              
| | Balance at December 31, 2005          |              
| |                                       |              

F - 28

---

---



|B.V.R. Systems (1998) Ltd                                             
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as of December 31, 2005
|                                                                      

# Note 16 
Commitments and Contingent Liabilities (contd)

| | F. | Derivative
financial instruments
| | -- | --------------------------------

| | The
Company enters, from time to time, into foreign currency future contracts and put and
call options contracts to reduce the impact of fluctuations of certain currencies against
the U.S. dollar resulting primarily from firm commitments not denominated in U.S.
dollars. Gains or losses resulting from qualified hedges of firm commitments are deferred
and recognized when the hedged transactions occur, while results of transactions which do
not meet all the criteria specified in SFAS No. 52 and SFAS No. 80 are recorded as
financial income or expense.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
at December 31, 2005, the Company did not have outstanding future contracts.
| | -------------------------------------------------------------------------------

# Note 17  Income
Taxes

| | A. | Tax
benefits under the Law for the Encouragement of Industry (Taxes), 1969
| | -- | --------------------------------------------------------------------------

| | The
Company is an industrial company, as defined by this law and, as such, is
entitled to certain tax benefits, mainly accelerated depreciation of machinery and
equipment, as prescribed by regulations published under the Inflationary Adjustments Law
(see Note 17C hereunder), the right to claim public issuance expenses and amortization of
patents and other intangible property rights as a deduction for tax purposes.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | B. | Tax
benefits under the law for the Encouragement of Capital Investments, 1959           (the
law)
| | -- | ---------------------------------------------------------------------------------------------------

| | In
1998, the Company applied for approval of the expansion of its facilities in Rosh Haayin
(the second plan).
| | -----------------------------------------------------------------------------------------------------------------

| | In
addition, in 2001 the Company filed a request for an additional new plan to expand its
production facilities in Rosh Haayin (the third plan). The request was
approved in 2002.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Pursuant
to the aforementioned law the Company will be entitled to a full exemption on its taxable
income arising from the second and third plan for a period of two years and a reduced tax
rate of 25% for an additional five years from the date on which the investments are
significantly completed and the Company has taxable income as defined by the law.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
benefits to which the Company will be entitled, will be granted on the proportionate part
of the income, deriving from a future increase in its income in excess of the base
turnover, which is not entitled to benefits. The utilization of the seven years of
benefits for the second and third plan is limited to 2012 and 2016, respectively.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2005, due to losses, the Company had not yet utilized the tax benefits
provided in the second and third plan.
| | --------------------------------------------------------------------------------------------------------------------------------

F - 29

---

---



|B.V.R. Systems (1998) Ltd                                             
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as of December 31, 2005
|                                                                      

# Note 17  Income
Taxes (contd)

| | B. | Tax
benefits under the law for the Encouragement of Capital Investments, 1959           (the
law) (contd)
| | -- | ------------------------------------------------------------------------------------------------------------

| | The
tax-exempt income attributable to the Approved Enterprise can be distributed
to shareholders without subjecting the Company to taxes only upon the complete
liquidation of the Company. The Companys Board of Directors has determined that
such tax-exempt income will not be distributed as dividends. Accordingly, no deferred
income taxes have been provided on income attributable to the Companys Approved
Enterprise.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | If
the retained tax-exempt income is distributed in a manner other than the complete
liquidation of the Company, it would be taxed at the corporate tax rate applicable to
such profits as if the Company had not chosen the alternative tax benefits (currently
25%). As at December 31, 2005 the Company has accumulated losses.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
aforementioned benefits are conditional upon compliance with the terms and regulations as
prescribed by law, and the approvals according to which the investments were carried out.
Non-compliance with the terms may result in the cancellation of the benefits, in whole,
or in part, and the refund of the benefit amounts in addition to accrued interest.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of the date of the financial statements, the Companys management is of the opinion
that it is in compliance with all of the aforementioned terms.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------

| | C. | Measurement
of taxable income under the Income Tax (Inflationary Adjustments)           Law, 1985
| | -- | -------------------------------------------------------------------------------------------------

| | Under
this law, taxable income is measured in real terms, in accordance with the changes in the
Israeli CPI.
| | ------------------------------------------------------------------------------------------------------------

| | D. | Tax
rates applicable to income from other sources in Israel
| | -- | -----------------------------------------------------------

| | Income
derived from sources other than the approved enterprise is not eligible for the
aforementioned benefits and is taxed at the regular rate of 34%.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
July 25, 2005 the Knesset passed the Law for the Amendment of the Income Tax Ordinance
(No.147 and Temporary Order)  2005 (hereinafter  the Amendment).
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Amendment provides for a gradual reduction in the company tax rate in the following
manner: in 2006 the tax rate will be 31%, in 2007 the tax rate will be 29%, in 2008 the
tax rate will be 27%, in 2009 the tax rate will be 26% and from 2010 onward the
tax rate will be 25%. Furthermore, as from 2010, upon reduction of the company tax rate
to 25%, real capital gains will be subject to tax of 25%.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 30

---

---



|B.V.R. Systems (1998) Ltd                                             
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as of December 31, 2005
|                                                                      

# Note 17  Income
Taxes (contd)

| | E. | Taxation
of foreign subsidiary
| | -- | ------------------------------

| | The
subsidiary in the Far East is taxed under the tax laws in force in that country.
| | ------------------------------------------------------------------------------------

| | F. | Deferred
income taxes
| | -- | ---------------------

| | Deferred
income taxes reflect the net tax effects of temporary differences between the carrying
amounts of assets and liabilities for financial reporting purposes and the amounts used
for income tax purposes.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Deferred
tax assets for future tax benefits from realization are included where their realization
is probable. As such, the Company has recorded a valuation allowance in regard of all its
tax losses carried forward as well as for other temporary differences.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Significant
components of the Companys deferred tax liabilities and assets are as follows:
| | -------------------------------------------------------------------------------------------

| |                                       | December 31,
| | ------------------------------------- | ------------
|
|
|
|
| | Deferred tax assets:                  |             
| | Provision for vacation                |             
| | Liability for employees severance pay |             
| | Net operating loss carryforwards*     |             
| | Research and development costs, net   |             
| | Issuance expenses                     |             
| | Others                                |             
| |                                       |             
| |                                       |             
| | Less: Valuation allowance*            |             
| |                                       |             
| |                                       |             
| | Deferred tax asset                    |             
| |                                       |             

| | * | As
result of the Amendment in the companies tax rate in 2005 (see G above), the net
operating loss carry forwards component and the valuation allowance were reduced by $2.3
million.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | If
the undistributed earnings of the Singapore subsidiary of approximately US$ 142 thousand
were to be distributed as a dividend, additional taxes of approximately US$ 36 thousand
will be payable.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 31

---

---



|B.V.R. Systems (1998) Ltd                                             
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as of December 31, 2005
|                                                                      

# Note 17  Income
Taxes (contd)

| | G. | A
reconciliation of the theoretical tax expense, assuming all income is taxable
               at the statutory rates applicable in Israel, and the actual tax expense,
is as                follows:
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                              | Year ended December 31,
| | -------------------------------------------- | -----------------------
|
|
|
|
| | Income (loss) before taxes on income         |                        
| |                                              |                        
| |                                              |                        
| | Statutory tax rate in Israel                 |                        
| |                                              |                        
| |                                              |                        
| | Theoretical tax cost (benefit)               |                        
| | Losses deductions and expenses in respect of |                        
| | which deferred tax assets were not recorded  |                        
| | Taxes in respect of previous years           |                        
| | Non-deductible expenses                      |                        
| |                                              |                        
| |                                              |                        
| | Actual tax expense                           |                        
| |                                              |                        

| | H. | Income
tax assessments
| | -- | ----------------------

| | During
2005, the Company reached an agreement with the Israeli Tax Authorities which finalized
the income tax assessments of the 1998-2000 tax years. According to the agreement the
Company should pay the tax authorities $1.3 million, including interest in 36 monthly
payments commencing April 2005 up to March 2008. As at December 31, 2005, the Company has
recorded $452 thousand as a current liability and $607 thousand as long-term liability.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | I. | Net
operating losses carryforward
| | -- | ---------------------------------

| | Net
operating loss carryforwards as of December 31, 2005 totaled approximately US$ 41 million
(as of December 31, 2004 approximately US$ 42 million). The net operating loss
carryforwards have no expiration date.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 32

---

---



|B.V.R. Systems (1998) Ltd                                             
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as of December 31, 2005
|                                                                      

# Note 18  Monetary
balances in Currencies Other than the US Dollar

| |                       | December 31, 2005 | December 31, 2004
| | --------------------- | ----------------- | -----------------
|
|
|
|
| | Assets                |                   |                  
| | Current assets        |                   |                  
| | Long-term assets      |                   |                  
| |                       |                   |                  
| | Total assets          |                   |                  
| |                       |                   |                  
| |                       |                   |                  
| | Liabilities           |                   |                  
| | Current liabilities   |                   |                  
| | Long-term liabilities |                   |                  
| |                       |                   |                  
| | Total liabilities     |                   |                  
| |                       |                   |                  

# Note 19 
Supplementary Statement of Operation Information

| | A. | Summary
information about geographical areas:
| | -- | ---------------------------------------------

| | Total
revenues are attributed to geographic areas based on the location of the customers.
| | -----------------------------------------------------------------------------------------

| |                                   | Year ended December 31,
| | --------------------------------- | -----------------------
|
|
|
|
| | Total revenues from:              |                        
| | Israel                            |                        
| | Far East                          |                        
| | Europe                            |                        
| | Africa                            |                        
| | America                           |                        
| |                                   |                        
| |                                   |                        
| |                                   |                        
| |                                   |                        
| |                                   |                        
| | Majorcustomers data as a          |                        
| | percentage of the total revenues: |                        
| |                                   |                        
| | Customer A                        |                        
| | Customer B                        |                        
| | Customer C                        |                        
| | Customer D                        |                        
| |                                   |                        
| |                                   |                        
| |                                   |                        
| |                                   |                        

| | * | Less
than 10%.
| | - | --------------

F - 33

---

---



|B.V.R. Systems (1998) Ltd                                             
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as of December 31, 2005
|                                                                      

# Note 19 
Supplementary Statement of Operation Information (contd)

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

| |                                         | Year ended December 31,
| | --------------------------------------- | -----------------------
|
|
|
|
| | Raw materials and components            |                        
| | Salaries, wages and employees' benefits |                        
| | Subcontractors                          |                        
| | Agents fees                             |                        
| | Depreciation                            |                        
| | Other manufacturing costs               |                        
| |                                         |                        
| |                                         |                        
| |                                         |                        
| |                                         |                        

| | C. | Financial
expenses, net
| | -- | -----------------------

| |                                                | Year ended December 31,
| | ---------------------------------------------- | -----------------------
|
|
|
|
| | Financial income:                              |                        
| | Interest on short-term deposits                |                        
| | Interest on loans to others and interest from  |                        
| | non-current receivables                        |                        
| | Other                                          |                        
| |                                                |                        
| |                                                |                        
| |                                                |                        
| |                                                |                        
| |                                                |                        
| | Financial expenses:                            |                        
| | Bank charges and interest on short-term credit |                        
| | Other                                          |                        
| |                                                |                        
| |                                                |                        
| |                                                |                        
| |                                                |                        
| |                                                |                        
| | Total financial expenses, net                  |                        
| |                                                |                        

F - 34

---

---



|B.V.R. Systems (1998) Ltd                                             
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as of December 31, 2005
|                                                                      

# Note 19 
Supplementary Statement of Operation Information (contd)

| | D. | Other
income (expenses), net
| | -- | ----------------------------

| |                                                 | 2005 | 2004 | 2003
| | ----------------------------------------------- | ---- | ---- | ----
|
|
|
|
| | Gain from sale of available for sale securities |      |      |     
| | Gain on waiver of long-term loan from           |      |     
| | former related party                            |      |      |     
| | Others                                          |      |      |     
| |                                                 |      |      |     
| |                                                 |      |     
| |                                                 |      |      |     
| |                                                 |      |      |     

| | E. | Supplementary
information onstatements of operations
| | -- | ----------------------------------------------------

| |                    |  |  | 
| | ------------------ |  |  | 
|
|
|
|
| | Rent costs         |  |  | 
| |                    |  |  | 
| |                    |  | 
| | Advertising costs  |  |  | 
| |                    |  |  | 
| |                    |  | 
| | Royalties expenses |  |  | 
| |                    |  |  | 

# Note 20  Related
Parties

| | A. | Balances
| | -- | --------

| | Related
parties are comprised of principal shareholders (10% holding of the Companys share
capital) and their subsidiaries and affiliates as well as affiliates of the Company.
Transactions with related parties are mainly as follows:
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 1. | Sales
of the Companys products and expenses related to such sales.
| | -- | -------------------------------------------------------------------

| | 2. | Interest
payable on loans received.
| | -- | -----------------------------------

| | 3. | Payment
of Management fees.
| | -- | ---------------------------

| | 4. | Purchases
of services and products.
| | -- | -----------------------------------

F - 35

---

---



|B.V.R. Systems (1998) Ltd                                             
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as of December 31, 2005
|                                                                      

# Note 20  Related
Parties (contd)

| | A. | Balances
(contd)
| | -- | -----------------

| | All
transactions, and terms with related parties were identical to those applied to
transactions with other customers or suppliers.
| | -----------------------------------------------------------------------------------------------------------------------------------

| |                           |  |  | December 31,
| | ------------------------- |  |  | ------------
|
|
|
|
| | Due from:                 |  |  |             
| | Cash and cash equivalents |  |  | -           
| | Restricted bank deposits  |  |  | -           
| |                           |  | 
| | Trade receivables         |  |  | -           
| |                           |  |  |             
| |                           |  |  |             
| | Other receivables         |  |  | -           
| | Other Non-current assets  |  |  | -           
| |                           |  | 
| | Due to:                   |  |  |             
| | Short-term bank credit    |  |  | -           
| |                           |  | 
| | Other payable             |  |  | -           
| |                           |  | 
| | Long-term loan            |  |  | -           

F - 36

---

---



|B.V.R. Systems (1998) Ltd                                             
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as of December 31, 2005
|                                                                      

Note
20  Related Parties (contd)

| | B. | Transactions
with related parties
| | -- | ---------------------------------

| |                                                    | Year ended December 31,
| | -------------------------------------------------- | -----------------------
|
|
|
|
| | Income from sales (1)(3) (5) (7)                   |                        
| | Cost of sales (mainly royalties and components for |                        
| | systems manufacturing) (1)(2)(3)                   |                        
| | Marketing expenses(8)                              |                        
| | General and administrative expenses (1) (4)        |                        
| | Finance expenses, net (6)                          |                        
| | Other income(5)                                    |                        
| |                                                    |                        

| | (1) | To
Elisra (*)
| | --- | -------------

| | (2) | To
Tadiran Spectralink (*)
| | --- | --------------------------

| | (3) | To
          Israel Aircraft Industries Ltd. (*)
| | --- | ------------------------------------------------

| | (4) | Including
the salary of the CEO and fees paid to directors.
| | --- | -----------------------------------------------------------

| | (5) | To
          Aeronautics
| | --- | ------------------------

| | (6) | To
Bank Leumi
| | --- | -------------

| | (7) | To
ST Training and           Simulation Pte Ltd.
| | --- | ------------------------------------------------

| | (8) | To
Prescient Systems and Technologies Pte           Ltd.
| | --- | --------------------------------------------------------

| | (*) | A
related party until December 2003
| | --- | -----------------------------------

# Note 21  Effect of
Differences Between Israeli and U.S. GAAP

| | A. | The
consolidated financial statements of the Company conform with generally
               accepted accountingprinciples in Israel (Israeli GAAP),
               which differ in certain significant respects from thosefollowed in
the                United States (U.S. GAAP), as described below:
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 1. | Comprehensive
Income
| | -- | --------------------

| | Israeli
GAAP does not require disclosure of comprehensive income.
| | -----------------------------------------------------------------

| | Under
U.S. GAAP, the amount of comprehensive income, comprising net income and
items described as other comprehensive income, such as foreign currency
translation adjustments, unrealized gains and losses on available-for-sale securities and
changes in the fair value of derivatives that qualify as cash flow hedges, should be
reported separately in the financial statements as a component of other comprehensive
income.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 37

---

---



|B.V.R. Systems (1998) Ltd                                             
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as of December 31, 2005
|                                                                      

Note 21  Effect of
Differences Between Israeli and U.S. GAAP (contd)

| | A. | The
consolidated financial statements of the Company conform with generally
               accepted accountingprinciples in Israel (Israeli GAAP),
               which differ in certain significant respects from thosefollowed in
the                United States (U.S. GAAP), as described below: (contd)
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | Earnings
per share
| | -- | ------------------

| | According
to Israeli GAAP
| | -------------------------

| | The
effect of options and warrants is included in the computation of basic earnings per share
only if their exercise is considered probable, based on the ordinary relationship between
the market price of the shares stemming from the exercise of the warrants and the
discounted present value of the future proceeds derived from the exercise of the options
and warrants.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
effect of convertible debentures is taken into account in the computation of basic
earnings per share only if their conversion is considered probable, based on the
relationship between the market price of the shares stemming from the conversion and the
discounted present value of the convertible debentures.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Diluted
earnings (losses) per share are computed based on the weighted average number of ordinary
shares used for computing the basic earnings per share plus options, warrants and
convertible debentures which were not included in the basic earnings per share
calculation and which are not anti-dilutive.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | According
to U.S. GAAP
| | ----------------------

| | U.S.
            GAAP also requires dual presentation of basic and diluted earnings per share
          for entities with complex capital structures as well as a reconciliation of the
          basic EPS computation to the diluted EPS computation. Basic EPS is calculated
by           dividing net income available to ordinary stockholders, by the weighted
average           number of common shares outstanding. The computation of diluted
EPS assumes           the issuance of common shares for all dilutive-potential common
shares           outstanding during the reporting period. The dilutive effect of stock
options is           considered in earnings per share calculations if dilutive, using the
if           converted treasury stock method.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | Liability
for termination of employer-employee relations
| | -- | --------------------------------------------------------

| | According
to Israeli GAAP
| | -------------------------

| | Amounts
funded by purchase of insurance policies are deducted from the related severance pay
liability.
| | -------------------------------------------------------------------------------------------------------

| | According
to U.S. GAAP
| | ----------------------

| | According
to U.S. GAAP, the amounts funded should be presented as long-term investments and the
gross amount of the liability should be presented as a long-term liability.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 38

---

---



|B.V.R. Systems (1998) Ltd                                             
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as of December 31, 2005
|                                                                      

Note 21  Effect of
Differences Between Israeli and U.S. GAAP (contd)

| | A. | The
consolidated financial statements of the Company conform with generally
               accepted accountingprinciples in Israel (Israeli GAAP),
               which differ in certain significant respects from thosefollowed in
the                United States (U.S. GAAP), as described below: (contd)
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4. | Stock
options granted to employees, service providers and other non-employees
               and stock issued toservice providers
| | -- | ---------------------------------------------------------------------------------------------------------------------------------

| | According
to Israeli GAAP
| | -------------------------

| | The
Company records expenses with respect to stock options granted to employees and service
providers that provide similar services to those that are provided by employees, in
accordance with the intrinsic value method that is prescribed by APB 25, Accounting for
Stock issued to Employees. Shares issued to service providers are recorded based on the
fair value at the grant date of the shares issued.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | According
to US GAAP
| | --------------------

| | Stock
options granted to employees
| | ----------------------------------

| | The
Company apply the intrinsic value-based method of accounting prescribed by Accounting
Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to
Employees, and related interpretations in accounting for its fixed plan stock options.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Under
APB 25, when the exercise price of the Companys employee stock options equals or is
above the market price of the underlying stock on the date of grant, no compensation
expense is recognized.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Stock
options granted to service providers and other non-employees and stock issued to service providers
| | --------------------------------------------------------------------------------------------------------

| | The
Company accounts for such awards in accordance with the provisions of EITF 96-18,
Accounting for Equity Instruments That are Issued to Other than employees for Acquiring,
or in conjunction of Selling, Goods or Services (EITF 96-18). Since the
warrants issued by the Company are not fully vested, and no performance commitment, as
defined in EITF 96-18 is reached, the Company estimates the cost of the unvested warrants
based on the fair value of the warrants at each reporting period (using the Black &Scholes
model) and accounts for the portion of the services that the recipient has rendered to
date using that estimate.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 39

---

---



|B.V.R. Systems (1998) Ltd                                             
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as of December 31, 2005
|                                                                      

Note 21  Effect of
Differences Between Israeli and U.S. GAAP (contd)

| | B. | The
effect of the differences between Israeli and U.S. GAAP of the
               aforementioned items on thefinancial statements is as follows:
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------

| | 1. | On
statements of income
| | -- | -----------------------

| |                                              | Year ended December 31,
| | -------------------------------------------- | -----------------------
|
|
|
|
| | Net Profit (loss) as reported, according to  |                        
| | Israeli GAAP                                 |                        
| |                                              |                        
| | GAAP differences:                            |                        
| |                                              |                        
| | Allocation of non-employee stock option      |                        
| | expenses under the fair value based method   |                        
| |                                              |                        
| |                                              |                        
| | Net loss under U.S. GAAP                     |                        
| |                                              |                        
| |                                              |                        
| | I.   Basic and diluted net (loss) income per |                        
| | share (in U.S. $)                            |                        
| |                                              |                        
| | As reported, according to Israeli GAAP       |                        
| |                                              |                        
| |                                              |                        
| | According to U.S. GAAP                       |                        
| |                                              |                        
| |                                              |                        
| | II .   Weighted average number of            |                        
| | ordinary shares outstanding (in              |                        
| | thousands) used in basic and                 |                        
| | diluted loss per share calculation           |                        
| | under U.S. GAAP                              |                        
| |                                              |                        
| |                                              |                        

F - 40

---

---



|B.V.R. Systems (1998) Ltd                                             
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as of December 31, 2005
|                                                                      

Note 21  Effect of
Differences Between Israeli and U.S. GAAP (contd)

| | B. | The
effect of the differences between Israeli and U.S. GAAP of the
                    aforementioned items on the financialstatements is as
follows:                     (contd)
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | On
balance sheet items
| | -- | ----------------------

|                        | December 31,
|----------------------- | ------------
|
|
|
|
|Severance pay fund      |             
|                        |             
|Total assets            |             
|                        |             
|Liability for employee  |             
|severance benefits, net |             
|                        |             
|Total liabilities       |             
|                        |             
|Total shareholders'     |             
|equity                  |             
|                        |             

F - 41

---

---



|B.V.R. Systems (1998) Ltd                                             
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as of December 31, 2005
|                                                                      

Note 21  Effect of
Differences Between Israeli and U.S. GAAP (contd)

| | B. | The
effect of the differences between Israeli and U.S. GAAP of the
                    aforementioned items on the financialstatements is as follows
                    (contd)
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | On
Statement of Changes in Shareholders Equity
| | -- | -----------------------------------------------

|                            | Share capital | Additionalpaid-incapital | Accumulatedothercomprehensiveincome (loss) | Accumulateddeficit | Total
|--------------------------- | ------------- | ------------------------ | ------------------------------------------ | ------------------ | -----
|
|
|
|
|Balance as of               |               |                          |                                            |                    |      
|January 1, 2003             |               |                          |                                            | 10,660,874         |      
|                            |               |                         
|Changes during 2003:        |               |                         
|Net loss for the year       |               |                          |                                            | -                  |      
|Realization of profit       |               |                         
|deriving from financial     |               |                         
|instruments                 |               |                          |                                            | -                  |      
|                            |               |                          |                                            |                    |      
|Comprehensive loss          |               |                          |                                            | -                  |      
|                            |               |                          |                                            |                    |      
|                            |               |                         
|Balance as of               |               |                         
|December 31, 2003           |               |                          |                                            | 10,660,874         |      
|                            |               |                         
|Changes during 2004:        |               |                         
|Net loss for the year       |               |                          |                                            | -                  |      
|Issuance of ordinary shares |               |                          |                                            | 67,072,669         |      
|Exercise of stock options   |               |                          |                                            | 17,666,667         |      
|Stock-based compensation    |               |                          |                                            | -                  |      
|                            |               |                          |                                            |                    |      
|                            |               |                         
|Balance as of               |               |                         
|December 31, 2004           |               |                          |                                            | 95,400,210         |      
|                            |               |                         
|Changes during 2005:        |               |                         
|Net loss for the year       |               |                          |                                            | -                  |      
|Issuance of Ordinary Shares |               |                          |                                            | 263,547            |      
|Stock-based compensation    |               |                          |                                            | -                  |      
|                            |               |                          |                                            |                    |      
|                            |               |                         
|Balance as of               |               |                         
|December 31, 2005           |               |                          |                                            | 95,663,757         |      
|                            |               |                          |                                            |                    |      

|(1) | Represents
an amount less than US$ 1 thousand.
|--- | ----------------------------------------------

F - 42

---

---