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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, 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, 2004                                                    
|  |                                                                                                 
|  | 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 001-14552
|                                

|Top Image Systems Ltd.                                                                          
|------------------------------------------------------------------------------------------------
|(Exact
 name of Registrant as specified in its charter)                                         
|                                                                                                
|Israel                                                                                          
|(Jurisdiction
 of incorporation or organization)                                                
|                                                                                                
|2 Habarzel Street, Ramat Hahayel, Tel Aviv 69710,
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, nominal value NIS 0.04 per share

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

Indicate the number of outstanding shares of each of the
issuers classes of capital or common stock as of the close of the period
covered by the annual report:8,753,991
Ordinary Shares

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.

YesoNox

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

Item 17oItem 18x

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TABLE OF CONTENTS

|             |          |    |                                                                              | Page
|------------ | -------- | -- | ---------------------------------------------------------------------------- | ----
|             |          |    |                                                                              |     
|             |          |    |                                                                              |     
|PART I       |          | 1 
|             |          |   
|             | ITEM 1.  |    | IDENTITY
 OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS                       |     
|             | ITEM 2.  |    | OFFER
 STATISTICS AND EXPECTED TIMETABLE                                     |     
|             | ITEM 3.  |    | KEY
 INFORMATION                                                             |     
|             |          |    |                                                                              |     
|RISK FACTORS |          | 3 
|             |          |   
|             | ITEM 4.  |    | INFORMATION
 ABOUT THE COMPANY                                               |     
|             | ITEM 5.  |    | OPERATING
 AND FINANCIAL REVIEW AND PROSPECTS                                |     
|             | ITEM 6.  |    | DIRECTORS,
 SENIOR MANAGEMENT AND EMPLOYEES                                  |     
|             | ITEM 7.  |    | MAJOR
  SHAREHOLDERS AND RELATED PARTY TRANSACTIONS                          |     
|             | ITEM 8.  |    | FINANCIAL
 INFORMATION                                                       |     
|             | ITEM 9.  |    | LISTING                                                                      |     
|             | ITEM 10. |    | ADDITIONAL
 INFORMATION                                                      |     
|             | ITEM 11. |    | QUANTITATIVE
 AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                  |     
|             | ITEM 12. |    | DESCRIPTION
 OF SECURITIES OTHER THAN EQUITY SECURITIES                      |     
|             |          |    |                                                                              |     
|PART II      |          | 63
|             |          |   
|             | ITEM 13. |    | DEFAULTS, DIVIDENDS, ARREARAGES AND DELINQUENCIES                            |     
|             | ITEM 14. |    | MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS |     
|             | ITEM 15. |    | CONTROLS
 AND PROCEDURES                                                     |     
|             |          |    |                                                                              |     
|PART III     |          | 66
|             |          |   
|             | ITEM 18. |    | FINANCIAL
 STATEMENTS                                                        |     
|             | ITEM 19. |    | EXHIBITS                                                                     |     

i

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Forward - Looking Statements

Certain
matters discussed in this report on Form 20-F are forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of
1995.  The words or phrases will likely
result,  are expected to, will
continue, is anticipated, estimate, project, believe, plan or
similar expressions identify some, but not all, of the forward looking
statements contained in this report.   
These statements are based on managements current expectations or
beliefs and are subject to a number of risks and uncertainties that could cause
actual results to differ materially and adversely, including, but not limited
to, those described under Risk Factors herein and in our subsequent filings
with the United States Securities and Exchange Commission.   We wish to caution readers not to place
undue reliance on any such forward looking statements, which speak only as of
the date made.   We are under no
obligation to, and expressly disclaim any obligation to, update or alter our
forward-looking statements, whether as a result of new information, future
events or otherwise.

Defined Terms

In
this report, we, us, our, TiS and the Company refer to Top Image
Systems Ltd. and its consolidated subsidiaries, collectively.

PARTI

ITEM 1.IDENTITY OF DIRECTORS,
SENIOR MANAGEMENT AND ADVISORS

Not applicable.

ITEM 2.       OFFER STATISTICS AND EXPECTED TIMETABLE

Not applicable.

ITEM 3.       KEY INFORMATION

SELECTED FINANCIAL DATA

The
following selected consolidated financial data as of, and for the years ended,
December 31, 2002, 2003, and 2004 have been derived from, and should be read in
conjunction with, our audited consolidated financial statements for the year
ended December 31, 2004 included in this report. The selected consolidated
financial data as of, and for the years ended, December 31, 2000 and 2001 have
been derived from our audited consolidated financial statements not included in
this report. Our consolidated financial statements have been prepared in
accordance with generally accepted accounting principles in Israel, or Israeli
GAAP. Israeli GAAP vary in certain significant respects from generally accepted
accounting principles in the United States, or U.S. GAAP. Application of U.S.
GAAP would have affected our results of operations and shareholders equity for
each of the years in the three-year period ended December 31, 2004 to the
extent summarized in Note 19 to our consolidated financial statements for the
year ended December 31, 2004 and in the table below. The selected consolidated
financial data should be read in conjunction with and are qualified by
reference to Item 5 of this report entitled Operating and Financial Review and
Prospects and the consolidated financial statements and notes thereto and
other financial information included elsewhere in this report.

1

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|                                                                |                                         | Year Ended December 31,                                   |          
|--------------------------------------------------------------- | --------------------------------------- | --------------------------------------------------------- | ---------
|                                                                |                                         |                                                           |          
|                                                                |                                         | 2000                                                      |          
|                                                                |                                         |                                                           |          
|                                                                |                                         | In US$ except for weighted average
 number of shares data |          
|Statement
 of Operations Data
 under Israeli GAAP:              |                                         |                                                           |          
|                                                                |                                         |                                                           |          
|                                                                | Revenues                                |                                                           | $        
|                                                                | Cost of revenues                        |                                                           |          
|                                                                | Gross profit                            |                                                           |          
|                                                                | Research and development,
 net          |                                                           |          
|                                                                | Selling, administrative and
 general    |                                                           |          
|                                                                | Financial expense (income),
 net        |                                                           |          
|                                                                | Other (income) expense                  |                                                           |          
|                                                                | Minority share in loss of a
 subsidiary |                                                           |          
|                                                                | Net loss                                |                                                           |          
|                                                                |                                         |                                                           |          
|Israeli GAAP net basic and
 dilutive loss per
    share         |                                         | $                                                         | (1.088   
|                                                                |                                         |                                                           |          
|Israeli GAAP weighted
 average number of
    shares outstanding |                                         |                                                           | 5,848,890
|                                                                |                                         |                                                           |          
|                                                                |                                         |                                                           |          

|                                                    |                           | As of December 31 |  
|--------------------------------------------------- | ------------------------- | ----------------- | -
|                                                    |                           | 2000              |  
|                                                    |                           |                   |  
|                                                    |                           | In US$            |  
|Summary of
 Balance Sheet Data
 under Israeli GAAP: |                           |                   |  
|                                                    | Cash and cash equivalents |                   | $
|                                                    | Working capital           |                   |  
|                                                    | Total Assets              |                   |  
|                                                    | Long Term debt            |                   |  
|                                                    | Total liabilities         |                   |  
|                                                    | Shareholders equity      |                   |  

2

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|                                                                                                           |                                         | Year Ended December 31,                                   |          
|---------------------------------------------------------------------------------------------------------- | --------------------------------------- | --------------------------------------------------------- | ---------
|                                                                                                           |                                         |                                                           |          
|                                                                                                           |                                         | 2000                                                      |          
|                                                                                                           |                                         |                                                           |          
|                                                                                                           |                                         | In US$ except for weighted average
 number of shares data |          
|Statement
 of Operations Data
 under U.S. GAAP:                                                            |                                         |                                                           |          
|                                                                                                           | Revenues                                |                                                           | $        
|                                                                                                           | Cost of revenues                        |                                                           |          
|                                                                                                           | Gross profit                            |                                                           |          
|                                                                                                           | Research and development,
 net          |                                                           |          
|                                                                                                           | Selling, administrative and
 general    |                                                           |          
|                                                                                                           | Financial expense (income),
 net        |                                                           |          
|                                                                                                           | Other (income) expense                  |                                                           |          
|                                                                                                           | Minority share in loss of a
 subsidiary |                                                           |          
|                                                                                                           | Net loss                                |                                                           |          
|                                                                                                           |                                         |                                                           |          
|U.S. GAAP net basic and
 dilutive loss per
    share                                                       |                                         | $                                                         | (1.095   
|                                                                                                           |                                         |                                                           |          
|U.S. GAAP weighted average
 number of
    shares outstanding for basic and dilutive
    net loss per share |                                         |                                                           | 5,810,376
|                                                                                                           |                                         |                                                           |          
|                                                                                                           |                                         |                                                           |          

|                                                 |                           | As of December 31, |  
|------------------------------------------------ | ------------------------- | ------------------ | -
|                                                 |                           |                    |  
|                                                 |                           | 2000               |  
|                                                 |                           |                    |  
|                                                 |                           | In US$             |  
|Summary of
 Balance Sheet Data
 under U.S. GAAP: |                           |                    |  
|                                                 | Cash and cash equivalents |                    | $
|                                                 | Working capital           |                    |  
|                                                 | Total Assets              |                    |  
|                                                 | Long Term debt            |                    |  
|                                                 | Total liabilities         |                    |  
|                                                 | Shareholders equity      |                    |  



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RISK FACTORS

You
should carefully consider the risks described below before making an investment
decision regarding our ordinary shares. Our business, financial condition or
results of operations could be materially adversely affected by any of these
risks. The trading price of our ordinary shares could decline due to any of
these risks, and you may lose all or part of your investment.

The market for data capture systems and
automatic form processing systems is highly competitive.

The
market for data capture systems in general, and for automatic form processing
systems in particular, is characterized by intense competition, significant
price erosion over the life of the product, and rapidly changing business
conditions, customer requirements, and technology. Our products compete with
those developed and marketed by numerous well-established companies including
Captiva Software, Mitek, Banctec, Dicom Group, Microsystems Technology,
Datacap, SER, and ReadSoft, as well as with manual data entry systems. Many of
our competitors have longer operating histories and greater financial resources
than we do. Furthermore, certain of these competitors are industry leaders with
the financial resources necessary to enable them to withstand substantial price
competition or downturns in the market for computer software. The fact that our
resources are more limited places us at a significant disadvantage. This risk
is particularly acute during difficult economic times.

A slowdown in our customers industry or a
decline in economic conditions could adversely impact the sale of our products
and our prospects of achieving or maintaining profitability

3

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A slowdown
in the industries to which we sell our products would likely result in
significantly reduced product demand, erosion of selling prices and
overcapacity. Such a downturn could materially reduce demand for the products
and technology that we offer. In addition, our ability to reduce expenses in
response to any downturn or slowdown in such industries may be limited because
of:

| | our
  continuing need to invest in research and development;
|- | ------------------------------------------------------------
|  |                                                             
| | our capital
  equipment requirements; and                   
|  |                                                             
| | marketing
  requirements.                                   

Our success depends
on our strategic marketing relationships and the marketing and distribution
efforts of our distributors and other strategic partners.

Our
business and prospects depend upon our ability to maintain our existing, and to
develop additional, strategic marketing relationships and upon the marketing
and distribution efforts of our distributors and other strategic partners. The
loss or diminishment of our relationship with any one of our significant
strategic partners could have a material and adverse effect on our existing
operations and growth prospects. We intend to recruit additional distributors
with established distribution channels and reputations for marketing and
installing document imaging, data capture and workflow systems to market our
products. We cannot assure you that we will be able to develop such
relationships.

Our industry is
marked by rapid technological changes and frequent new or updated product
introductions, and if we do not respond to such rapid technological changes,
new product introductions and enhancements and evolving industry standards, our
products and services could become obsolete.

Our ability
to compete will depend upon our ability to offer products at competitive prices
in a timely and cost-effective manner. Our product decisions must anticipate
the changing demand for products. If we are unable to develop, modify and
enhance our existing technology to respond to such changing demands, standards
and customer demands, our business could be adversely affected. In addition,
the development of new technologies, new product introductions or enhancements
by our competitors could adversely affect our sales.

We have had a
history of losses and may incur future losses.

Since our
inception in March 1991, we have incurred net losses in every year other than
in 1995, 1997 and 1998, and our losses may continue. For the year ended
December 31, 2004, we had a net loss of $178,392, and accumulated deficit of $
14,992,222.  We plan to maintain the
level of our aggregate product development expenses and may significantly
increase our sales and marketing and administrative expenses in the near
future. Accordingly, to maintain our current level of financial performance, we
will need to increase or maintain our revenues. We cannot assure you that our
revenues will grow or that we will achieve positive profitability in the
future. Failure to increase revenues could result in a material adverse effect
on our business, prospects and financial results.

We have a history of
quarterly fluctuations in our results of operations and expect these
fluctuations to continue. This may cause our stock price to decline.

We have
experienced and expect to experience in the future significant fluctuations in
our quarterly results of operations.

Our lengthy
sales cycle increases our exposure to customer cancellations or delays in
orders, which may result in volatile quarterly revenues. Given the high average
selling price of, and the cost and time required to implement, our solutions, a
customers decision to license our products typically involves a significant
commitment of resources and is influenced by the customers budget cycles and
internal approval procedures for information technology purchases. In addition,
selling our solutions requires us to educate potential customers about our
solutions uses and benefits. As a result, our solutions have a long sales
cycle, which can take 9 to 12 months or more. Consequently, we have difficulty
predicting the quarter in which sales to expected customers may occur. The sale
of our solutions is also subject to delays from the lengthy budgeting, approval
and competitive evaluation processes of our customers, which typically
accompany significant capital expenditures.

4

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Other
factors that may contribute to fluctuations in our quarterly results of
operations include:

| | the size,
  timing and shipment of orders;                                                                                                  
|- | --------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                             
|  |                                                                                                                                             
| | customer
  deferral of orders in anticipation of new products, product upgrades or price
  enhancements;                                    
|  |                                                                                                                                             
| | the high
  level of competition that we encounter; and                                                                                      
|  |                                                                                                                                             
|  |                                                                                                                                             
| | the timing
  of our product introductions, upgrades or enhancements or those of our
  competitors or of providers of complementary products.

Fluctuations
in our quarterly results could discourage investors and cause the market price
of our ordinary shares to decline.

We derive
significant revenue from distributors or resellers of our products and default
in payment by them could adversely affect us.

A default
in payment by one or more of our significant distributors or resellers could
adversely affect our business, results of operations, and financial condition.
Although we believe that we have made adequate reserves against our receivables,
we cannot assure you that uncollected receivables will not exceed those
reserves. If they do exceed our reserves in a significant manner, we could
suffer a material adverse effect on our business, prospects, and financial
results.

Large customers constitute
a significant portion of our orders and we may have difficulty in expanding our
customer base in the future.

Several
large customers account for a significant part of our sales. For example, Swiss
PostFinance accounted for 10% and 17% of our sales in 2004 and 2003,
respectively. The loss of large customers could adversely impact our business,
prospects, and financial results.

Our success depends
on our key personnel.

Our success
depends upon the contributions of our executive officers and other key
personnel. All of our key management and technical personnel have expertise
which is in high demand among our competitors, and the loss of any of these
individuals could cause our business to suffer. We do not as a general matter maintain
key person life insurance policies on our officers, directors and key
employees.

Our
solutions require a sophisticated sales effort targeted at senior management of
our prospective customers. New employees in our sales department require
extensive training and typically take several months to achieve full productivity. There is no assurance that new
sales representatives will ultimately become productive. If we were to lose
qualified and productive sales personnel, our revenues could be adversely
impacted.

Our success depends
on our proprietary software technology.

Our success
depends upon our proprietary software technology. Although we believe that our
technology has been developed independently and does not infringe on the proprietary
rights of others, we cannot assure you that the technology does not and will
not infringe or that third parties will not assert infringement claims against
us in the future. In the case of infringement, we would, under certain
circumstances, be required to modify our products or obtain a license. We
cannot assure you that we would be able to do either in a timely manner under
acceptable terms and conditions or at all, or that we will have the financial
or other resources necessary to defend successfully a patent infringement or
other proprietary rights infringement action. Further, even if we were not
infringing, intellectual property litigation is expensive and time consuming
for management. Failure to do any of the foregoing could have a material
adverse effect on us. Furthermore, if our products or technologies are deemed
to infringe upon the rights of others, or if infringement claims are asserted
against third parties whom we are obligated to indemnify, we could become
liable for damages, which could have a material adverse effect on us.

5

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Readsoft,
one of our competitors, filed a patent application entitled Method and
arrangement for Automatic Data Acquisition of Forms. The patent was granted on
August 18, 2003 (EP 0976092). We believe that there are legal grounds for the
patent to be revoked or substantially limited and are vigorously pursuing such
ends. In May 2004, we filed a Notice of Opposition with the European Patent
Office requesting that the patent be revoked in its entirety. However, there is
no assurance that our efforts will be successful. Although we do not believe
that any of our products would infringe upon this patent, there is some risk
that if the patent remains intact, Readsoft may at some point in the future allege
that we infringe on the patent, requiring us to dedicate time and resources to
defend our intellectual property rights, which could impact our financial
results. If Readsoft were to prevail in such a claim, there could be a material
adverse effect on our business, prospects and financial condition. In addition,
we license components of our software systems and technology from third parties
in reliance on such parties representations as to ownership of the licensed
intellectual property. If our licensors are found not to own or have rights to
sublicense such rights to us and we are unable to replace the licensed
technology with a comparable substitute, there could be a material adverse
effect on our business prospects and financial results. Even if we were to
replace licensed technology with available alternatives, it could take time to
identify the best replacement and integrate it into our software. The delay and
uncertainly could negatively impact our financial results.

Yehezkel
Yeshurun, our former Chief Scientist, and currently a member of our board of
directors, was, at the time of his employment with us, a Professor of the Tel
Aviv University Computer Science Department where he conducted research in the
areas of computer vision, neural computation and robotics. While the University
consented to Prof. Yeshuruns employment by us and has not asserted any claim
that intellectual property developed by Prof. Yeshurun on our behalf belongs to
the University, the University has not acknowledged our rights to any
intellectual property developed by Prof. Yeshurun. We cannot assure you that
the University will not assert a claim for such intellectual property rights in
the future or that the University does not have any rights to such intellectual
property.

Our inability to
protect our intellectual property could adversely affect our competitive
position and, consequently, our business and operations.

Our success
depends on our ability to protect our intellectual property. We rely upon trade
secret protection, employee and third-party nondisclosure agreements and other
intellectual property protection methods to protect our confidential and
proprietary information. Despite these efforts, we cannot be certain that
others will not otherwise gain access to our trade secrets or copy and use
information that we regard as proprietary without our authorization. We have
not obtained any patents and we cannot assure you that we will obtain any
patents. In addition, we cannot assure you that:

| | any patents
  which we may obtain will be broad enough to protect our technology, will
  provide us with competitive advantages or will escape challenge or
  invalidation by third parties;
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                             
| | the patents
  of others will not have an adverse effect on our ability to do business; or                                                                                                   
|  |                                                                                                                                                                                             
| | others will
  not independently develop similar products, duplicate our products or, if
  patents are issued to us, design around these patents.                                            

Further,
the laws of foreign jurisdictions where we sell and seek to sell our products
may afford little or no protection of our intellectual property rights. We
cannot assure you that the protection provided to our intellectual property
rights by the laws and courts of foreign nations will be substantially similar
to the remedies available under U.S. law.

If we are unable to
build awareness of our brands, we may not be able to compete effectively
against competitors with greater name recognition and our sales could be
adversely affected.

6

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If we are
unable to economically achieve and maintain a leading position in data
recognition software or to promote and maintain our brands, our business,
results of operations and financial condition could suffer. Development and
awareness of our brands will depend largely on our success in increasing our
customer base. In order to attract and retain customers and to promote and
maintain our brands in response to competitive pressures, we may be required to
increase our marketing and advertising budget or increase our other sales
expenses. There can be no assurance that our efforts will be sufficient or that
we will be successful in attracting and retaining customers or promoting our
brands. Failure in this regard could harm our business and results of
operations.

Our products may
contain defects, damaging our reputation, causing a loss of customers, and
requiring us to allocate significant time and financial resources to correct,
and which may result in damage to our reputation and liability claims.

Our
products may contain undetected errors or defects, particularly when first
introduced or when new versions or enhancements are released. In the past, we
have discovered minor software bugs in certain products after they were
released to the market.Such
errors or defects could require us to divert financial and other resources to
correct the problems.

In
addition, our products are combined with complex products developed by other
vendors. As a result, should problems occur, it may be difficult to identify
the source or sources of the problems. Defects and errors, or end-user
perception of defects and errors, found in current versions, new versions or
enhancements of these products after commencement of commercial shipments may
result in:

| | loss of
  customers;                                            
|- | ----------------------------------------------------------------
| | warranty claims;                                                
| | damage to
  brand reputation;                                   
| | delay in
  market acceptance of current and future products; and
| | diversion of
  development and engineering resources.           

Defects,
errors or successful product liability claim against us could have a material adverse
effect on our business, prospects and financial results.   For addition information on our warranty
policy, see the subsection below entitled Warranty and service.

We engage in
international sales, which expose us to a number of foreign political and
economic risks.

We engage
in international sales, which are subject to a number of risks that could
seriously impede our financial condition and growth. As a result of our product
sales in various geographic regions, we are subject to the risks associated
with international sales, including license requirements, economic and
political instability, shipping delays, customs duties, export quotas and other
trade restrictions, any of which could have a significant impact on our ability
to deliver products on a competitive and timely basis and exacerbate the risks
inherent in our business. While we have not encountered significant
difficulties in connection with the sales of our products in international
markets, the future imposition of, or significant increases in, the level of
custom duties, export quotas or other trade restrictions could have an adverse
effect on us. Further, we cannot assure you that the laws of foreign
jurisdictions where we sell and seek to sell our products afford similar or any
protection of our intellectual property rights as may be available under U.S.
laws. We are directly impacted by the political, economic, military and other
conditions in the countries where we sell or seek to sell our products.

Our capital requirements
have historically been significant and we may not in the future be able to meet
our requirements with our working capital.

Historically,
our capital requirements have been significant. We may in the future require
additional financing to fund our operations and capital requirements beyond our
current resources and that provided from our operations. In such event, we
cannot assure you that additional financing will be available to us when
needed, on commercially reasonable terms, or at all. We have no expectation
that our existing shareholders will provide any portion of our future financing
requirements. Any inability to obtain additional financing when needed would
have a material adverse effect on us, requiring us to curtail our expansion efforts.
In addition, to the extent that we incur substantial indebtedness, we will be
subject to risks associated with incurring substantial indebtedness, including
the risk that interest rates may fluctuate, and cash may be insufficient to
repay interest and principal on any such indebtedness. Any additional equity
financing may involve substantial dilution of the interests of our
then-existing shareholders.

7

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Political, economic
and military conditions in Israel may adversely affect our ability to develop,
manufacture and market our products.

Because our
principal offices are located in 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. A state of hostility, varying in degree
and intensity, has led to security and economic problems for Israel. There has
been a marked increase in such hostility and a significant deterioration of
Israels relationship with the Palestinian community since October 2000,
although recent regional developments have led to an improvement in Israels
relationship with the Palestinian Authority. Continuing or escalating
hostilities in the region or curtailment of trade between Israel and its
present trading partners may have an adverse affect on our business conditions,
including our ability to develop, manufacture and market our products.

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

Some of our
executive officers and employees in Israel are obligated to perform up to 36days of military reserve duty annually.
Moreover, in light of escalating hostilities and threats of armed conflict in
the Middle East since October 2000, our executive officers and employees may be
called for active military duty for an unlimited period of time. Increased
military activity could also result in a reduction of prospective qualified
employees available to work for us to increase our business or replace
employees on active military duty. Our operations could be disrupted by the
absence for a significant period of our executive officers or key employees as
a result of military service. Any disruption in our operations could adversely
affect our ability to develop and market products.

Since most of our
revenues will most likely be generated in U.S. dollars and other non-Israeli
currencies while a significant portion of our expenses are and will continue to
be incurred in New Israeli Shekels, we may be adversely impacted by inflation
and fluctuations in currency exchanges.

We
anticipate that most of our revenues will be generated in currencies other than
the NIS, but most of our expenses will be incurred in NIS. As a result, we are
exposed to risk to the extent that the rate of inflation in Israel exceeds the
rate of devaluation of the NIS in relation to the U.S. dollar or such other
currencies, or if the timing of this devaluation lags behind inflation in
Israel. In that event, the cost of our operations in Israel measured in NIS
will increase and our results of operations could be adversely affected. In
addition, our operations also could be adversely affected as a result of
fluctuations in currency exchange rates. We have not engaged in currency
hedging transactions, nor can we assure you that engaging in such transactions
could materially reduce the effect of fluctuations in foreign currency exchange
rates on our results of operations.

We may not be able
to expand our personnel or marketing efforts quickly enough to support our
growth.

Because of
our small size and our business strategy to increase our sales, we anticipate
an increased demand on all of our resources. If we do not accurately estimate
our need for personnel or marketing and customer support, we may not be able to
support our future growth. For example, if we are successful in our efforts to
obtain significant orders for our products, we may be required to install and
service, on a timely basis, large numbers of installations at our customers
locations. We cannot assure you that we will be able to provide such services
on adequate terms and conditions or at all. Furthermore, in order to remain
competitive and keep our products up to date, we need to continue to attract
and retain a qualified team of employees. If we fail to obtain the human
resources our business requires, there could be a material adverse effect on
our business, prospects, and financial results.

8

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---

Our expansion
through acquisitions, including our recent purchase of a Japanese business,
could lead to increased expenditures and integration costs, and could strain
management, financial, and operational resources.

We may  pursue the acquisition of related businesses
or complementary businesses, including individual products or technologies, in
an effort to expand capacity, enter new markets and diversify our sources of
revenue. We recently acquired the business of the EDMS division of Toyo Ink in
Japan.  We may not be able to
successfully integrate the EDMS business into our existing business or to
manage growth through acquisitions. Acquisitions and expansions may require
significant additional expenditures, including integration and absorption
costs, before we are able to obtain any benefits of integration resulting from
them. These expenditures may strain management, financial and operational
resources. We may also lose key personnel from our operations or those of any
acquired business.

Our ability
to effectively manage our operations and growth requires us to continue to
improve our operational, financial and management controls, reporting systems,
and procedures and to attract and retain sufficient numbers of talented
employees.

Additionally,
future acquisitions may also result in potentially dilutive issuances of equity
securities, the incurring of additional debt, the assumption of known and
unknown liabilities, the amortization of expenses related to intangible assets
and the impairment of goodwill, all of which could harm our business, financial
condition and operating results. Acquisitions in foreign countries may pose
additional problems, and we could experience inefficiencies in conducting our
business as we integrate new operations and manage geographically dispersed
operations. We may not succeed in hiring and retaining qualified management,
sales, customer support, and technical personnel to integrate acquired
operations, manage future growth effectively, and accomplish our overall
objectives. Competition for qualified personnel is intense. If we expand too
fast, or fail to integrate our new Japanese business or other new businesses,
there could be a material adverse effect on our business, prospects and
financial condition.

Government grants we
received for research and development expenditures may be reduced or eliminated
in the future due to Israeli government budget cuts. Furthermore, our receipt
of such grants limits our ability to develop products and transfer technologies
outside of Israel, and require us to satisfy specified conditions.

In the
past, we have received grants from the government of Israel through the Office
of the Chief Scientist of the Ministry of Industry and Trade, or the OCS, for
the financing of a portion of our research and development expenditures in
Israel. The Israeli government has reduced the benefits available under this
program in recent years and may decide not to continue the program in the
future at its current level or to terminate it altogether.

The terms
of the OCS grants limit our ability to develop products and transfer
technologies outside of Israel without the prior approval of the OCS, if such
products or technologies were developed using OCS grants. Such approval, if
granted, will generally be subject to additional financial obligations. In
addition, if we fail to comply with any of the conditions imposed by the OCS,
including the payment of royalties with respect to grants received, we may be
required to refund any payments previously received from the OCS, together with
interest and penalties. See also under Governmental Regulation

If we fail to
satisfy the condition specified by our Approved Enterprise program, we may be
denied benefits to which we are currently entitled to in the future.

The
Investment Center of the Israeli Ministry of Industry and Trade has granted us
Approved Enterprise status to certain development programs. The benefits
available to an Approved Enterprise program are dependent upon the continuing
fulfillment of ongoing conditions stipulated under applicable law and in the
certificate of approval. If we fail to comply with these conditions, in whole
or in part, benefits from tax exemptions or reduced tax rates would likely be
denied to our shareholders or us in the future.  On December 19, 2004, the Israeli government extended the term of
the legislation pursuant to which the Ministry of Industry and Trade
administers the Approved Enterprise programs for an additional three months.
Unless extended again, future entitlements to the benefits under the statute
shall expire on March 31, 2005. The government has extended the term of the
legislation on previous occasions for three-month periods. Termination of the
entitlement may affect our ability to make effective use of the benefits to
which we are or may become entitled to as a result of our Approved Enterprise
status. In the event that the term of the statute is extended beyond March 31,
2005, we anticipate that the statute will be substantially amended. An
amendment could affect our eligibility for benefits.

9

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The resale of the
2,524,351 ordinary shares and related warrants to purchase up to an additional
1,262,188 ordinary shares we recently issued and registered, as well as the resale of certain other ordinary
shares we recently registered, could negatively impact the market price of our
ordinary shares.

On
September 24, 2004, we sold 2,524,351 of our ordinary shares at a purchase
price of $3.16 per share to investors for gross proceeds to us of approximately
$8 million. The investors also received warrants to purchase up to an
additional 1,262,188 ordinary shares, with an exercise price of $4.26 per
share. The warrants expire on September 23, 2007.

In
connection with the private placement, we filed a registration statement under
the Securities Act of 1933 (the Securities Act) covering the shares purchased
in the private placement (including the shares underlying the warrants). In
accordance with prior agreements, the registration statement also covers the
ordinary shares held by Charter TiS L.L.C., an affiliate of Charterhouse Group,
Inc., Izhak Nakar, and their affiliates. The registration statement became
effective on March 1, 2005.  We are
required to maintain an effective registration statement covering the resale of
our ordinary shares sold to the selling shareholders who purchased our ordinary
shares in the September 24, 2004 private placement transaction, and the shares
issuable upon exercise of the warrants issued to those investors, until the
earlier of the date that all shares issued and issuable to the investors and
the holders of the warrants have been sold and March 1, 2010. While the
registration statement is effective, or pursuant to the exemption from registration
provided by Rule 144 under the Securities Act, if applicable, the investors,
Charter and Mr. Nakar may sell their shares into the general trading market. An
influx of additional shares could exert downward pressure on the market price
of our ordinary shares. Accordingly, there could be material adverse effect on
the market price of our ordinary shares.

Our ability to raise
capital could be impaired as a result of certain rights of first offer held by
certain shareholders.

Pursuant to
our agreement with the investors in the private placement described in the
preceding risk factor, we are subject to restrictions with respect to the sale
of our securities. Until March 1, 2006, before we are able to sell our
securities, in most instances we are required to first offer the securities to
the investors pursuant to terms set forth in our agreement with them. The
foregoing terms and right of first offer could delay our efforts to raise
capital and increase transaction costs and could limit our ability to obtain
additional financing.

Our ordinary have
been subject to frequent significant price fluctuations. If we fail to maintain
minimum bid requirements, we could be delisted.

Our
ordinary shares are quoted on the NASDAQ SmallCap Market, and have been subject
to frequent significant price fluctuations, due in part to speculative
activity. We must continue to meet certain maintenance requirements, including
minimum bid requirements, in order for such securities to continue to be listed
on the NASDAQ SmallCap Market. If our securities are delisted from the NASDAQ
SmallCap market, investors liquidity in our securities could be reduced.
Delisting or suspension of trading of our ordinary shares on the NASDAQ
SmallCap Market could also trigger an obligation for us to pay liquidated
damages to the investors in the private placement described in the preceding
risk factors.

In
addition, if our securities were to be delisted from the NASDAQ SmallCap
Market, our ordinary shares could be considered a penny stock under federal
securities law. Additional regulatory requirements apply to trading by
broker-dealers of penny stocks that could result in the loss of an effective
trading market for our securities.

We could be subject
to an enforcement action by the Securities and Exchange Commission and private
lawsuits in connection with our past failure to report as a United States
issuer.

Since our
initial public offering, we have considered ourselves to be a foreign private
issuer under SEC rules.  A foreign
private issuer is subject to different requirements for reporting under, and is
exempt from certain provisions of, the Exchange Act of 1934 (the Exchange
Act) which apply to U.S. issuers, including, among others, the rules requiring
the filing with the SEC of quarterly reports on Form 10-Q, annual reports on
Form 10-K, current reports on Form 8-K, proxy regulations and Regulation
FD.

10

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In
connection with the SECs review of our registration statement on Form F-1,
which became effective on March 1, 2005, we discovered that we had not met the
criteria for being considered a foreign private issuer since October 2003, and
possibly since August 2002.  Under SEC
rules, if a majority of the members of the board of directors of company are
U.S. citizens or residents, the company cannot qualify as a foreign private
issuer if a majority of its voting securities are held by U.S. residents.  Beginning in August 2002, a majority of the
members of our board of directors were U.S. citizens and residents, and since
October 2003, and possibly since August 2002, a majority of our ordinary shares
were held by U.S. residents.  Upon being
informed of this discovery, in December 2004, our board of directors voted
unanimously to reconstitute itself such that it is no longer composed of a
majority of U.S. residents or citizens. 
As a result, we once again qualify as a foreign private issuer under SEC
rules.  However, because we filed
reports under the Exchange Act as a foreign private issuer during the period
when we did not meet the criteria for being considered a foreign private
issuer, we will not be able to meet the eligibility requirements for
registering the sale of our securities on Form F-3 (which, as opposed to Form
F-1, may incorporate future filings by reference) until at least twelve months
have elapsed since the date we requalified as a foreign private issuer.

In seeking
to determine why we did not discover earlier that we may not have met the
foreign private issuer criteria, we identified a deficiency in our disclosure
controls and procedures in that they did not include a proper procedure for
periodically assessing whether we qualified as a foreign private issuer.  On December 8, 2004, our management
concluded that our disclosure controls and procedures were ineffective as of
December 31, 2002 and 2003 solely because of this deficiency.  This deficiency did not affect the accuracy
of the financial and other information disclosed in our annual reports on Form
20-F and other filings with the SEC under the rules applicable to foreign
private issuers.  Rather, it affected
the scope and format of our disclosure, inasmuch as we did not comply with
rules applicable to U.S. issuers, including:

| | The
  requirement that financial statements be prepared in accordance with U.S.
  GAAP;                                                                                                                                                                                                                                              
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                                                                                                                                                      
| | The rules
  requiring the filing with the SEC of quarterly reports on Form 10-Q (which
  include quarterly financial information, with managements discussion and
  analysis) and current reports on Form 8-K(disclosing certain material
  events);                                                                                
|  |                                                                                                                                                                                                                                                                                                                                      
| | Proxy
  regulations;                                                                                                                                                                                                                                                                                                                 
|  |                                                                                                                                                                                                                                                                                                                                      
| | Regulation
  FD, which is aimed at preventing issuers from making selective disclosures of
  material nonpublic information; and                                                                                                                                                                                                     
|  |                                                                                                                                                                                                                                                                                                                                      
| | The sections
  of the Exchange Act requiring insiders of an issuer to file public reports of
  their stock ownership and trading activities and establishing insider
  liability for short-swing profits (i.e. profits from a purchase and sale, or
  sale and purchase, of an issuers equity securities within a six-month period).

After
reaching this conclusion, on December 8, 2004, we immediately revised our
disclosure controls and procedures to require our controller to evaluate, and
promptly report to our Chief Executive Officer and Chief Financial Officer,
whether we qualify as a foreign private issuer on the last day of each fiscal
quarter and if and when any of the following events occur:

| | A change in
  the composition of our board of directors or our executive management;                                                                              
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                   
| | A purchase
  or sale of any assets by us other than in the ordinary course of business, or
  the relocation of any of our material assets to the United States; or
|  |                                                                                                                                                                   
| | A relocation
  of the administration of any material part of our business to the United
  States.                                                                 

While we
are not aware of any action pending in connection with any past noncompliance,
we could be subject to future enforcement action by the SEC, which could expose
us to penalties and require us to amend past filings at considerable expense
and to dedicate a substantial amount of managements time to amendment.  An enforcement action could result in the
suspension of the effectiveness of the registration statement registering the
resale of the shares we issued in connection with our September 24, 2004
private placement and could trigger a requirement for us to pay additional
liquidated damages to the investors in the transaction. See the discussion of
those damages requirements in Item 5 under Liquidity and Capital
Resources.  Furthermore, we could be
exposed to claims and litigation from shareholders seeking damages based on
allegations that our disclosure was inadequate.

11

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We do not intend to
pay dividends.

We have
never declared or paid any cash dividends on our ordinary shares. We currently
intend to retain any future earnings to finance operations and to expand our
business and, therefore, do not expect to pay any cash dividends in the
foreseeable future.

The application
and/or amendment of Israeli laws or laws of other countries may adversely
affect our ability to enforce judgments or other rights.

Because our
principal offices are located in Israel, we are subject to Israeli law. Many of
our contracts with third parties are subject to the laws of other
jurisdictions. We cannot assure you that any judgments granted in the United
States or any jurisdiction other than Israel would be capable of enforcement or
execution in Israel. Nor can we assure you that any of our contracts pursuant
to the laws of any foreign country are enforceable by us. The inability to
enforce or execute judgments or other rights and/or the possibility of the laws
of various jurisdictions being amended from time to time may have a material
adverse effect on our business, prospects, and financial condition.

|ITEM 4. | INFORMATION ABOUT THE COMPANY
|------- | -----------------------------

History and Development

We were
incorporated and are domiciled in Israel and exist as a company with a limited
share capital subject to Israeli law. 
Our registered and principal executive offices are located in Israel at
2 Habarzel Street, Ramat Hahayal, Tel Aviv 69710, and our telephone number is
011-972-3-767-9100.  Our website is http://www.topimagesystems.com(the information contained in our website is not a part of this annual
report and no portion of such information is incorporated herein).

General

We develop
and market automated data capture solutions for managing and validating content
gathered from customers, trading partners and employees. Whether originating
from electronic, paper, mobile or other sources, our solutions deliver digital
content to the applications that drive an enterprise by using advanced
technologies including wireless communications, servers, form processing and
information recognition systems. Our software improves business processes by
integrating different types of data from multiple sources. Our products
integrate information regardless of the source and format of the data, whether
structured, as in the case of application forms or surveys, or semi-structured,
such as invoices, purchase orders, checks, freight and shipping bills and
others. Our solutions seamlessly deliver the extracted data to applications
such as document and content management, enterprise resource planning, or
customer relationship management. Our solutions minimize the need for manual
data entry by automatically reading, identifying, interpreting and processing
information, thereby increasing data capture accuracy and the rate of
information processing. The platform solution we offer replaces traditional
means of extracting information from paper-based documents and integrates
multiple information sources into a single enterprise-level solution that
increases speed and efficiency.

Products

TiS
signature solution is the eFLOW Unified
Content Platform . eFLOW  provides the common architectural infrastructure for our solutions. We
anticipate that future developments will also be based on the Unified Content
Platform.

Based on a
single, integrated environment, the eFLOWTMplatform provides a visual application designed to enable the structure
of a complete form processing and data capture solution quickly and easily.
Providing a modular platform with an open, scalable and flexible architecture, eFLOWTMfacilitates the
development of applications ranging from desktop, stand-alone applications to
high-volume, network-based systems.

12

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TiS eFLOW  provides
enterprise-wide solutions for every data capture and content delivery need, all
on a single platform, using one set of business rules. eFLOW  allows a customer to
integrate data from multiple sources, including the Internet, paper, fax,
microfilm, microfiche, electronic, and email, and of different types such as
invoices, freight and shipping bills, purchase orders and others , to provide a
single connection to the enterprise application system. Our eFLOW  platform allows maximum
flexibility, using one set of rules for all applications, dramatically reducing
implementation time while broadening the utility of the solution across the
customers business.

eFLOW
TMis designed to address the needs of companies, institutions,
government agencies, and other organizations with a broad range of form
processing requirements (5,000 or more forms per day).

eFLOWTMoffers a definite
advantage in mixed environments where documents in different formats need
simultaneous processing, sorting, and storing in databases for retrieval at a
later date. Top Image Systems technology can manage these tasks without the
need to pre-design a working template.

In
addition, eFLOW  may
integrate with a customers financial systems, enterprise resource planning
(ERP) and other relevant applications to provide an end-to-end solution for
managing invoices and payments. eFLOW therefore eliminates a significant
portion of traditional manual data entry, decreases the need for data entry
resources and processing time, and significantly improves the quality, accuracy
and value of the data.

eFLOWs
underlying infrastructure utilizes advanced technologies, such as Microsoft
..NET and Microsoft Visual Basic for applications, to provide an accelerated
data capture solution for paper, electronic forms, fax, and ftp files.
Developing the advanced version of eFLOW
Unified Content Platform , eFLOW  Version 2.0 and future version, based on
the Microsoft .NET technology ensures its compatibility to future Microsoft
technologies and other technology partners, as well as its usability to our
customers. The use of these technologies allows customers, developers and
partners to modify user interfaces, extend functionality and connect TiS eFLOW  with other
mission-critical applications to create fully integrated business solutions. eFLOW TMincludes support for
the XML standard which enables the interchange of documents between systems and
applications in a standard format.

Targeting
banking and finance, logistics, insurance, postal systems, healthcare, tax,
statistics and many other potential markets, eFLOW
technologies enable enterprises to implement digital information recognition,
improving processing and speeding up the data entry cycle by providing a single
data collection entry point.

Integra
for Structured Content

Integra,
our eFLOW plug-in for structured content,provides a solution for data capture,
validation and delivery from structured predefined forms.

Freedom
for Semi-Structured Content

Freedom,the eFLOW plug-in for semi-structured content,
enables customers to identify and capture critical data from semi-structured
documents such as invoices, purchase orders, shipping notes and checks. Based
on artificial intelligence, Freedomis
designed to understand the format of a document without the need to predefine
its structure. Freedom is able to
locate, identify, capture and validate critical data contained in the document.
The market for this product includes companies that receive thousands of
semi-structured documents such as invoices every month from hundreds of
suppliers, and allows them to automatically identify and process any type of
such documents.

The
Learning module is one of eFLOW s
innovative modules which automatically learns new types of forms in order to
both introduce new forms previously unseen into the system and to improve
recognition of existing forms already captured into the system. Unrecognized
forms reach the Learning module, where an operator trains the system to locate
certain important fields. The new information would then be available for the
system to recognize a similar, although not necessarily identical, form in the
future.

13

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Smart
for Unstructured Content

Smart!,the eFLOW  plug-in for unstructured content, is an automated
classification solution. By automatically capturing, recognizing, classifying
and routing all incoming information, regardless of format or origin, Smart!functions as the gateway to
enterprise information systems.

Smart!offers
a single point of entry for any kind of information entering the organization.
Whether originating from paper mail, fax, email, or any other source, Smart! automatically recognizes the image,
understands it, and accordingly defines its destination within the
organization. Smart! consists of
sophisticated artificial intelligence and machine learning algorithms, and
provides tracking capabilities, while the digitized image of the document is
routed for further processing. Additional benefits of Smart!include reduced operational costs,
quick and accurate delivery of business-critical information, elimination of
burdensome paper-based information, and much improved mail security.

AFPSPro

AFPSPro
had been our flagship product until the introduction of the eFLOW Unified Content Platform .
We are at the end of the process of upgrading AFPSPro
customers to eFLOW
and plan to gradually phase out AFPSPro .
In 2004 there were no sales of the AFPSProTMproduct.

Principal
Markets

As of
December 31, 2004, we operated branch offices in the United States, the United
Kingdom, Germany and Japan through subsidiaries. During 2004, we began to
modify our corporate structure in Europe (see the section entitled
Organizational Structure). However, we do not believe that these changes will
have a material effect on our business, prospects and financial condition.

Our U.S.
branch is responsible for sales, marketing and support activities in the United
States, Canada, and Latin America. These three territories, together with
Germany, the UK and Japan, define our principal markets. In addition, we
believe that there exist significant opportunities in France, South Africa, the
Czech Republic, Spain, Australia, Belgium, the Netherlands and Luxembourg.
During 2004, we added to our local subsidiaries several local sales
representatives around the world, mainly in Europe. These representatives
manage our sales, marketing and operational activity in their locations,
providing integration and implementation services, as well as marketing
support. As part of our previously announced strategic plan, we established Top
Image Systems Japan (TISJ) in order to expand our already strong presence and
market position in Japan and utilized a portion of the proceeds from our recent
private placement (see also the section entitled Liquidity and Capital
Resources in Item 5 below) to acquire certain assets of Toyo Inks EDMS
division (as more fully described in the section entitled Competition below).
We are currently exploring various options regarding our expansion plans. We
continuously review opportunities for expansion in both new and existing
markets.

The
following table summarizes total revenues by category of activity and
geographic market for each of the last three completed fiscal years:

|Product Revenues by Region       | 
|-------------------------------- | 
|                                 | 
|                                 | 
|                                 | 
|                                 | 
|                                 | 
|Europe                           | 
|Far East (excluding Japan)       | 
|South America                    | 
|Africa                           | 
|North America                    | 
|Israel                           | 
|Middle East (excluding
  Israel) | 
|Japan                            | 
|Other                            | 
|Total                            | 

14

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|Service Revenues by Region       | 
|-------------------------------- | 
|                                 | 
|                                 | 
|                                 | 
|                                 | 
|                                 | 
|Europe                           | 
|North America                    | 
|Far East (excluding Japan)       | 
|Africa                           | 
|Japan                            | 
|Israel                           | 
|South America                    | 
|Middle East (excluding
  Israel) | 
|Other                            | 
|Total                            | 

Seasonality

Our
business significantly depends upon the requirements of large corporations and
governmental agencies. Because many of these entities operate according to
annual budgets, their tendency is to approve budgets in the beginning of the
fiscal year and release the budgets toward the end of the fiscal year. This
mode of operation affects our results of operations throughout the year. See
the section of Item 5 herein entitled Quarterly Results; Seasonality for
additional detail.

Marketing
Strategy

Over the
past few years, we have shifted our marketing emphasis from a time and labor intensive
orientation, which required us to provide technical support and customization
for our customers, to eFLOW ,
which is marketed as an enterprise solution. We now market eFLOW  to value added
resellers, distributors and systems integrators to assist them in building form
processing systems more quickly, easily, and economically at their customers
locations. This change in our marketing strategy has freed us from having to
expend resources in providing support and services to the end-user since value
added resellers, distributors and systems integrators increasingly perform
these functions. As we have shifted our marketing strategy from
project-oriented to solution-oriented, we have increasingly sought
strategic alliances with value added resellers, distributors and systems
integrators. This has also enabled us to expand our market share in new
geographic markets by partnering with the top-tier value added resellers,
distributors and systems integrators located in or selling products in each country.
This enables us, together with each partner, to initiate common marketing and
sales strategies and thereby, to generate sales. This strategy is based on our
belief that value added resellers, distributors, systems integrators and
Original Equipment Manufacturers, or OEMs,generally
have better access to end-users in their respective markets than we do. By
engaging value added resellers, distributors, systems integrators and
potentially, OEMs, to include our products as part of their products and service
offerings, we can sell products to end-users without the costs of directly
marketing to end-users. However, working through channels instead of engaging
in direct sales to customers limits our share in each transactions revenues.

It is essential
while working in remote territories to provide an efficient platform for
marketing eFLOWTMacross
the globe. In territories where we enjoy a strong presence and maintain a local
branch office, and where the market potential is high, we choose to work
directly with the customers. While cooperating with partners in these
territories, we can offer an expanded solution. We provide consulting,
implementation and support services directly to the customers and thus we enjoy
a closer relationship with the customer and larger share of the deals
revenues. We are endeavoring to continue this trend in the coming years.
Currently, we sell through a network of value added resellers, distributors and
systems integrators in approximately 30 countries worldwide. The system
integrators are managed via our sales and marketing force located in our sales
centers and in our headquarters in Israel. We have implemented a program to
align ourselves with major complementary strategic level partners who can help
us reach new target customers and market segments. These agreements call for
the strategic partner and us to plan and coordinate marketing and sales
activities in their respective territories.

15

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In March
2005, we announced the availability of eFLOW
Version 3.0, an end-to-end solution that streamlines the entire flow
of information in organizations. eFLOW
Version 3.0 provides customers with a complete originally designed
platform to handle any kind of document in any format from any source. eFLOW Version 3offers organizations a
single point of contact and control for delivering valuable information to
enterprise information systems via a single platform and a single set of
business rules. eFLOW integrates
with any enterprise information system, including SAP, Oracle and others.  (See also Research and Development, Patents
and Licenses, etc. in Item 5 herein.)

In February
2005, we hosted an international conference in Barcelona for our customers and
strategic business partners. The conference drew almost 200 participants from
various business segments.  The
highlight of the conference was our launch of eFLOW
Version 3.0.

In December
2004, we announced the availability of Smart!,
a new, automated classification solution which offers a single point of entry
for any kind of information entering the organization. Smart!extends beyond classical form
processing and recognition to include unique capabilities that allow
sophisticated collection and understanding of any kind of information. Smart! fits well with our long-term
strategy, to expand our offering and provide our customers with a comprehensive
solution to handle all incoming information entering the enterprise, regardless
of its format and origin.

In
September 2004, we announced the establishment of Top Image Systems, TiS Japan
Ltd, a new subsidiary in Japan (TiSJ)  formed in August of 2004. At the end of August 2004, we signed a
definitive agreement with our longtime partner Toyo Ink Mfg. Co., Ltd. to
acquire certain assets of Toyo Inks EDMS division. The division, established
nine years ago and dedicated to the imaging business, has been exclusively
marketing and implementing TiS solutions in Japan. Pursuant to the agreement,
Toyo Ink transferred certain customers and channels from Toyos EDMS division
to Top Image Systems, TiS Japan, Ltd. 
TiSJ also received the rights to distribute the Japanese localized
version of TiS eFLOW Unified Content
Platform. Certain members of EDMS professional team have been
assigned to TiSJ in order to ensure the continuity of knowledge and high level
services provided to Japanese customers and partners. TiSJ is now responsible
for all operations in Japan, including technical support and maintenance
services for existing, as well as new, channels and customers.

In
September 2004, we also announced a strategic OEM partnership with Xtramind
Technologies GmbH, the major provider of AI-based software for the disclosure
of unstructured content. The integration of Xtraminds content classification
component into TiS eFLOWplatform
allows for automatic routing, classifying and archiving of documents according
to user-defined categories. Utilizing Xtraminds modern language technology and
artificial intelligence, we now offer a complete, integrated self-learning system
with unparalleled precision in content analysis.

In July
2004, we announced the cooperation with Arthis to automate supplier invoice
processing, including multipage, multitax and multicurrency options, for La
Rinascenete Group, a prominent Italian retail player. Arthis is a company
established by The La Rinascente Group and Accenture, in order to manage many
of the retailers back-office functions, from accounting services to financial
reporting.

In June
2004, we announced the OEM integration with Tranmit plc, a UK based
eProcurement and ePayables solutions provider. Through this partnership we may
now offer a complete Account Payable and Receivable solution: an automated
financial capture solution for invoices and purchase orders.

In May
2004, we announced a strategic partnership with RAG INFORMATIK GmbH, one of the
largest specialized IT service providers in Germany, after successful
implementation at Deutsche Steinkohle AG. Through this partnership we offer
customers a unique, complete, best-of bread, SAP R/3-based account payable
solution: an automated financial capturing solution for invoices, fully
integrated with SAP R/3 Workflow.

16

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In April
2004, we announced strategic partnership with ASI Solutions, an Australian
system integration and services provider, to distribute eFLOW in Australia and New Zealand.

In March
2004, we announced a partnership with IFN Systems, an international software
development company and the Israeli representative of FILENET®, based on shared technological
knowledge and complementary technologies. Previously to this announcement, we
have been cooperating with IFN on a joint project, to provide the customer with
a complete solution for various documents, including data capture, workflow,
and document management across the company. According to the terms of the
agreement, IFN Systems will act as our system integrator and local support
provider in Israel, leveraging its strong presence across various industry
sectors, such as the banking and insurance markets in Israel.

Licensed
Technology

We license
various recognition software technologies from third parties in order to
utilize them in our products. We currently use technologies developed by several
different companies. Depending upon the requirements of each customer, we
incorporate one or several of such technologies into a specific product. We are
not dependent upon any single source of recognition software technology and the
various technologies that we use are, in large part, interchangeable.

Intellectual
Property Rights

Our success
depends upon our proprietary software technology. We rely upon trade secret
protection, employee and third-party nondisclosure agreements and other
intellectual property protection methods to protect our confidential and
proprietary information. Despite these efforts, we cannot be certain that
others will not otherwise gain access to our trade secrets or copy and use
information that we regard as proprietary without our authorization. We have
not obtained any patents and we cannot assure you that we will obtain any
patents. In addition, we cannot assure you that:

| | any patents
  which we may obtain will be broad enough to protect our technology, will
  provide us with competitive advantages or will escape challenge or
  invalidation by third parties;
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                             
| | the patents
  of others will not have an adverse effect on our ability to do business; or                                                                                                   
|  |                                                                                                                                                                                             
|  |                                                                                                                                                                                             
| | others will
  not independently develop similar products, duplicate our products or, if
  patents are issued to us, design around these patents.                                            

Further,
the laws of foreign jurisdictions where we sell and seek to sell our products
may afford little or no protection of our intellectual property rights. We
cannot assure you that the protection provided to our intellectual property
rights by the laws and courts of foreign nations will be substantially similar
to the remedies available under U.S. law.

We believe
that our technology has been developed independently and does not infringe on
the proprietary rights of others. However, we cannot assure you that the
technology does not and will not infringe or that third parties will not assert
infringement claims against us in the future. In the case of infringement, we
would, under certain circumstances, be required to modify our products or
obtain a license. We cannot assure you that we would be able to do either in a
timely manner under acceptable terms and conditions or at all, or that we will
have the financial or other resources necessary to defend successfully a patent
infringement or other proprietary rights infringement action. Further, even if
we were not infringing, intellectual property litigation is expensive and time
consuming for management. Failure to do any of the foregoing could have a
material adverse effect on us. Furthermore, if our products or technologies are
deemed to infringe upon the rights of others, we could become liable for
damages, which could have a material adverse effect on us.

Readsoft,
one of our competitors, filed a patent application entitled Method and
arrangement for Automatic Data Acquisition of Forms. The patent was granted on
August 18, 2003 (EP 0976092). We believe that there are legal grounds for the
patent to be revoked or substantially limited and are vigorously pursuing such
ends. In May 2004, we filed a Notice of Opposition with the European Patent
Office requesting that the patent be revoked in its entirety. However, there is
no assurance that our efforts will be successful. Although we do not believe
that any of our products would infringe upon this patent, there is some risk
that if the patent remains intact, Readsoft may at some point in the future
allege that we infringe on the patent, requiring us to dedicate time and
resources to defend our intellectual property rights, which could impact our
financial results. If Readsoft were to prevail in such a claim, there could be
a material adverse effect on our business, prospects and financial condition.

17

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In
addition, we license components of our software systems and technology from
third parties in reliance on such parties representations as to ownership of
the licensed intellectual property. If our licensors are found not to own or
have rights to sublicense such rights to us and we are unable to replace the
licensed technology with a comparable substitute, there could be a material
adverse effect on our business prospects and financial results. Even if we were
to replace licensed technology with available alternatives, it could take time
to identify the best replacement and integrate it into our software. The delay
and uncertainty could negatively impact our financial results.

Yehezkel
Yeshurun, our former Chief Scientist, and currently a member of our board of
directors, was, at the time of his employment with us, a Professor of the Tel
Aviv University Computer Science Department where he conducted research in the
areas of computer vision, neural computation and robotics. While the University
consented to Prof. Yeshuruns employment by us and has not asserted any claim
that intellectual property developed by Prof. Yeshurun on our behalf belongs to
the University, the University has not acknowledged our rights to any
intellectual property developed by Prof. Yeshurun. We cannot assure you that
the University will not assert a claim for such intellectual property rights in
the future or that the University does not have any rights to such intellectual
property.

We believe
that product recognition is an important competitive factor in the form
processing industry. Accordingly, we promote the eFLOW name
in connection with our marketing activities. We either hold or intend to apply
for trademark registration of our significant solution and module names,
although we cannot assure you that such applications will be successful.
Although we have not sought to market our products using our trade name TiS
as a trademark, we believe that certain other companies use trademarks that
contain the letters TIS for products, which we believe do not compete with
our products. We cannot assure you that this will not limit our ability to use
our trade name TiS to market our products.

Competition

The market
for data capture systems in general, and for automatic form processing systems
in particular, is characterized by intense competition, significant price
erosion over the life of the product, and rapidly changing business conditions,
customer requirements, and technology.

Our
solutions compete with those developed and marketed by numerous
well-established companies, as well as with manual data entry systems. Many of
these competitors have substantially greater financial, technical, personnel
and other resources than we do, and have established reputations for success in
the development, licensing and sale of their products and technology. Certain
of these competitors are industry leaders with the financial resources
necessary to enable them to withstand substantial price competition or
downturns in the market for computer software.

Our
products compete with those developed and marketed by numerous well-established
companies including Captiva Software, Mitek, Banctec, Dicom, Microsystems
Technology, Datacap, SER, and ReadSoft, as well as with manual data entry
systems.

During the past
few years, several mergers and acquisitions have taken place between our
competitors and companies with related and complementary technology,
dramatically changing our marketplace. 
They include:

18

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| |  | During 2002,
  Captiva Software Corporation merged with ActionPoint, a provider of
  enterprise information capture software. The merger created the largest
  provider of input management software solutions under the name Captiva
  Software Corporation. Towards the end of 2003, Captiva Software announced the
  acquisition of Context Inc. from the financial service outsourcing firm
  Automatic Data Processing, Inc. (ADP). Context Inc. develops software that
  improves the processing of healthcare claims.
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |  | Vignette, a
  leading web content management provider, acquired Australian-based document
  imaging specialist Tower Technology to strengthen its position in the rapidly
  consolidating ECM space.                                                                                                                                                                                                                                                                                                                        
|  |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |  | Stellent, a
  web content management specialist, recently acquired Optika, an imaging and
  workflow vendor.                                                                                                                                                                                                                                                                                                                                                                                                                
|  |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |  | IBM acquired
  Green Pasture, an electronic document management specialist.                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|  |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |  | Verity, an
  enterprise software provider, that enables organizations to maximize the
  return on their intellectual capital investment, recently acquired Cardiff
  Software Inc., a privately-held developer of technology that enables the
  capture and automation of dynamic business information.                                                                                                                                                                                                                     
|  |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |  | EMC, a world
  leader in information storage and management, acquired Documentum, an
  enterprise content management solutions provider.                                                                                                                                                                                                                                                                                                                                                                                    

In
addition, we often compete with major systems suppliers such as IBM, Siemens
and Unisys. In these cases, the major systems suppliers offer one of our
competitors solutions as part of an integrated solution. There are also
numerous other companies that have developed or may develop technologies or
products that may be functionally similar to some or all of those we offer. We
cannot assure you that other companies with greater financial resources and
expertise do not have or are not currently developing functionally equivalent
or superior products or that functionally equivalent or superior products will
not become available in the near future.

The market
for our technology and solutions is also characterized by rapid changes and
evolving industry standards, often resulting in product obsolescence or
shortened product lifespan. Accordingly, our ability to compete will be dependent
upon our ability to continually enhance and improve our existing products and
technologies, complete the development of, and introduce new solutions into the
marketplace in a timely manner. We cannot assure you that we will be able to
compete successfully, that our present or future competitors will not develop
technologies or products that will render our products and technology obsolete
or less marketable, or that we will be able to enhance successfully our
existing products and technology or adapt them satisfactorily or develop new
products.

In certain
markets such as the United States, the United Kingdom and Germany, we compete
with more than one company supplying similar solutions. In Japan, where these
competitors are less active, we hold a more prominent position in the market.
At the end of August 2004, we signed a definitive agreement with our longtime
partner Toyo Ink Mfg. Co., Ltd. to acquire certain assets of Toyo Inks EDMS
division, and established TiSJ. The division, established nine years ago and
dedicated to the imaging business, has been exclusively marketing and
implementing TiS solutions in Japan. In September 2004, TiSJ commenced
operations.

Pursuant to
the agreement, Toyo Ink transferred certain customers and sales channels from
Toyos EDMS division to the TISJ. TISJ also received the rights to distribute
the Japanese localized version of TiS eFLOW
Unified Content Platform. EDMS professional team has been assigned
to TiSJ in order to ensure the continuity of knowledge and high level services
provided to Japanese customers and partners. TiSJ is now responsible for all
operations in Japan, including technical support and maintenance services for
existing, as well as new, channels and customers.

Customers

Our
customers consist of both governmental and other enterprises. During 2003, we
demonstrated our solutions compatibility to large-scale projects, enhancing
our competitive position in the industry. We were awarded a
multi-million-dollar data-capture sale to Swiss Post  Finance, rendering it
the largest contract in our history.

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During
2004, we have strengthened our position as the technology provider for
semi-structured applications, including supplier invoices, purchase orders,
checks and remittances, different financial applications, health claims and
freight bills. We have integrated systems for complicated semi-structured
applications, including automating the capture and process of data from
hundreds of different form formats of 3M facilities across Europe, of Business
Transformation Outsourcing (BTO), a subsidiary of IBM that was established in
order to provide automated outsourcing services to manage accounts payable and
accounts receivable activities, and of T-Mobile Group which belongs to the
world leaders in mobile telecommunications and is one of the fastest growing
nationwide wireless service providers in the United States.

Additional
complicated semi-structured applications were purchased by the following
customers: The Rinascente Group, one of the most important Italian retailers;
Privredna banka Zagreb, PBZ, a bank of the Italian Gruppo Banca Intesa; Jet
Airways, the leading domestic airliner in India; the Australian Department of
Defence; HMSL Group,
one of the largest and leading UK-based, privately-owned outsourcing specialist;
Recall, one of the worlds largest archive bureaus for physical documents and
Datamatics Technologies Ltd. one of Indias leading information technology
organizations.

In
addition, we have further strengthened our position in the automated data
collection for national population census projects, with the successful
completion of the population census projects of the Republic of Cyprus, Italy
and India. The Indian census is the largest census project in the world, and
included the processing of approximately 6 million forms per week. All projects
were completed on time, beating extremely aggressive deadlines. Other market
solutions provided by us include integrated systems for complicated
semi-structured applications, including automating the capture and process of
data from hundreds of different form formats of 3M facilities across Europe,
and Business Transformation Outsourcing (BTO), a subsidiary of IBM that was established
in order to provide automated outsourcing services to manage accounts payable
and accounts receivable activities.

We have
also strengthened our competitive position with the release of eFLOWVersion 2.0, the latest version of
our signature software, eFLOW
Unified Content Platform. This version of the product dramatically reinforces
our ability to successfully compete and implement complicated projects
involving processing documents of semi-structured formats. In addition, eFLOWs Smartextends beyond classical form processing and recognition to include
a unique capability that allows sophisticated collection and understanding of
unstructured forms, thus providing the possibility to handle projects in a
mixed environment.

We
strengthened our presence in the German market, with several large scale
projects, including for BKK group, T-Mobile, and Deutsche Post, to name a few.
We succeeded in developing a strong customer and prospect base in the German
market, considered to be one of the most advanced in the data capture and
content management niches worldwide.

We also
strengthened our presence in the Far East, with new and existing customers in
Australia, Japan, India, and Singapore that have chosen the eFLOW platform in the past few months.

Warranty
and Service

We
generally negotiate our warranty obligations with respect to our products on a
case-by-case basis. Performance warranties typically extend for 90 days.

We may be
exposed to potential product liability claims by our customers and users of our
products. Currently, we hold a worldwide product liability insurance policy
that provides coverage limited to $3,000,000 in aggregate for the policy period
ending on September 30, 2005. Despite this coverage, a successful claim against
us for product liability could have a material adverse effect on our financial
condition. While we have not experienced material warranty liability in the
past, we cannot assure you that future warranty expense will not have an
adverse effect on us.

We have
entered into maintenance and service agreements with certain of our customers.
These agreements typically provide for regular payment to us of an amount equal
to 15% per annum of the applicable license fees for maintenance. Our technical
team also provides support to value added resellers, distributors and systems
integrators to assist in integration of our products.

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If we are
successful in our efforts to obtain significant orders for our products, we may
be required to install and service, on a timely basis, large numbers of
installations at our customers locations. We cannot assure you that we will be
able to provide such services on adequate terms and conditions, or at all.

Governmental Regulation

The
government of Israel encourages research and development projects oriented
towards products for export through its Office of the Chief Scientist Office,
or OCS, pursuant to the Law for the Encouragement of Industrial Research and
Development, 1984, commonly referred to as the Research Law. In exchange for
assistance provided by the Israeli government in connection with research and
development cost, we are committed to pay to the Israeli government royalties
at the rate of 2% to 3.5% of revenues from sale of our FormOut!  and eFLOW  software, up to a
maximum of 150% of the amount of participation received, linked to the U.S.
dollar plus interest at the LIBOR rate. Our total outstanding obligation in
respect of royalty-bearing government participation received or accrued, net of
royalties paid or accrued, amounted to $ 1,456 as of December 31, 2004.

The terms
of grants under the Research Law also require that the manufacture of products
developed with government grants be performed in Israel, unless a special
approval has been granted. Ordinarily, any such approval will be conditioned
upon acceleration of the rate of royalties and increasing the total amount to
be repaid to up to 300% of the grants. Israeli government consent is required
to transfer to third parties technologies developed through projects in which
the government participates. Such restrictions do not apply to exports from
Israel of products developed with such technologies. The consent of the OCS is
required for the transfer of manufacturing rights out of Israel.
Royalty-bearing grants received from the State of Israel for research and
development are offset against our research and development costs.

Recent
amendments to the Research Law provide for greater flexibility with regard to
the place of manufacturing of products funded with development grants and give
the authorities larger discretion than in the past based on the value added to
the products. A plan may now be approved if the applicant is an Israeli
corporation and, as a result of the plan, the applicant will develop in Israel,
by Israeli residents, a new product or a significant improvement to an existing
product, unless the plan is performed as part of an international cooperation
agreement to which Israel is a party, or the OCS is convinced that it is
essential for the execution of the plan that part of it will be performed out
of Israel or by non-Israeli residents. The amendment also determined a variety
of fixed levels of grants which the research committee (appointed according to
the law) will be entitled to grant based on the expected contribution of the
planned research and development to the Israeli economy.

The
amendment requires the grant recipient and its controlling shareholders and
interested parties to notify the OCS of any change in control of the recipient
or a change in the holdings of the means of control of the recipient that
results in a non-Israeli becoming an interested party directly in the
recipient. Such interested party will also be required to sign an undertaking
in favor of the OCS in form published by the OCS. For this purpose, control
is defined as the ability to direct the activities of a company other than any
ability arising solely from serving as an officer or director of the company. A
person is presumed to have control if such person holds 50% or more of the
means of control of a company. Means of control refers to voting rights and
the right to appoint directors or the chief executive officer. An interested
party of a company includes its chief executive officer and directors, anyone
who has the right to appoint its chief executive officer or at least one
director, and a holder of 5% or more of the companys outstanding equity or
voting rights.

We also
benefit from being designated as an Approved Enterprise under Israels Law
for the Encouragement of Capital Investments, 1959. For additional information,
see the section herein entitled Law for the Encouragement of Capital
Investments, 1959.

Additionally,
we may be subject to varied regulation in the markets where we sell our
products. The burden of complying with such regulatory schemes (which may be
contradictory) could have a material adverse effect on our ability to diversify
or grow our sales.

Organizational Structure

We
currently have four operating subsidiaries. In August 1991, we established TiS
America, Inc. to provide sales, marketing and technical support to our
customers. TiS America is incorporated under the laws of Delaware and is a
wholly owned subsidiary of TiS. In January 2000, we, together with others,
established e-Mobilis. e-Mobilis was incorporated in Israel, and we initially
held 80.2% of its issued shares. During 2001, we acquired the remaining 19.8%
interest in e-Mobilis, and e-Mobilis operations were integrated into ours. For
additional information, see the section herein entitled Related Party
Transactions. In July 2000, we established TiS B.V., a wholly owned subsidiary
incorporated under the laws of the Netherlands, with operating branches in the
United Kingdom and Germany. We recently modified our corporate structure in
Europe, and have established a new wholly owned subsidiary in the United
Kingdom, which owns a subsidiary in Germany. The activity and assets of our
existing European branches have been transferred to the new entities. We do not
believe that these changes will have a material effect on our business,
prospects and financial condition. In August, 2004 we established Top
Image Systems, TiS Japan Ltd. in order to strengthen our increased presence in
Japan.

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Property, Plant and Equipment

We lease
approximately 707 square meters in Ramat Hahayal, Tel Aviv, Israel, for which
we pay a monthly rent of approximately $18,000. The lease expires in November
2007. Our subsidiary in Germany leases approximately 241 square meters of
office space in Cologne, Germany for a monthly sum of $7,000 and our English
subsidiary leases approximately 35 square meters of office space in Uxbridge
for the amount of $5,500 per month. We also lease approximately 250 square
meters of office space in Tokyo, Japan for approximately $11,000 per month
pursuant to a lease expiring in 2006. All other lease agreements other than for
our Israeli headquarters will either expire or will be terminated during
2006.

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|ITEM 5. | OPERATING AND FINANCIAL REVIEW AND PROSPECTS
|------- | --------------------------------------------

Managements discussion and analysis of
financial conditions and results of operations.

The
following discussion and analysis have been derived from, and should be read in
conjunction with, our consolidated financial statements, related notes and
other financial information included herein.

General

We derive
revenue from the sale of products and solutions and also from service and
maintenance agreements.

Our sales
to end-users, resellers, value added resellers, distributors and system
integrators are made on credit terms and we do not hold collateral to secure
payment.  The terms of the agreements
with these customers do not provide them with the right to return the purchased
products or solutions.  Payment with
respect to such sales is generally due within a specified period following
receipt of an invoice. The period varies, but has been up to 180 days.

In the
fourth quarter of 2003, we revised this credit policy to set payment terms of
up to 150 days for end users and up to 90 days for resellers, distributors and
system integrators. We are not party to any extended payment arrangements.

A default
in payment by one or more of our resellers, value added resellers, distributors
and system integrators could adversely affect our business, results of
operations, and financial condition. We cannot assure you that uncollectible
receivables will not exceed our reserves. Any significant increase in
uncollected accounts receivable beyond reserves could have a material adverse
effect on our business, results of operation, and financial condition.

As a result
of our strategy of pursuing strategic alliances with value added resellers,
distributors and system integrators, a substantial portion of our revenues are
derived from such alliances. During the years ended December 31, 2002, 2003 and
2004, revenues deriving from value added resellers, distributors and system
integrators accounted for approximately 72%, 51% and 28%, respectively, of our
revenues.  The decline over the past two
years is  mainly because of our direct
sales to a major customer in Europe.

Historically,
we have recognized a majority of our revenues from product sales. During the
years ended December 31, 2002, 2003 and 2004, product revenues accounted for
approximately 82%, 75% and 62% respectively, of revenues, while service
revenues accounted for approximately 18%, 25% and 38% respectively, of
revenues. In 2002, sales of AFPSProTMaccounted for 25% of our product sales and for approximately 21% of our
revenue; sales of eFLOW
accounted for 69% of our product sales and for approximately 57% of our
revenue. In 2003, sales of AFPSProTMaccounted for 1% of our product sales and for approximately 1% of our
revenue; sales of eFLOW
accounted for 95% of our product sales and for approximately 71% of our
revenue. During 2004, we stopped selling our AFPSPro .

Quarterly
Results; Seasonality

Our sales
cycle for AFPSPro  as
well as eFLOWTMhas
ranged from 9 to 12 months. These sales cycles vary by customer and could
extend for longer periods depending on the time required by the customer to
evaluate the utility of the applicable product to its operations. Our operating
results could vary between periods as a result of this fluctuation in the
length of our sales cycles, the purchasing patterns of potential customers, the
timing of introduction of new products and product enhancements introduced by
us and our competitors, technological factors, variations in sales by
distribution channels, competitive pricing and generally non-recurring product
sales. Consequently, our product revenues may vary significantly by quarter.
During 2002, 30% of our revenues in the first quarter were from Schneider
Logistics, a customer in the United States, while it only accounted for 10% of
our annual revenues. During 2003, 32% of our revenues in the third quarter were
from Swiss Post  Finance, a customer in Switzerland, which accounted for 17%
of our 2003 annual revenues. During 2004, 14% and 13% of our revenues in the
second and third quarter respectively were from Swiss Post  Finance, which
accounted for 10% of our revenues in the year ended December 31, 2004.

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Geographical
Considerations

The
following table summarizes total revenues by geographic market for each of the
last three completed fiscal years.

|Revenues by Region             | 
|------------------------------ | 
|                               | 
|                               | 
|                               | 
|                               | 
|                               | 
|                               | 
|Europe                         | 
|North America                  | 
|Far East (excluding Japan)     | 
|Africa                         | 
|Japan                          | 
|Israel                         | 
|South America                  | 
|Middle East (excluding Israel) | 
|Other                          | 
|Total                          | 

As a result
of the fluctuation in product sales in various geographic regions, we are
subject to the risks associated with international sales, including economic
and political instability, shipping delays, customs duties, export quotas and
other trade restrictions, any of which could have a significant impact on our
ability to deliver products on a competitive and timely basis and exacerbate
the risks inherent in our business. While we have not encountered significant
difficulties in connection with the sales of our products in international markets,
the future imposition of, or significant increases in, the level of custom
duties, export quotas or other trade restrictions could have an adverse effect
on us.

Critical
Accounting Policies and Estimates

Our
consolidated financial statements have been prepared in accordance with
generally accepted accounting principles in Israel, or Israeli GAAP. Israeli
GAAP vary in certain significant respects from generally accepted accounting
principles in the United States, or U.S. GAAP. Application of U.S. GAAP would
have affected our results of operations and shareholders equity for each of
the years in the three-year period ended December 31, 2004 to the extent
summarized in Note 19 to our consolidated financial statements for the year ended
December 31, 2004.

We believe that
several accounting policies applied in the preparation of our consolidated
financial statements may be considered critical because they are most important
to the portrayal of our financial condition and results, and they require
managements most difficult, subjective or complex judgments, often as a result
of the need to make estimates about the effect of matters that are inherently
uncertain.  We periodically evaluate our
estimates, including those relating to the allowance for doubtful accounts,
contingencies and litigation. We base our estimates on historical experience
and on various other assumptions that we believe to be reasonable under present
circumstances.  Actual results may
differ from these estimates under different assumptions or conditions.  We believe the following critical accounting
policies require our more significant judgments and estimates used in the
preparation of our consolidated financial statements.

Revenue
Recognition

We derive
revenue from primarily two sources: sales of software licenses and provision of
services. Service revenues include contracts for software maintenance and
technical support, consulting and training.

24

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We apply
the provisions of Statement of Position (SOP) 97-2, Software Revenue
Recognition (as amended by SOP 98-4 and SOP 98-9) and related interpretations
to all revenue transactions.

We allocate
revenue from software arrangements involving multiple elements to each element
based on the relative fair values of the elements. The determination of fair
value of each element in multiple element arrangements is based on the price
charged when a similar element is sold separately.

A typical
solution includes software licenses, maintenance, and technical support. Some
customer arrangements include training and consulting. Maintenance includes
unspecified updates on an if-and-when available basis, and support includes
telephone support, and bug fixes or patches. Training consists of courses
taught by our instructors at our facility or at the customers site. Consulting
consists primarily of product installation and insignificant tailoring the
product to the customers needs.

We have
analyzed all of the elements included in our multiple-element arrangements and
determined that we have vendor specific objective evidence of fair value to
allocate revenue to the different services. Accordingly, assuming all other
revenue recognition criteria are met, revenues from licenses are recognized
upon delivery of the software license in accordance with SOP 97-2, as amended.
Revenues from maintenance and support services are recognized ratably over the
term of the agreement. Revenue for consulting and training is recognized as the
services are performed.

Our
criteria for revenue recognition are as follows:

1. Persuasive Evidence of an Arrangement Exists.
It is our customary practice to have a written contract, which is signed by
both the customer and us, or to have a purchase order from our customers, prior
to recognizing revenue from an arrangement.

2. Delivery Has Occurred. Our software is
physically or electronically delivered to the customer. If undelivered products
or services exist that are essential to the functionality of the delivered
product in an arrangement, delivery is not considered to have occurred.

3. The Vendors Fee is Fixed or Determinable.
The fee our customers are to pay for the products or services is negotiated
prior to the inception of the arrangement. Therefore, the fees are considered
to be fixed or determinable at the inception of the arrangement.

4. Collection is Probable. Probability of
collection for our customers debts is assessed by management on a
customer-by-customer basis. This assessment is based, among other factors, on
actual payment by the customer in previous transactions, general reputation of
the customer in the market, and the history of relations between us and the
customer.

License
revenues from reseller arrangements are recognized upon delivery unless payment
is dependent on third party collection by the reseller.  During the years ended December 31, 2002,
2003 and 2004, we had no arrangements in which payment terms were dependent on
third-party collection by the reseller.

When
services are considered essential, revenue under the arrangement is recognized
using contract accounting. When consulting services are not considered
essential, the revenue allocable to the consulting services is recognized as
the services are performed or when acceptance is received, if required by the
agreement.

If services
are considered essential to the functionality of the software licenses that require significant customization,
integration and installation, revenues are recognized on the percentage of completion basis
provided that the revenues are fixed or can be reasonably estimated, collection
is probable, costs related to performing the work are determinable or can be
reasonably determined, there is no substantial uncertainty regarding the
ability of the Company to complete the contract and to meet the contractual
terms and the percentage of completion can be reasonably estimated. The
percentage of completion is determined based on the ratio of actual cost to
total estimated cost. Any changes in those estimates could affect our results of operations. As for contracts in which a loss is anticipated, a
provision is recorded for the full amount of the expected loss.

If all the
criteria for recognition of revenue from performance contracts are not met,
then revenue is recognized up to the amount of costs incurred whose collection
is probable (zero profit margin presentation).

25

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Trade
Receivables and allowance for doubtful accounts.Trade receivables are recorded at cost,
less the related allowance for doubtful trade receivables. Management considers
current information and events regarding the customers ability to repay its
obligations and determines accounts receivable to be impaired when it is
probable that we will be unable to collect those amounts.

The balance
sheet allowance for doubtful debts for all the periods through December 31,
2004 is determined as a specific amount for those accounts the collection of
which is uncertain. We regularly review the allowance by considering factors
such as historical experience, credit quality, age of the accounts receivable
balances, and current economic conditions that may affect a customers ability
to pay. If a major customers creditworthiness deteriorates, or if actual
defaults are higher than our historical experience, or if other circumstances
arise, our estimates of the recoverability of amounts due to us could be
overstated, and additional allowances could be required, which could have an
adverse impact on our results of operations.

Goodwill and other intangible assets

Under
Israeli GAAP, goodwill is amortized over the estimated period of benefit, but
 no longer than 20 years. We amortized our goodwill over 10 years. Intangible assets are amortized over their
useful life using the straight-line method. Acquired technology and customer
relationships are amortized over a 5 year period.

According to Accounting
Standard No. 15, Impairment of Assets, goodwill and intangible assets are
reviewed for impairment when circumstances indicate the possibility that
impairment exists.

In assessing goodwill and other intangible assets, we make
assumptions regarding the estimated future cash flows and other factors to
determine the fair value of the respective assets. If these estimates or their
related assumptions change in the future, we may be required to record
impairment charges for these assets.

Under U.S. GAAP, Under Statement of Financial Accounting Standard No.
142, Goodwill and Other Intangible Assets goodwill is not amortized. SFAS No.
142 requires goodwill to be tested for impairment on adoption and at least
annually thereafter or between annual tests in certain circumstances, and
written down when impaired, rather than being amortized as previous accounting standards
required. Goodwill attributable to each of the reporting units is tested for
impairment by comparing the fair value of each reporting unit with its carrying
value. Fair value is determined using discounted cash flows, market multiples
and market capitalization. Significant estimates used in the methodologies
include estimates of future cash flows, future short-term and long-term growth
rates, weighted average cost of capital and estimates of market multiples for
each of the reportable units. As of December 31, 2004, the effect of the
accounting difference between Israeli GAAP and U.S. GAAP on our financial
statements amounted to $11,630, due to the 
amortization of goodwill during 2004.

Government
Grants

When the
Israeli government participates in software research and development costs, we
are committed to pay the Israeli government royalties as a percentage of
revenues from the sale of the software developed with this support.

Research
and Development Costs

Research
and development costs, net of participations and grants received, are charged
to our statement of operations as incurred.

Loss
Contingencies

We are subject to the possibility of various loss contingencies arising
in the ordinary course of business. We consider the likelihood of loss or
impairment of an asset or the incurrence of a liability, as well as our ability
to reasonably estimate the amount of loss in determining loss contingencies. An
estimated loss contingency is accrued when it is probable that an asset has
been impaired or a liability has been incurred and the amount of loss can be
reasonably estimated. We regularly evaluate current information available to us
to determine whether such accruals should be adjusted and whether new accruals
are required.

Recently Enacted Accounting Pronouncements

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On December 16, 2004, the Financial
Accounting Standards Board (FASB) issued SFAS No. 123 (revised 2004), Share-Based
Payment (SFAS 123(R)), which is a revision of SFAS 123 Generally, the
approach in SFAS 123(R) is similar to the approach described in SFAS 123. However, SFAS
123 permitted, but not required, share-based payments to employees to be recognized based
on their fair values while SFAS 123(R) requires all share-based payments to employees to
be recognized based on their fair values. SFAS 123(R) also revises, clarifies and expands
guidance in several areas, including measuring fair value, classifying an award as equity
or as a liability and attributing compensation cost to reporting periods. The new standard
will be effective for the Company in the first interim period beginning after June 15,
2005. The adoption of SFAS 123(R) will have a significant effect on the Companys
results of operations.

SFAS
123(R) must be adopted no later than July 1, 2005. Early adoption is permitted in periods
in which financial statements have not yet been issued. The Company expects to adopt SFAS
123(R) on July 1, 2005.

SFAS
123(R) permits companies to adopt its requirements using one of the following two methods:

| | 1.       

                     The modified prospective method, in which compensation cost is
                    recognized commencing with the effective date (i) based on the requirements of
                    SFAS 123(R) for all share-based payments granted after the effective date and
                    (ii) based on the requirements of SFAS 123 for all awards granted to employees
                    prior to the effective date of SFAS 123(R) that remain unvested at the effective
                    date.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2.       

                     The modified retrospective method, which includes the requirements
                    of the modified prospective method described above, but also permits entities to
                    restate based on the amounts previously recognized under SFAS 123, for purposes
                    of pro forma disclosures either (i) all prior periods presented or (ii) the
                    prior interim period of the year of adoption.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

As
permitted by SFAS 123, the Company currently accounts for share-based payments to
employees using APB 25, the intrinsic value method, and, as such, recognizes no
compensation cost for employee stock options. Accordingly, the adoption of the SFAS 123(R)
fair value method will have significant impact on the Companys results of
operations, although it will have no impact on the Companys overall financial
position. The impact of the adoption of SFAS 123(R) cannot be predicted at this time, as
it depends on levels of share-based payments for future grant. However, had the Company
adopted SFAS 123(R) in prior periods, the impact of that Standard would have approximated
the impact of SFAS 123, as described in the disclosure of the pro forma net loss and net
loss per share above.

Results
of Operations

The
following discussion and analysis should be read in conjunction with the
section herein entitled Selected Financial Data and the consolidated
financial statements, related notes and other financial information included
herein.

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

Revenues.  Total revenues for the year ended December
31, 2004 amounted to $11,178,448 compared to $8,319,002 for the year ended
December 31, 2003, an increase of 34%. Product sales increased by $753,892, or
12%, from $6,210,526 in 2003 to $6,964,418 in 2004, mainly because, of an
increase in product sales in Germany. 
Service revenues increased by $2,105,554, or approximately 100%, from
$2,108,476 in the year ended December 31, 2003 to $4,214,030 in the year ended
December 31, 2004. This significant increase is attributable mainly to services
performed for a major customer during 2004 and due to our continued focus on
providing comprehensive support to our customers document management
environment.

Cost
of Revenues. 
Cost of revenues increased $1,132,309 or 48% from $2,339,790 in the year
ended December 31, 2003 to $3,472,099 in the year ended December 31, 2004. The
increase is a result of growth in demand for our products and services, which
required us to allocate and invest more resources to meet such demand.

Research
and Development. 
During 2004, we continued to focus efforts in enhancing our software
recognition and core capabilities. Research and development expenses in the
year ended December 31, 2004 amounted to $929,432 compared to $863,209 for the
year ended December 31, 2003.

Selling,
General and Administrative Expenses.Selling,
general and administrative expenses in the year ended December 31, 2004
amounted to $7,134,709 compared to $5,818,426 for the year ended December 31,
2003.  This increase of $1,316,283 or
23% is mainly attributable to the expansion our sales force and establishing
roots for major sales centers in several locations worldwide.

Financing
Income, net. 
Financing income for the year ended December 31, 2004 amounted to
$179,400, compared to financing income of $98,376 for year ended December 31,
2003.  The increase in financing income
was primarily due to an increase of exchange gain in 2004, which is a product of
the strengthening of the Euro and British Pound against the U.S. Dollar.

Net
Loss.  As a
result of the foregoing, our net loss for the year ended December 31, 2004 was
$178,392, compared to a net loss of $604,047 in year ended December 31, 2003.

Year
Ended December 31, 2003 Compared to Year Ended December 31, 2002

Revenues.  Total revenues for the year ended December
31, 2003 amounted to $8,319,002 compared to $7,799,093 for the year ended
December 31, 2002.   Product sales
decreased by $212,822, or 3%, from $6,423,348 in 2002 to $6,210,526 in 2003,
mainly because there were no product revenues in Japan during 2003.  Service revenues increased by $732,731, or
50%, from $1,375,745 in 2002 to $2,108,476 in 2003, mainly because of services
performed for one of our major customers.

Cost
of Revenues. 
Cost of revenues decreased 22% from $3,005,463 in 2002 to $2,339,790 in
2003 primarily as a result of the cost cutting measures instituted by us in the
fourth quarter of 2002, which included the layoff of employees, and reduction
in payments to the Office of the Chief Scientist.  The layoffs contributed approximately $216,000 to the decrease in
our cost of revenues, and the reduction in payments to the Office of the Chief Scientist
attributed approximately $167,000 to such decrease. Our payments to the Office
of the Chief Scientist were higher by $160,000 in 2002 than in 2003 primarily
because of payments made pursuant to a royalty settlement reached with the
Office of the Chief Scientist during 2002. 
As a percentage of our revenues, cost of revenues decreased from 39% in
2002 to 28% in 2003.

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Research
and Development. 
During 2003, our development efforts were concentrated on the
semi-structured module capabilities, and its different applications. Gross
research and development expenses aggregated $863,209 for 2003 compared to
$1,340,408 for 2002. The decrease is mainly due to a decrease in salary
expenses resulting from the cost cutting measures implemented during 2002,
entailing the layoff of seven research and development employees. This
reduction attributed to decrease the salary expenses in the amount of $404,000.

Selling,
General and Administrative Expenses.Selling,
general and administrative expenses decreased from  $7,150,617 in 2002 to $5,818,426 in 2003.  This decrease was primarily due to a
material decrease of salary expenses in the amount of approximately $960,000, a
decrease of marketing expenses in the amount of approximately $465,000 and
commissions payable to third parties, which increased by approximately
$115,000.  During the fourth quarter of
2002, we implemented several cost cutting measures targeted at reducing staff
and other expenses during coming years, which had only a partial effect during
2002, but had a noticeable impact during 2003.

Financing
Income. 
Financing income, net for the year ended December 31, 2003 was $98,376,
compared with $187,318 in the year ended December 31, 2002.  Approximately $83,000 of the decrease in
financing income was attributable to the combination of the decrease of
interest rates in the United States and Israel and an increase in our line of
credit.

Net
Loss.  As a
result of the foregoing, our loss was $604,047 in the year ended December 31,
2003, compared to a loss of $3,827,788 in the year ended December 31, 2002.

Impact
Of Currency Fluctuation And Inflation

Most of our
product and service revenues from transactions outside of Israel are
denominated in  currencies other than
the NIS, and revenues from transactions in Israel are denominated in NIS but
are linked to the U.S. dollar exchange rate. 
In the early to mid 1980s, Israels economy was subject to a period of
very high inflation.  However, inflation
was significantly reduced by the late 1980s due primarily to government
intervention.  The annual rate of
inflation in Israel was 1.4%, 6.5%, 1.9%, and 1.21% in 2001, 2002, 2003 and
2004, respectively. The dollar cost of our operations in Israel is influenced
by the extent to which any increase in the rate of inflation in Israel is not
offset (or is offset on a lagging basis) by devaluation of the NIS in relation
to the dollar.  For example, during the
years 2001, 2002 and 2004, the devaluation of the NIS against the dollar, which
amounted to 9.28%, 7.27% and 1.62% accordingly, exceeded the inflation rate for
the same periods. On the other hand, the negative inflation rate for 2003  of 1.9% exceeded the devaluation of the
dollar against the NIS, which amounted to 7.56%.  The increase in the dollar cost of our operations in Israel
relates primarily to the costs of salaries in Israel, which constitute a
substantial portion of our expenses and are paid in NIS.  In addition, inflation in Israel will have a
negative effect on the profitability to our contracts under which we are to
receive payment in dollars or other non-Israeli currencies while incurring
expenses in NIS (some of which are linked to the Israeli consumer price index),
unless such inflation is offset by a devaluation of the NIS.  Inflation in Israel and currency
fluctuations will also have a negative effect on the profitability resulting
from our fixed price contracts under which we are to receive payment in
NIS.  A devaluation of the NIS in relation
to the dollar will have the effect of decreasing the dollar value of any assets
of the Company, which consist of receivables payable in NIS (unless such
receivables are linked to the dollar). 
Such a devaluation would also have the effect of reducing the dollar
amount of our liabilities which are payable in NIS (unless such payables are
linked to the dollar). Conversely, any increase in the value of the NIS in
relation to the dollar will have the effect of increasing the dollar value of
any unlinked NIS assets of the Company and the dollar amounts of any unlinked
NIS liabilities of the Company.

Because
exchange rates between the NIS and the other currencies in which we conduct
business, including the dollar, fluctuate continuously (albeit with a
historically declining trend in the value of the NIS), exchange rate
fluctuations and especially larger periodic devaluations have an impact on our
profitability and period-to-period comparisons of our results.  Such impact is recorded in our financial
statements as financial income/expense. Favorable exchange rates will tend to
increase reported financial income, and unfavorable exchange rates will tend to
reduce reported income.  To date, we
have not engaged in currency-hedging transactions intended to reduce the effect
of fluctuations in foreign currency exchange rates on our results of
operations.  In the future, we may enter
into currency hedging transactions to decrease the risk of financial exposure
from fluctuations in the exchange rate of the dollar against the NIS; however,
we cannot assure you that such measures will adequately protect us from
material adverse effects due to the impact of inflation in Israel.  In addition, if for any reason exchange or
price controls or other restrictions on the conversion of foreign currencies
into NIS were imposed, our business could be adversely affected.

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Political and Economic Conditions in Israel
Affecting our Business

Because our principal offices and manufacturing facilities and many of
our suppliers are located in 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.  A state of hostility, varying in degree and
intensity, has led to security and economic problems for Israel.  There has been a marked increase in such
hostility and a significant deterioration of Israels relationship with the
Palestinian community since October 2000, although recent regional developments
have led to an improvement in Israels relationship with the Palestinian
Authority. Continuing or escalating hostilities in the region may have an
adverse affect on our business, including our ability to develop, manufacture
and market our products.

Some of our
executive officers and employees in Israel are obligated to perform up to 36days of military reserve duty
annually.  Moreover, in light of
escalating hostilities and threats of armed conflict in the Middle East since
October 2000, our executive officers and employees may be called for active
military duty for an unlimited period of time. 
Our operations could be disrupted by the absence for a significant
period of our executive officers or key employees as a result of military
service.  Any disruption in our
operations could adversely affect our ability to develop and market products.

Economic
Conditions

Israels
economy has experienced 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, for
these and other reasons, intervened in the economy by utilizing fiscal and
monetary policies, import duties, foreign currency restrictions and control of
wages, prices and exchange rates.  The
Israeli government has periodically changed its policies in all these areas.

The Israeli
governments monetary policy contributed to relative price and exchange rate
stability in recent years, despite fluctuating rates of economic growth and a
high rate of unemployment.  We cannot
assure you that the Israeli government will be successful in its attempts to
keep prices and exchange rates stable. 
Price and exchange rate instability may have a material adverse effect
on our business.

Trade
Relations

Israel is a
member of the United Nations, the International Monetary Fund, the
International Bank for Reconstruction and Development and the International
Finance Corporation. Israel is also a member of the World Trade Organization
and is a signatory of the Global Agreement on Trade in Services and the
Agreement on Basic Telecommunications Services. In addition, Israel has been
granted preferences under the Generalized System of Preferences from the United
States, Australia, Canada and Japan. These preferences allow Israel to export
the products covered by such programs either duty-free or at reduced tariffs.

Israel and
the European Economic Community, now known as the European Union, concluded a
Free Trade Agreement in 1975. This agreement confers advantages on Israeli
exports to most European countries and obligates Israel to lower its tariffs on
imports from these countries over a number of years. In 1985, Israel and the
United States entered into an agreement to establish a free trade area. The
free trade area has eliminated all tariff and some non-tariff barriers on most
trade between the two countries. On January 1, 1993, an agreement between
Israel and the EFTA, which includes Austria, Norway, Finland, Sweden,
Switzerland, Iceland and Liechtenstein, established a free trade zone between
Israel and the EFTA nations. In recent years, Israel has established commercial
and trade relations with a number of other nations, including Russia, China,
Turkey and other nations in Eastern Europe and Asia. We cannot assure you that
the recent increase of armed conflict and hostility and the significant
deterioration of Israels relationship with the Palestinian community will not
have an adverse affect on our ability to conduct trade in the international
market.

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Trends

We also forecast that in the near future, the semi-structured technology is expected to become take
a central part of the document management market. We are addressing this trend by strengthening and further developing our
semi-structured technology.

We anticipate that growth will
continue in the data capture market. However, we believe that there will be a move toward
integrated software solutions instead of individual data capture products and
semi-structured technology, such asFreedom,our Eflowplug-in for
semi-structured content. We also anticipate that the need for applications will increase
substantially. We expect outsourcing with respect to documents solutions to increase and
for the date capture industry to continue to move toward consolidation. We are addressing
this trend by solidifying our relationships with our existing partners and seeking to
become the preferred data capture solution provider for many large integrated system
providers. .

Liquidity and Capital Resources

As of
December 31, 2004, our cash, cash equivalents, bank deposits and marketable
securities were $10,414,776, compared to $6,130,951 as of December 31, 2003.
The balance increased significantly in the third quarter of 2004 due to our
private placement, which contributed approximately $8 million before issuance
expenses (see Private Placement below). We believe that our cash, cash
equivalents, bank deposits and short-term marketable securities will be
sufficient to fund our working capital needs and planned capital expenditures
for the next twelve months.

Net cash
used in operating activities for the year ended December 31, 2004 was
$1,073,040, as compared to $2,516,369 for the corresponding period in 2003.
This decrease was attributable primarily to the increase in our sales and the
results of our cost cutting measures we took in 2003. Our trade receivables
increased to $5,541,006 at December 31, 2004 from $4,606,254 at December 31, 2003. This increase
reflects our increased sales in 2004 and receivables under our old payment
terms.  As sales increase, we incur cash
costs of sales in the current period, but do not receive of the cash flows from
such sales until later periods. While the effect of increasing sales on our
cash flows will continue if we succeed in further sales growth, we believe that
the cash flows from operations and other resources will be sufficient to
support such growth. We expect trade receivables to continue to increase as our
sales grow and to represent a significant portion of our working capital for
the foreseeable future.    Other payables and accrued expenses
decreased by  $278,116  mainly
as result of payments connected
with our settlement with Millennium in the amount of $100,000 and payments of
approximately $246,000 connected to termination of employment of an officer.

In 2004, we
closed a transaction with our longtime partner Toyo Ink Mfg. Co., Ltd. to
acquire certain assets from Toyo Inks EDMS division for consideration of
approximately $1.9 million. The division, established nine years ago and
dedicated to the imaging business, has been exclusively marketing and
implementing TiS solutions in Japan. We expect that our uses of cash in the
near future will be to fund working capital and increases in selling and
marketing expenditures and research and development expenditures. In addition,
we may also use cash for potential investments and potential strategic
acquisitions of, or investments in, related businesses, and technologies.
However, we currently have no commitments for any specific acquisitions,
expenditures or investments. We cannot assure you that the uses will not be
different.

For the year ended December
31, 2004, the aggregate amount of our capital expenditures was $415,997. These
expenditures were principally for the purchases of computer hardware and
software and facilities improvements.

Cash used
in operating activities in 2003 was $2,516,369, compared to cash used in
operating activities in 2002 of $1,983,285. 
During 2003, we decreased our trade payables by $46,644, decreased our
accrued liabilities and other payables by $536,910, increased our accounts
receivable by $1,457,473 and increased our other receivables by $114,552.  The increase in our accounts receivable reflects both increase in our sales
and transactions which were made under the previous payment terms policy. The
decrease in our accrued liabilities and other payables is mainly attributable
to  a payment connected to
termination of employment of an officer. 
Cash provided by investing activities in 2003 was $185,250, compared to
cash used in investing activities in 2002 of $199,028.  Cash provided by financing activities in
2003 was $784,666, compared to cash provided by financing activities in 2002 of
$164,037.

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Private
Placement

On September 24, 2004, we sold 2,524,351 of our ordinary shares at a
purchase price of $3.16 per share to institutional investors for gross proceeds
to us of approximately $8 million.

Pursuant to
our agreements with the investors, we are obligated to use the net proceeds
from the sale of our ordinary shares for working capital purposes and not (i)
for the satisfaction of any portion of our debt (other than payment of trade
payables and accrued expenses in the ordinary course of our business and
consistent with prior practices), (ii) to redeem any equity or
equity-equivalent securities in TiS, or (iii) to settle any outstanding
litigation. Accordingly, upon exercise of the warrants, we intend to use the
proceeds in accordance with the foregoing provision.

The
investors also received warrants to purchase up to an additional 1,262,188
ordinary shares, with an exercise price of $4.26 per share. The warrants expire
on September 23, 2007.  The investors
may only transfer the warrants to the investors affiliates, qualified
institutional buyers, or in the event of our dissolution or winding down. The
warrants contain a provision preventing a holder from exercising a warrant
where the exercise would result in such holder beneficially owning more than
4.999% of our outstanding ordinary shares. Accordingly, no selling shareholder
could be rendered a beneficial holder of more than 4.999% of our ordinary
shares solely because of shares issuable to such shareholder upon exercise of
such warrants held by the holder.

We have the
right, but not the obligation, to call upon prior notice all or part of the
warrants if the market price for our ordinary shares is equal to $8.52 for 20
consecutive days. Our calling the warrants would require the holders of the
warrants to timely exercise the warrants. Failure to so exercise would result
in our cancellation of the warrants. If we call any warrants, we must issue to
each holder exercising in response to our call notice replacement warrants to
purchase a number of shares equal to the number of shares acquired upon such
exercise, with an exercise price equal to 120% of the closing price on the day
prior to the call notice we provide to the holders.

Our
shareholders approved the transaction at a special shareholders meeting held on
August 24, 2004.

Pursuant to
our agreement with the investors, we are subject to restrictions with respect
to the sale of our ordinary shares or securities convertible into our equity.
Until March 1, 2006, before we are able to sell our securities, in most
instances we are required to first offer the securities to the investors
pursuant to terms set forth in our agreement with them. The foregoing terms and
right of first offer could delay our efforts to raise capital and increase
transaction costs and could limit our ability to obtain additional
financing.

In connection
with the private placement, we filed a resale registration statement covering
the shares purchased in the private placement (including the shares underlying
the warrants). The registration statement became effective on March 1,
2005.  However, we did not obtain effectiveness
of the registration statement within the timeframe set forth in our agreements
with the investors, which has subjected us to liquidated damages of
approximately $160,000 (plus interest). 
In addition, any future failure to maintain effectiveness of the
registration statement could subject us to additional liquidated damages,
including if we fail to file an amendment to the registration statement within
ten days of the Securities and Exchange Commissions having notified us that an
amendment is necessary for the registration statement to continue to be
effective, or if we fail to maintain the listing of our ordinary shares on the
NASDAQ SmallCap Market.

The
liquidated damages that we would be obligated to pay under the circumstances
described above are in the amount of 1% of the amount invested and an
additional 1% for every month in which we do not cure the issue that led to the
obligation.

Line
of Credit

We
currently have a short-term line of credit with First International Bank of
Israel. The total amount available under this line of credit is the lesser of
$1,500,000 and 75% of certain eligible trade receivables. As of December 31,
2004, we had approximately $1,707,151 outstanding after extension of additional
credit from the bank.  The revolving line
of credit in NIS bears interest at a rate of prime + 1% (as of December 31,
2004, the prime rate was 5.2%). The line of credit in US dollars bears interest
at a rate of Libor + 2% (as of December 31, 2004, the Libor rate was 2.375%).
Any indebtedness under this credit line is payable on demand and secured by a
floating charge on our assets. Our ability to issue securities is restricted. In the event that we
default under the line of credit, the bank could declare our indebtedness
immediately due and payable and, if we are unable to make the required
payments, foreclose on our assets. Moreover, to the extent that our assets
continue to secure such indebtedness, such assets will not be available to secure
additional indebtedness unless approved by the Bank.

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Contractual
Obligations and Commitments

The
following is a summary of our contractual obligations as of December 31,
2004:

|Contractual
  Obligation     |  | Total |           | Less Than 1
  Year |  | 2 Years   |  | 3 Years and more |        
|---------------------------- |  | ----- | --------- | ------------------ |  | --------- |  | ---------------- | -------
|                             |  |       |           |                    |  |           |  |                  |        
|Operating
  Lease Obligation |  |       | 1,563,529 |                    |  | 762,856   |  |                  | 517,131
|Purchase
  Obligation        |  |       | 300,000   |                    |  | 300,000   |  |                  |       
|Total                        |  |       | 1,863,529 |                    |  | 1,062,856 |  |                  | 517,131

We also
have a long-term liability on our balance sheet as of December 31, 2004 in the
amount of $186,514 related to employee severance obligations mandated by
Israeli law.  As we cannot determine the
period, if any, during which we will be required to make any payments in
respect of that liability, it is not reflected in the table above.

Our
contractual obligations and commitments at December 31, 2004 principally
include obligations associated with our outstanding indebtedness, future
minimum operating lease obligations, a right to use a third party software (see
below) and contractual and legal obligations to employees and officers
severance expense. Such obligations are detailed in Notes 9, 10, and 12 to the
consolidated financial statements for the year ended December 31, 2004 as well
as the section entitled Compensation herein. We expect to finance these
contractual commitments from cash on hand and cash generated from operations.

We entered
into an engagement under which we have to the right to use third party software
during fiscal years 2005 and 2006. Pursuant to the agreement, we agreed to pay
an annual license fee equal to the greater of $ 300,000 and 2.5% of related
sales. The amount is due in four equal quarterly payments for each year.

Research and Development, Patents and
Licenses, etc.

During
2004, our Research and Development efforts were focused mainly on enhancing our
product performance and extending its capabilities. Such efforts include
refinements of our products, such as improvements in image enhancement,
automatic forms recognition, automatic forms removal, machine print and
handwritten character recognition, as well as special purpose algorithms.

Our
research and development efforts have led to the development of our current solutions
technology, eFLOW Unified Content Platform .
Our latest research and development efforts have concentrated on the
semi-structured forms processing, resulting in the development of our Freedom product. These developments are enhancing, and we believe they will
continue to enhance, our ability to compete in complicated projects as a
solution provider for all kinds of forms and all types of information. Freedom and its different applications fit well with our plans to keep pace with
the trend towards the ultimate integration of all forms and formats of
information entering the organization.

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During the
first quarter of 2005, we released eFLOW
Version 3, the latest version of our leading software, eFLOW Unified Content Platform. eFLOW Version 3
offers organizations a single point of contact and control for delivering
valuable information to enterprise information systems via a single platform
and a single set of business rules. eFLOW
integrates with any enterprise information system, including SAP, Oracle and
others. The enhanced solution includes our new automated classification
solution, Smart!,which adds the
ability to automatically sort the incoming information, classify all documents,
recognize and extract the data from documents, apply the organizations
business rules, validate the data, and seamlessly deliver this data to back-end
enterprise systems. These capabilities are efficiently achieved by using best
of combination of fuzzy search and recognition engines, to provide customers
with the highest recognition results. Processing efficiency, accurate
information and improved throughput lead to significant savings and rapid ROI.
The entire development of eFLOW Version 3
is based on .NET, Microsofts latest technology, as well as its roadmap for
future developments. This choice is compatible with TIS forward-looking
strategy to maintain eFLOW on the
cutting edge of new technologies. At the same time, the new developments are
compatible with all former eFLOW
versions. eFLOW Version 3 is a
robust stable scalable platform which efficiently copes with large-scale
projects and balances loads of millions of documents per day. With the use of a
central controller, eFLOW Version 3
can administrate and monitor both local and remote production sites in
real-time and simultaneously manage more than one application. Its highly
sophisticated designer enables minimal code writing to adjust the solution to
customers unique needs. Various powerful recognition engines have been
integrated into the new version to allow mixed Full Page OCR & ICR which
enables the recognition of both handwriting and printed information on any type
of document. eFLOWs unique
voting algorithm along with its component for approximate search on very large
databases, further increase recognition rates and speed up the process.   The foregoing statement does not constitute our commitment to deliver these products.  New versions will be released if and
when available.

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|ITEM 6. | DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
|------- | ------------------------------------------

Directors and Senior Management

The
following table sets forth the identity of our directors, and senior
management. The mailing address for each of the individuals below is c/o Top
Image Systems Ltd. at our address set forth herein.

|Thomas C.
  Lavey    | 60 | Chairman of
  the Board of Directors        
|-------------------- | -- | --------------------------------------------
|                     |    |                                             
|Ido
  Schechter      | 42 | Chief
  Executive Officer and Director      
|                     |    |                                             
|Arie Rand            | 44 | Chief
  Financial Officer                   
|                     |    |                                             
|Gideon
  Shmuel      | 32 | Vice
  President of Sales                   
|                     |    |                                             
|Oded Leiba           | 33 | Vice
  President of Engineering             
|                     |    |                                             
|Ofir Shalev          | 32 | Vice
  President of Research and Development
|                     |    |                                             
|Victor
  Halpert     | 43 | Director                                    
|                     |    |                                             
|Zamir Bar
  Zion     | 46 | Director                                    
|                     |    |                                             
|Izhak Nakar          | 52 | Director                                    
|                     |    |                                             
|Elie Housman         | 67 | Director                                    
|                     |    |                                             
|Yehezkel
  Yeshurun  | 55 | Director                                    
|                     |    |                                             
|William M.
  Landuyt | 48 | Director                                    
|                     |    |                                             

Thomas
C. Lavey became a Director of TiS in August 2002 and
the Board elected him as non-Executive Chairman at the same meeting. Since
September 2003, Mr. Lavey has served as Executive Vice President of Global
Sales and Business Development at Taleo Inc. 
Previously Mr. Lavey served as Executive Vice President, Worldwide Field
Operations of MS2, Inc, which provides product life cycle automation software
Prior to joining MS2, Mr. Lavey was senior vice president of worldwide
operations at Extricity, which became part of Peregrine Systems and provided
B2B relationship management software. Mr. Lavey also served as senior vice
president at i2 Technologies and, from 1994 through 1999, he served as vice
president of application sales at Oracle Corporation. Mr. Lavey has a
bachelors degree in mathematics from Penn State University and an MBA from the
University of Southern California.

Ido
Schechterhas been the CEO of TiS since January 2002
and has been a director since December 2004. From January 2001 until he became
CEO, Dr. Schechter was Vice President of TiS ASP2 , an initiative
of TiS to offer data collection services via the Internet, using the eFLOWplatform solution. Prior to that Dr.
Schechter had been the TiSs Vice President of Sales since August 1996. From
January 1995 until August 1996, Dr. Schechter served as General Manager of
Super Image, a former affiliate of ours, which operated a form processing
service bureau. From August 1993 to December 1994, Dr. Schechter oversaw the
start-up of automatic form processing services at Israel Credit Cards, Ltd.
From 1991 to 1993, Dr. Schechter was a research scientist at the Horticultural
Research Institute of Ontario, Canada. Dr. Schechter is the recipient of eight
Honors and Scholarships, has published or presented more than twenty-five
articles and is a Captain in the Israeli Air Force. Dr. Schechter received his
Ph.D. and M.Sc. in Plant Physiology from the University of Guelph in Ontario,
Canada and his B.Sc. from the Hebrew University in Israel.

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Arie
Rand joined TiS as its Chief Financial Officer in
April 2001 from Tescom, a high tech company with 600 employees and several
subsidiaries worldwide, where he served as Chief Financial Officer from
September 1996 through March 2001. Prior to Tescom, from September 1991 to June
1996 Mr. Rand served as a senior manager in the finance department of Delta
Galil Industries, a major industrial company. Mr. Rand also has several years
of experience at Almagor & Co., one of Israels leading accounting firms.
He holds an MBA in Finance from Bar Ilan University.

Gideon
Shmuel joined us as our Vice
President of Sales for Europe, Middle East and Asia during 2001 from Pangea Ltd
(UK), where he was a Senior Vice President. Pangea provides telecommunications
infrastructure throughout Europe. Prior to that, Mr. Shmuel was Managing
Director of LCR Telecom UK, a company that provides aggregated data, voice,
Internet and mobile communications services to the corporate market during the
years 1998 to 2000. Mr. Shmuel holds an MA in Marketing Management from
Middlesex University Business School in London.

Oded
Leiba is Vice President of Engineering, and has held
that position since May 2001. From May 1999 to May 2001, Mr. Leiba was our
representative in Japan and worked with its exclusive distributor, EDMS for a
period of three years. Before joining TiS, Mr. Leiba was employed as a senior
level programmer at VISA where he was involved in the installation of the first
of our forms-processing system (AFPS) from the client side. Oded Leiba holds a
Bachelor of Arts in Computer Science and Business Management from Tel Aviv
University.

Ofir
Shalevhas served as Vice President of Research and
Development since October 2002. Prior to his promotion to Vice President of
Research and Development, Mr. Shalev served as our Director of Recognition for
three years. During this period, Mr. Shalev was responsible for the development
of TiS semi-structured data module that plugs into the eFLOW Unified Content Platform . In this position, Mr. Shalev was responsible for maintaining TiS technological
advantages over its competitors in the recognition arena. Before joining TiS,
Mr. Shalev served as a senior development leader at the Israeli Defense Force.
Mr. Shalev holds a Bachelor of Science degree from the Technion, the Israeli
Institute of Technology, and is a candidate for a Master of Science degree in
Computer Science from the Open University in Israel.

Victor
Halpert was elected to serve as an external director
of TiS at the shareholders meeting in December 2003. Mr. Halpert has served in
various positions in the field of equity research. From June 1999 through
January 2003 Mr. Halpert served as director for Salomon Smith Barney in New
York, NY. From January 1998 through May 1999 Mr. Halpert served as vice
president (equity research, telecommunications and technology) for Robertson
Stephens, New York, NY. From January 1995 through December 1997, Mr. Halpert
served as vice president for Salomon Brothers Inc. New York, New York. Mr.
Halpert has a bachelors of science degree in Accounting from State University
of New York, College at New Paltz, NY, a Master of Science in Accounting from
the University of Illinois at Chicago, Graduate Business School and an MBA from
the University of Chicago Graduate Business School.

Zamir
Bar-Zion was elected to serve as an external director
of TiS at the shareholders meeting that took place in December 2003. Mr.
Bar-Zion served as Managing Director for Nessuah Zannex & Co./USBancorp
Piper Jaffray from 1998 through 2001. From 1995 to 1998 Mr. Bar-Zion served as
a private financial consultant. Mr. Bar-Zion received his B.Sc. in Computer
Science and Finance from New York Institute of Technology, an MA from the
Department of Finance from Pace University, New York, and a PMD from the
Program Management Development Program at Harvard University. Currently, Mr.
Zamir represents Piper Jaffrey in Israel.

Izhak
Nakar founded TiS and served as its Chief Executive
Officer from inception until December 2001. He has been a director of ours
since 1991. In 1997 he initiated an entrepreneurial venture, TopGuard that was
later sold to Elron. Mr. Nakar served in the Israel Air Force from 1970 to
1987, where he led various large-scale highly technical development projects,
including leading a development team that worked in cooperation with the U.S.
Air Force. He received his B.Sc. in Computer Science from Bar Ilan University
in 1982, and an MBA from Tel-Aviv University in 1984. Mr. Nakar is a recipient
of the Israel Defense Award, bestowed annually by the President of Israel,
for the development of high-tech systems in the field of intelligence for the
Israeli Defense Forces. He also received the Man of the Year Award in
Business and Management (95-96) in recognition of his business
accomplishments and contributions to the growth and development of Israeli
high-tech companies.

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Elie
Housman has been a director of TiS since May 2000. Mr.
Housman joined InkSure in February 2002 as Chairman. Mr. Housman was a
principal at and consultant to Charterhouse from 1989 until June 2001. At
Charterhouse, Mr. Housman was involved in the acquisition of a number of
companies with total sales of several hundred million dollars. Prior to
Charterhouse, he was co-owner of AP Parts, a $250 million automotive parts
manufacturer. Mr. Housman was also the Chairman of Novo Plc. in London, a
leading company in the broadcast storage and services industry. At present, Mr.
Housman is a director of three public companies, deltathree, Inc., ICTS
International, N.V., a prominent aviation security company and EVCI Career
Colleges Incorporated. In addition, Mr. Housman serves as a director of Jazz
Photo, Inc., and Bartech Systems International, Inc., which are both privately
held companies in the United States.

William M. Landuyt, has
been a director of TiS since March 2, 2004. 
Mr. Landuyt has been a Principal at Charterhouse Group International,
Inc. since December 2003.  He served as
Chairman of the Board and Chief Executive Officer of Millennium Chemicals Inc.
from its demerger from Hanson Plc (Hanson) in October 1996 until July 2003.
He had served as the President of that company from June 1997 until that date.
Mr. Landuyt was Director, President and Chief Executive Officer of Hanson
Industries (which managed the United States operations of Hanson until the
demerger) from June 1995 until the demerger, a Director of Hanson from 1992
until September 29, 1996, Finance Director of Hanson from 1992 to May 1995, and
Vice President and Chief Financial Officer of Hanson Industries from 1988 to
1992. He joined Hanson Industries in 1983. He was a director of Bethlehem Steel
Corporation from April 1997 until October 2003.

Yehezkel
Yeshurunhas been a director of the Company since
December 2004.  He brings to Top Image Systems Board of
Directors over 25 years of technical and management experience. He is a faculty
member in the School of Computer Science at Tel Aviv University, and his
research areas are Computer Vision, Pattern Recognition and Computational
Neuroscience. He authored more than 80 scientific publications and served on
numerous international program committees. Professor Yeshurun has co-founded
several technology companies including us and TapGuard (provider of QoS
solutions over the internet, acquired by Elron Software (NASDAQ: ELRN)), and is
the Chairman of the Board of ForeScout Technology (Internet Security startup).
Among other positions, he served as the chairman of the Department of Computer
Science at Tel Aviv University, chairman of the Israeli National Committee for
IT, a member of the board of the Israeli chapter of W3C, a board member of the
US-Israel Science and Technology Commission and
a member of the board of governors of the International Association for Pattern
Recognition. Professor Yeshurun holds a Ph.D. in Mathematics from Tel Aviv
University and held visiting positions at New York University, McGill
University and the University of Paris.

There are
no familial relationships between any of the persons named above. Elie Housman
and was initially appointed to the Board seat by Charter pursuant to the terms
of the investment by Charter in us and a voting agreement with Mr. Nakar. For
further details, see the sections entitled Major Shareholders and   Related
Party Transactions in this report. Mr. Housman left the employ of Charterhouse
in 2001.

Compensation

For the
year ended December 31, 2004, the compensation paid, and value of benefits in
kind granted, to Ido Schechter, our Chief Executive Officer, was $353,620,
which was comprised of a base salary of $175,951, bonus of $114,168 and $63,501
paid to provide for automobile allowance, pension, retirement, severance,
vacation or similar benefits. The compensation paid to all other persons, as a
group, who were, at December 31, 2004, directors or members of our
administrative, supervisory or management bodies during that time was $513,304.
In addition, in 2004, members of that group, together with our Chief Executive
Officer, were granted an aggregate of options to purchase 95,000 ordinary
shares under our ESOP 2003 with an exercise price of $3.27 per share. For
further details, see the section herein entitled Directors, Senior Management
and Employees. The compensation paid to all persons other than Ido Schechter
does not include (i) reimbursement of directors expenses, (ii) $ 197,628 which
has been accrued to provide pension, retirement, severance, vacation or similar
benefits, and allowance for automobiles made available to our officers, and
other expenses (including business travel, and professional and business
association dues and expenses) reimbursed to officers.

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In
connection with the private placement of our shares and the investment by
Charter, Izhak Nakars employment agreement was amended during 2000. First, an
amendment approved at the extraordinary annual meeting held on March 10, 2000
provided that Mr. Nakars annual base salary (not including managers
insurance, retirement and other benefits added to the base salary) was
$216,000, that he would be eligible for an annual bonus of up to 50% of his
annual base salary, that the term of his employment agreement would be for 18
months after the closing date of Charters investment of May 8, 2000), and an
automatic renewal thereafter for successive 12 months periods, and that he
would be entitled to certain rights including the right to receive a lump sum
payment equaling his annual salary upon termination for any reason. In the
annual meeting held on October 5, 2000, a further amendment to Mr. Nakars
employment agreement was approved providing that:

|1. | Upon
  resignation by Mr. Nakar in connection with a merger, acquisition, sale of
  all or substantially all of assets or other change of control of us or,
  Change of Control, (i) Mr. Nakar would be entitled to receive a lump sum payment
  in cash equal to three times the highest annual salary plus bonus received(or
  scheduled to be received) by Mr. Nakar during any annual period covered by
  the employment agreement; (ii) we would be required to continue the benefits
  granted to Mr. Nakar and his family (at the same level in effect for one year
  prior to the date of termination or resignation) for a period of three years;
  (iii) the restrictions on competition contained in Section 8 of Mr. Nakars
  current employment agreement would be void and of no effect; and                                                             
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|2. | Upon
  termination of Mr. Nakars employment with us for any reason (other than a
  resignation by Mr. Nakar in connection with a Change of Control or a
  termination of Mr. Nakars employment for Cause), subject to the immediately
  following paragraph, (i) Mr. Nakar would be entitled to receive payments in
  cash, payable in eighteen equal monthly installments commencing immediately
  after termination of Mr. Nakars employment, equaling in the aggregate 1.5
  times the highest annual salary plus bonus received(or scheduled to be
  received) by Mr. Nakar during any annual period covered by the Agreement; and
  (ii) we would be required to continue all of the benefits granted to Mr.
  Nakar and his family (at the same level in effect for one year prior to the
  date of termination or resignation) for a period of eighteen months).

For so long
as we did not default on our obligations set forth in paragraph 2 above, Mr.
Nakar was subject to certain restrictions on competition contained in his employment
agreement. Those restrictions lapsed in May 2004.

In
accordance with the foregoing and as a result of Mr. Nakars resignation of his
employment, we recorded a non-recurring severance provision, the expenses in
our financial statements for which were in the amount of approximately $759,000
during prior years. See the immediately following section for a description of
a consulting arrangement with Mr. Nakar.

Board Practices

Board
of Directors

All
directors (other than external directors) currently hold office until the next
annual meeting of shareholders and until their successors are duly elected and
qualified. External directors currently hold office for three years from their
appointment (in December 2003) and until their successors are duly elected and
qualified at the relevant annual meeting. The external directors may be elected
for one additional three-year period. TiS, at its shareholders meeting held on
December 18, 2003, approved a monthly payment to Mr. Thomas C. Lavey in the
amount of $2,000 as compensation for his service as a director and Chairman of
the Board, and that Mr. Victor Halpert, Mr. Zamir Bar-Zion for their service as
external directors, members of Audit Committee and the board of directors and
Mr. Elie Housman for his service as member of the Audit Committee and board of
directors receive as compensation a payment in the amount of 15,750 NIS per
annum. In addition each of the above directors shall receive an amount of 3,000
NIS for each Board and/or Audit committee meeting attended. Mr. Izhak Nakar
receives compensation for his service as a member of the board of directors, in
the amount of 19,841 NIS per annum and 993 NIS for each Board and/or committee
meeting attended.  We reimburse all of
the directors for reasonable travel expenses incurred in connection with their
activities on our behalf.

Other than
Mr. Nakar and Mr. Ido Schechter, no director or other member of our
administrative, supervisory or management bodies has a service contract with us
or any of our subsidiaries providing for benefits upon termination of
employment. For additional information on Mr. Nakars arrangement, see the
section entitled Compensation in the section herein entitled Directors,
Senior Management and Employees.

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In addition
to the above, based on the resolution of the shareholders in a meeting held on
December 18, 2003 as further clarified in the shareholders extraordinary
meeting held on August 24, 2004, relating to a large-scale transaction between
us and Toyo Ink Mfg. Co. Ltd. (Japan), Mr. Nakar has become entitled to receive
a one time payment of $100,000 and, in addition, an annual fee of $100,000 as
consideration for consulting services to be provided one week per month for our
operation in Japan. At the conclusion of 6 months from the commencement of
operation of our new business, discussions shall be conducted regarding the
possibility of our paying Mr. Nakar a percentage of the income received by us
from the operations of the new business and, if so resolved at that time, what
percentage of such income shall be paid. In addition, should we require the
active involvement of Mr. Nakar with any other business of ours, then he shall
be paid a fee of $1,000, plus reimbursement of any expenses, for every business
day invested by him with regard to same. During 2004, we recorded on our books
an amount of $ 267,631 for Mr. Nakars services.

Independent Directors

The rules
of the NASDAQ Stock Market require that a majority of our directors be
independent as defined in Rule 4200(15) thereof. The board of directors has
determined that each of Zamir Bar Zion, William Landuyt, Elie Housman, Yehezkel
Yeshurun, Victor Halpert, and Thomas Lavey is an independent director for purposes
of the NASDAQ rules.

Audit
Committee; Remuneration Committee

The new
Israeli Companies Law (5759-1999), which became effective February 1, 2000,
requires that public companies appoint an audit committee. The responsibilities
of the audit committee include identifying irregularities in the management of
the companys business and approving related party transactions as required by
law. An audit committee must consist of at least three directors, including all
of the external directors of the Company. The chairman of the board of
directors, any director employed by or otherwise providing services to the
Company, and a controlling shareholder or any relative of a controlling
shareholder, may not be members of the audit committee. Our audit committee is
governed by an audit committee charter, which is an exhibit to our registration
statement on Form F-1 which became effective on March 1, 2005.

We are also
required by the rules of the NASDAQ Stock Market to establish an audit
committee, all of whose members are independent of management, and to adopt an
audit committee charter. Our two external directors, Victor Halpert and Zamir
Bar-Zion, serve on the audit committee of the board of directors, along with
Elie Housman.

In August
2004, the board of directors authorized the establishment of a Compensation
Committee. The current members of the Committee are Thomas C. Lavey (Chairman)
and William M. Landuyt. At the time of establishing the Committee, the board of
directors also adopted a Compensation Committee Charter to govern the operation
of the Committee. Notwithstanding the provisions of the Compensation Committee
Charter, the board of directors resolved to require the Committee to submit its
recommendations to the board of directors, which shall be solely authorized to
approve the recommendations of the Compensation Committee.

Employees

As of
December 31, 2004, we employed 48 full-time employees and one part time
employee in our headquarters. Five are employed in administration and three in
finance, seven in marketing and sales, and 33 in product development and
production. In addition, our North American subsidiary employs three full-time
persons and one half time person. Our German subsidiary employs 12 full-time
persons and one half-time person, and our United Kingdom subsidiary employs
nine full-time persons. Management believes that its relations with its
employees are good.

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

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Pursuant to
Israeli law, we are legally required, subject to certain exceptions, to pay
severance benefits upon the retirement or death of an employee or the
termination of employment of an employee without due cause. We satisfy the
majority of this obligation by contributing funds to a fund known as Managers
Insurance. This fund provides a combination of savings plans, insurance, and
severance pay benefits to the employee, giving the employee a lump sum payment
upon retirement and a severance payment, if legally entitled, upon termination
of employment. The remaining portion of this obligation is represented on our
balance sheet as Provision for severance pay. The Israeli law has recently
been amended to address some of the issues that were, in the past addressed
only by the collective bargaining agreements mentioned above, such as
procedures for dismissing employees, minimum wages and other issues.  In the event of contradiction between a
provision of the law and that of a collective bargaining agreement, the
principal for interpretation is that the provision which is more favorable to
the employee will prevail.

Share Ownership

Board
of Directors, Senior Management and Certain Employees

Mr. Izhak
Nakar currently holds in his name 84,174 ordinary shares. These shares
represent 1.0% (0.8% on a fully diluted basis) of our outstanding share
capital. In addition, Mr. Nakar and members of his immediate family own Nir 4
You Technologies Ltd., an Israeli company that holds 280,000 ordinary shares
amounting to 3.2% (2.5% on a fully diluted basis) of our outstanding share
capital. None of the ordinary shares discussed in this section have different
voting rights than those of other outstanding ordinary shares.

Charter
owns 2,000,000 ordinary shares representing 22.8% (17.9% on a fully diluted
basis) of our outstanding share capital.

Stock
Options

We have
reserved 115,000 ordinary shares for issuance upon exercise of outstanding
non-plan share options granted to certain executive officers and key employees
all of which have exercise prices of between $2.77 and $5.00 per share.
Pursuant to the terms of the option grant letters, of the options granted to
two employees, options to purchase 25% of the shares became exercisable upon
our initial public offering, and options to purchase 25% of the shares are to
become exercisable upon each of the first three anniversary dates of the
issuance of the options provided that the employees continue to be employed by
us on such dates. Of the options granted to these employees, options to
purchase 50,000 shares expired when the employees employment with us ended. Pursuant
to the terms of the option grant letters, the options granted to three other
employees were to become exercisable in four equal parts upon each of the first
four anniversary dates of the issuance of the options provided that the
employees continue to be employed by us on such dates. Of the options granted
to two of the said employees, options to purchase 12,250 shares expired when
their employment with us ended. In order to attract, retain and motivate
employees (including officers) who perform services for or on behalf of us, we
have three Employee Share Option Plans. The first was established in 1996, the
second during the year 2000 and the third was approved during 2003.

Employee
Share Option Plan (1996)

In
September 1996, the board of directors adopted, and our shareholders approved,
the Employee Share Option Plan (1996). ESOP 1996 authorizes the granting of
options to purchase up to 250,000 ordinary shares, consisting of options
intended to qualify as incentive stock options within the meaning of Section
422 of the United States Internal Revenue Code of 1986, as amended, and options
not intended to satisfy the requirements for incentive stock options. At
December 31, 2004, options to purchase 101,875 ordinary shares were outstanding
under the plan at exercise prices between $0.52 and $5.00 per share. All of the
outstanding options under the plan become exercisable in four equal parts upon
each of the first four anniversaries of the option grant dates. No exercises of
options took place during 2003. During 2004, 18,875 options had been exercised
and 23,125 had been forfeited through December 31, 2004.

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Options
granted under ESOP 1996 have terms of up to ten years, provided, however, that
options that are intended to qualify as incentive stock options and that are
granted to an employee who on the date of grant is a 10% shareholder of us or
any subsidiary corporation or parent corporation shall be for no more than a
five-year term. ordinary shares issuable upon the exercise of the options
granted under ESOP 1996 will be held in trust for the benefit of the optionee
for a period of at least two years after the grant of the options. The exercise
price of options granted under ESOP 1996 may not be less than 100% of the fair
market value of the ordinary shares on the date of the grant and the exercise
price of options granted under future employee share options shall not be less
than 85% of the fair market value of the ordinary shares on the date of grant,
in each case, as determined by the Board (or the Share Option Committee, if the
Board elects to appoint one). In the case of options that are intended to be
incentive stock options granted to an employee who, at the date of such grant,
is a 10% shareholder of us or any subsidiary corporation or parent corporation,
the exercise price for such options may not be less than 110% of the fair
market value of the ordinary shares on the date of such grant. The number of
shares covered by an option granted under ESOP 1996 is subject to adjustment
for stock splits, mergers, consolidations, reorganizations and
recapitalizations. Options are non-assignable except by will or by the laws of
descent and distribution, and may be exercised only so long as the optionee
continues to be employed by us. If the optionee dies, becomes disabled or
retires, the right to exercise the option will be determined by the Board (or
the Share Option Committee) in its sole discretion. The optionee is responsible
for all personal tax consequences of the grant and the exercise thereof. For so
long as we are not a U.S. taxpayer, we believe that, other than a 1% stamp tax,
no tax consequences will result to us in connection with the grant or exercise
of options pursuant to ESOP 1996.

Upon
termination of employment, other than for death or disability, grantees may
exercise vested options for three months following termination. ESOP 1996
contains similar provisions in relation to a grantee that becomes disabled or
dies, only in these cases, the vested options may be exercised for a period of
one year.

On February
28, 2000, we filed a registration statement on Form S-8 regarding ESOP
1996.

Upon
adoption of the Employee Share Option Plan (2003) all shares previously
available for grant under ESOP 1996 that were not the subject of outstanding
options, were transferred to such new plan (see below) and are subject to the
terms of the new plan.

Employee Share Option Plan (2000)

The
Employee Share Option Plan (2000) is designed to benefit from, and is made
pursuant to, the provisions of Section 102 of the Israeli Income Tax Ordinance
(New Version) 1961 and the rules promulgated thereunder (Section 102), as
applied prior to the implication of the tax reform in Israel, described
elsewhere herein.

ESOP 2000
is administered by a committee appointed by the board of directors or
alternatively the Board itself. The Committee has discretion as to when and to
whom and upon what terms to grant options under ESOP 2000. Options under the
plan may be granted to any officer or employee of us or of any of our
subsidiaries. The Committee will examine various factors when determining to
whom to grant options and upon what terms; however, these factors shall always
include the grantees salary and duration of employment with us or our
subsidiary.

The options
and/or shares issued upon exercise thereof shall be held in trust. The trustee
shall act in accordance with our instructions.

A total of
240,000 of authorized but unissued shares were reserved for issuance upon the
exercise of options granted pursuant to ESOP 2000 and, as of December 31, 2004,
options to purchase an aggregate of 143,500 shares were outstanding. All of the
granted options vest over a three-year period and have exercise prices between
$0.99 and $4.125 per share The number of shares covered by an option granted
under ESOP 2000 is subject to adjustment for stock splits, mergers,
consolidations, reorganizations and recapitalizations. During 2004, 5,000 options
were exercised and 9,500 had been forfeited through December 31, 2004.

Upon
termination of employment, other than for death or disability, grantees may
exercise vested options within three months of termination. Unvested options
may only be exercised with the consent of the Committee. If employment is
terminated by us due to the improper actions of the grantee, all options,
whether vested or not, are immediately forfeited. ESOP 2000 contains similar
provisions in relation to a grantee who becomes disabled or dies.

40

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On December
19, 2002, we filed a registration statement on Form S-8 regarding ESOP 2000.

Any tax
consequences that arise from the grant or exercise of any option are borne
solely by the grantee.

Upon
adoption of the Employee Share Option Plan (2003) all shares previously
available for grant under ESOP 2000 that were not the subject of outstanding
options, were transferred to such new plan (see below) and are subject to the
terms of the new plan.

Employee
Share Option Plan (2003)

An
additional stock option plan was approved by the board of directors on May 13,
2003 and by our shareholders at our annual meeting on December 18, 2003. All
the shares reserved for grant under ESOP 2000 and ESOP 1996 that were not
granted or that were not the
subject of outstanding options under those plans were transferred to the new
plan. Further, all options under such old plans that expire prior to their
exercise according to the conditions detailed therein will be transferred into
the new plan. We intend to file a registration statement on Form S-8 to
register these shares. We filed the necessary documents with the Israeli tax
authorities for the approval of the new option plan on June 4, 2003. Such
approval shall provide the grantees the eligibility for certain benefits under
Section 102 as revised by the Israeli tax reform.

As of
December 26, 2004, options to purchase an aggregate of 254,000 shares were
outstanding at exercise prices between $1.31 and $2.67 per share.  During 2004, 153,000 options were granted
and 15,000 had been forfeited through December 31, 2004.

The board
of directors and the shareholders of the Company approved the issuance of
options to purchase an additional 650,000 ordinary shares pursuant to ESOP
2003.

As of
December 31, 2004, options to purchase 685,917 ordinary shares were available
for future grant.

Issuance
of Options to Certain Persons

In November
2001, we issued to Izhak Nakar, our then CEO and Yehezkel Yeshurun, our former
Chief Scientist and a former director, options to each purchase 50,000 ordinary
shares in exchange for the minority interest held by them in our subsidiary,
e-Mobilis. For additional information, see the section herein entitled Related
Party Transactions.

At December
31, 2004, Mr. Yeshurun and Mr. Nakar had exercised all these options.

In November
2002, we issued to Thomas C. Lavey, our Chairman of the Board of directors, options
to acquire 20,000 ordinary shares at an exercise price of $0.46 per share.

|ITEM 7. | MAJOR
  SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
|------- | ---------------------------------------------------

As of
December 31, 2004, Charter held 2,000,000 ordinary shares, or 22.8% (17.9% on a
fully diluted basis) of our outstanding share capital. At that time, Izhak
Nakar held in his name 84,174 ordinary shares, or 1.0% (0.8% on a fully diluted
basis) of the outstanding share capital, and Nir 4 You Technologies Ltd., a
company owned by Mr. Nakar and his immediate family, held 280,000 ordinary
shares, or 3.2% (2.5% on a fully diluted basis) of our outstanding share
capital. Except as provided in the Share Purchase Agreement described below,
none of these shares have special voting rights attached to them.

Charter
acquired its ordinary shares in May 2000 in exchange for a $15,000,000
investment. Under the terms of the Share Purchase Agreement, the board of
directors appointed by the shareholders meeting to serve immediately following
the closing was comprised of seven members out of whom Charter designated four.
Charter obtained the right to demand registration of its shares on three
separate occasions, Charter was granted pre-emptive rights with respect to
future issuances of securities by us, and certain informational rights.
Charters right to appoint four of our seven directors was a one-time right
only. This right is not attached to the shares purchased by Charter and the
entire Board faces re-election at each annual general meeting. Currently, one
person nominated by Charter, William Landuyt, serves on the Board.

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In
connection with the investment by Charter, certain rights were granted to Mr.
Nakar, our then Chief Executive Officer. These included the modification of Mr.
Nakars compensation, as described in the section entitled Compensation in
the section herein entitled Directors, Senior Management and Employees., as
well as the granting to Mr. Nakar of the right to demand registration of any or
all of the shares held by him in the event that his employment was terminated
under certain specific conditions. These rights to demand registration have
come into effect following the termination of Mr. Nakars employment. The grant
of these rights was approved by our board of directors, Audit Committee and
shareholders. Charter and Mr. Nakar have requested the registration of the
resale of the ordinary shares held by them or their affiliates. We registered
the resale of those shares in our registration statement on Form F-1 which
became effective on March 1, 2005.

In
accordance with the foregoing and as a result of Mr. Nakars resignation from
employment, we recorded a non-recurring severance expense in our financial
statements in the amount of approximately $759,000 during prior years. During
2004, we recorded on our books an amount of $ 267,631 for Mr. Nakars
services.  For additional information,
see the section entitled Compensation in the section entitled Directors,
Senior Management and Employees herein, and Note 12 to the consolidated
financial statements included herein.

In January
2000, TiS, together with Izhak Nakar, our then CEO, and Yehezkel Yeshurun, our
former Chief Scientist and a former director, established e-Mobilis Ltd. as a
subsidiary of TiS. The shareholdings in e-Mobilis at that time were as follows:
TiS held 80.2%, Mr. Nakar held 9.9% and Mr. Yeshurun held 9.9%. In November
2001, we acquired from Mr. Nakar, and Mr. Yeshurun, their interests in
e-Mobilis. The acquisition was in consideration of the issuance to each of them
of immediately vested options to purchase 50,000 ordinary shares at an exercise
price of $2.00 per share. These options expire three years from the date they
were granted and were valued at $90,000 using the Black Scholes valuation model.
As of December 31, 2004, all these options were exercised.

Twenty
record holders of ordinary shares have declared postal addresses in the United
States. These twenty record holders hold, between them, 92% of our outstanding
share capital. There are no arrangements known to us that may at a subsequent
date result in a change in control of us.

42

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|ITEM 8. | FINANCIAL
  INFORMATION
|------- | -----------------------

Consolidated statements and other financial
information

| | Consolidated Financial Statements
| | ---------------------------------
| |                                  
| | See Item 18.                     
| |                                  
| | Other Financial Information      

The amount
of export revenues constitutes a significant portion of our total revenues. The
following is a  table giving details of
our export revenues, as well as the breakdown of revenues between products and
services.

|Export Revenues                |  |      |            |      |  |      |          
|------------------------------ |  | ---- | ---------- | ---- |  | ---- | ---------
|                               |  | 2004 |            | 2003 |  | 2002 |          
|                               |  |      |            |      |  |      |          
|Export
  Revenues              |  |      | 10,994,226 |      |  |      | 8,288,344
|                               |  |      |            |      |  |      |          
|Total
  Revenues               |  |      | 11,178,448 |      |  |      | 8,319,002
|                               |  |      |            |      |  |      |          
|Percentage
  of Total Revenues |  |      | 98         | %    |  |      | 99       
|                               |  |      |            |      |  |      |          
|Breakdown of Revenues          |  |      |            |      |  |      |          
|Product
  Revenues             |  |      | 62         | %    |  |      | 75       
|                               |  |      |            |      |  |      |          
|Service
  Revenues             |  |      | 38         | %    |  |      | 18       

Legal Proceedings

During
2003, we were named as a defendant in a case brought by a patent holder,
Millennium LP in the district court for the Southern District of New York. In
that case Millennium was asserting that certain image processing systems sold
or offered for sale by the Company in the U.S. infringe certain U.S. patents
held by Millennium. Subsequent to the reporting period, the Company has settled
the matter for $ 250,000, which will be paid as follows: $ 100,000 at the time
the settlement agreement was finalized and a monthly payment of $ 6,250 for 24
months. According to the settlement agreement, the abovementioned payment was
for the release for past and covenant for the future. The settlement gave the
Company a full release and discharge under the patents for all the companys
products sold by the company or its customers up to the date of the settlement
agreement and from then on until the last patent expires.

Dividend Policy

To date, we
have not paid any dividends on our ordinary shares.  The payment of dividends in the future, if any, is within the
discretion of the Board of Directors and will depend upon our earnings, our
capital requirements and financial condition and other relevant factors.  We do not anticipate declaring or paying any
dividend in the foreseeable future.

Significant
Changes

Recent $8 Million Private Placement

On
September 24, 2004, we sold 2,524,351 of our ordinary shares at a purchase
price of $3.16 per share to institutional investors for gross proceeds to us of
approximately $8 million.

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Pursuant to
our agreements with the investors, we are obligated to use the net proceeds
from the sale of our ordinary shares for working capital purposes and not (i)
for the satisfaction of any portion of our debt (other than payment of trade
payables and accrued expenses in the ordinary course of our business and
consistent with prior practices), (ii) to redeem any equity or
equity-equivalent securities in TiS, or (iii) to settle any outstanding
litigation. Accordingly, upon exercise of the warrants, we intend to use the
proceeds in accordance with the foregoing provision.

The
investors also received warrants to purchase up to an additional 1,262,188
ordinary shares, with an exercise price of $4.26 per share. The warrants expire
on September 23, 2007.  The investors
may only transfer the warrants to the investors affiliates, qualified
institutional buyers, or in the event of our dissolution or winding down. The
warrants contain a provision preventing a holder from exercising a warrant
where the exercise would result in such holder beneficially owning more than
4.999% of our outstanding ordinary shares. Accordingly, no selling shareholder
could be rendered a beneficial holder of more than 4.999% of our ordinary
shares solely because of shares issuable to such shareholder upon exercise of
such warrants held by the holder.

We have the
right, but not the obligation, to call upon prior notice all or part of the
warrants if the market price for our ordinary shares is equal to $8.52 for 20
consecutive days. Our calling the warrants would require the holders of the
warrants to timely exercise the warrants. Failure to so exercise would result
in our cancellation of the warrants. If we call any warrants, we must issue to
each holder exercising in response to our call notice replacement warrants to
purchase a number of shares equal to the number of shares acquired upon such
exercise, with an exercise price equal to 120% of the closing price on the day
prior to the call notice we provide to the holders.

Our
shareholders approved the transaction at a special shareholders meeting held on
August 24, 2004.

Pursuant to
our agreement with the investors, we are subject to restrictions with respect
to the sale of our ordinary shares or securities convertible into our equity.
Until March 1, 2006, before we are able to sell our securities, in most
instances we are required to first offer the securities to the investors
pursuant to terms set forth in our agreement with them. The foregoing terms and
right of first offer could delay our efforts to raise capital and increase
transaction costs and could limit our ability to obtain additional financing.

In connection with the private placement, we filed a resale registration
statement covering the shares purchased in the private placement (including the
shares underlying the warrants). The registration statement became effective on
March 1, 2005.  However, we did not
obtain effectiveness of the registration statement within the timeframe set
forth in our agreements with the investors, which has subjected us to
liquidated damages of approximately $160,000 (plus interest).  In addition, any future failure to maintain
effectiveness of the registration statement could subject us to additional
liquidated damages, including if we fail to file an amendment to the
registration statement within ten days of the Securities and Exchange
Commissions having notified us that an amendment is necessary for the
registration statement to continue to be effective, or if we fail to  maintain the listing of our ordinary shares
on the NASDAQ SmallCap Market.

In
accordance with prior agreements, we also registered the resale all of the
ordinary shares held by Charter, Izhak Nakar and their affiliates on the same
registration statement. We are required to maintain an effective registration
statement covering the resale of our ordinary shares sold to the investors and
the shares issuable upon exercise of the warrants issued to the investors until
the earlier of the date that all shares issued and issuable to the investors
and the holders of the warrants have been sold and the March 1, 2010.

In
connection with the transaction, Mr. Nakar and Charter agreed to vote in favor
of the private placement and to waive preemptive and participation rights.

Acquisition of Our Japanese Distributor

In
August 2004, the Company signed a definitive agreement with Toyo Ink Mfg. Co. Ltd.
(Toyo) which was, until then, the Companys distributor in Japan, to
acquire through its newly established Japanese subsidiary (TISJ), certain
assets comprising the Toyos business of distributing the Companys products in
Japan. The consideration for the acquisition amounted to $1,965,214 (including $465,214 in
transaction costs). In addition, the Company agreed to pay Toyo an annual amount
equivalent to five percent (5%) of the total annual sales of TISJ in Japan derived from
licensing and customization of software to customers transferred to TISJ by Toyo for two
years from the closing. The payment of the annual amount is contingent on the continuance
of service by certain employees that Toyo assigned to TISJ.

44

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Pursuant
to the agreement, Toyo transferred certain assets including intellectual rights, customers
and maintenance agreements from Toyo EDMS division to TISJ. TISJ also received the rights
to distribute the Japanese localized version of TISJ products. Certain employees from
Toyo professional team had been assigned to TISJ for a period of two years.

The results
of operations of the acquired business have been included in the financial
statements of the Company since the date of acquisition.

Allocation
of the consideration paid to purchase the business was as follows:

|Identifiable intangible assets |  | $ | 1,500,000 | 
|------------------------------ |  | - | --------- | 
|Goodwill                       |  |   | 465,214   | 
|                               |  |   |           | 
|                               |  |   |           | 
|Total assets
  acquired        |  | $ | 1,965,214 | 
|                               |  |   |           | 

The
following are the identifiable intangible assets acquired and the respective
periods over which the assets will be amortized on a straight-line basis:

|                     |  | Amount |           | Amortization
  
  period
  (in years) | 
|-------------------- |  | ------ | --------- | ------------------------------------- | 
|                     |  |        |           |                                       | 
|                     |  |        |           |                                       | 
|Technology           |  | $      | 750,000   |                                       | 
|Customer
  relations |  |        | 750,000   |                                       | 
|                     |  |        |           |                                       | 
|                     |  |        |           |                                       | 
|                     |  | $      | 1,500,000 |                                       | 
|                     |  |        |           |                                       | 

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|ITEM 9. | LISTING
|------- | -------

Stock price history

The annual
high and low market prices for the ordinary shares for the five most recent
full financial years are set forth below:

| | Year Ending       |  |  |    | *Boston
  Stock
  Exchange |  | NASDAQ
  Small Cap
  Market |      
| | ----------------- |  |  | -- | -------------------------- |  | --------------------------- | -----
| |                   |  |  |    |                            |  |                             |      
| | December 31, 2004 |  |  | Hi |                            |  |                             | 5.00 
| |                   |  |  | Lo |                            |  |                             | 2.13 
| |                   |  |  |    |                            |  |                             |      
| | December 31, 2003 |  |  | Hi |                            |  |                             | 3.140
| |                   |  |  | Lo |                            |  |                             | 0.420
| |                   |  |  |    |                            |  |                             |      
| | December 31, 2002 |  |  | Hi |                            |  |                             | 3.92 
| |                   |  |  | Lo |                            |  |                             | 0.42 
| |                   |  |  |    |                            |  |                             |      
| | December 31, 2001 |  |  | Hi |                            |  |                             | 4.04 
| |                   |  |  | Lo |                            |  |                             | 0.99 
| |                   |  |  |    |                            |  |                             |      
| | December 31, 2000 |  |  | Hi |                            |  |                             | 16.0 
| |                   |  |  | Lo |                            |  |                             | 1.875

The high
and low market prices for the ordinary shares for each financial quarter over
the two most recent full financial years and any subsequent period are set
forth below:

| | Quarter Ending     |  |    |  | * Boston
  Stock
  Exchange |      | NASDAQ
  SmallCap
  Market | 
| | ------------------ |  | -- |  | --------------------------- | ---- | -------------------------- | 
| |                    |  |    |  |                             |      |                            | 
| | December 31, 2004  |  | Hi |  |                             | 3.35 |                            | 
| |                    |  | Lo |  |                             | 2.72 |                            | 
| |                    |  |    |  |                             |      |                            | 
| | September 30, 2004 |  | Hi |  |                             | 3.23 |                            | 
| |                    |  | Lo |  |                             | 2.54 |                            | 
| |                    |  |    |  |                             |      |                            | 
| | June 30, 2004      |  | Hi |  |                             | 3.88 |                            | 
| |                    |  | Lo |  |                             | 3.14 |                            | 
| |                    |  |    |  |                             |      |                            | 
| | March 31, 2004     |  | Hi |  |                             | 4.44 |                            | 
| |                    |  | Lo |  |                             | 2.36 |                            | 
| |                    |  |    |  |                             |      |                            | 
| | December 31, 2003  |  | Hi |  |                             | 3.14 |                            | 
| |                    |  | Lo |  |                             | 1.90 |                            | 
| |                    |  |    |  |                             |      |                            | 
| | September 30, 2003 |  | Hi |  |                             | 2.20 |                            | 
| |                    |  | Lo |  |                             | 1.15 |                            | 
| |                    |  |    |  |                             |      |                            | 
| | June 30, 2003      |  | Hi |  |                             | 1.49 |                            | 
| |                    |  | Lo |  |                             | 0.61 |                            | 
| |                    |  |    |  |                             |      |                            | 
| | March 31, 2003     |  | Hi |  |                             | 0.77 |                            | 
| |                    |  | Lo |  |                             | 0.42 |                            | 
| |                    |  |    |  |                             |      |                            | 

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For the
most recent six months, the high and low market prices of the ordinary shares
for each month are set forth below:

| | Month
  Ending     |  |    |  | * Boston Stock
  Exchange |  | NASDAQ
  SmallCap
  Market |     
| | ------------------ |  | -- |  | ------------------------- |  | -------------------------- | ----
| |                    |  |    |  |                           |  |                            |     
| |                    |  |    |  |                           |  |                            |     
| | February 28, 2005  |  | Hi |  | 3.82                      |  |                            | 3.82
| |                    |  | Lo |  | 3.28                      |  |                            | 3.28
| |                    |  |    |  |                           |  |                            |     
| |                    |  |    |  |                           |  |                            |     
| | January 31, 2005   |  | Hi |  | 3.25                      |  |                            | 3.25
| |                    |  | Lo |  | 2.92                      |  |                            | 2.92
| |                    |  |    |  |                           |  |                            |     
| | December 31, 2004  |  | Hi |  | 3.05                      |  |                            | 3.05
| |                    |  | Lo |  | 2.13                      |  |                            | 2.13
| |                    |  |    |  |                           |  |                            |     
| | November 30, 2004  |  | Hi |  | 3.49                      |  |                            | 3.49
| |                    |  | Lo |  | 2.70                      |  |                            | 2.70
| |                    |  |    |  |                           |  |                            |     
| | October 31, 2004   |  | Hi |  | 3.31                      |  |                            | 3.31
| |                    |  | Lo |  | 2.71                      |  |                            | 2.71
| |                    |  |    |  |                           |  |                            |     
| | September 30, 2004 |  | Hi |  | 3.23                      |  |                            | 3.23
| |                    |  | Lo |  | 2.54                      |  |                            | 2.54
| |                    |  |    |  |                           |  |                            |     
| | August 31, 2004    |  | Hi |  | 2.89                      |  |                            | 2.89
| |                    |  | Lo |  | 2.13                      |  |                            | 2.13
| |                    |  |    |  |                           |  |                            |     
| | July 31, 2004      |  | Hi |  | 2.71                      |  |                            | 2.71
| |                    |  | Lo |  | 3.51                      |  |                            | 3.51

*  See the section entitled
Markets below. While still listed on the Boston Stock Exchange, there has
been no trading activity in the ordinary shares on that exchange since November
1999.

Markets

Effective
November 1996, the ordinary shares were quoted on the Nasdaq SmallCap Market,
under the symbol TISAF and listed on the Boston Stock Exchange, under the
symbol TPM.  Effective April 29, 1999,
the symbol for the ordinary shares was changed to TISA on the Nasdaq SmallCap
Market. The ordinary shares are not publicly traded outside the United States.

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Although we
are still listed on the Boston Stock Exchange, there has been no trading
activity in our ordinary shares on that exchange since November 1999.  In March of 2005, our board of directors
determined that we derive no material benefit from continued listing on the
Boston Stock Exchange and authorized and directed management to commence
voluntary delisting procedures. 
Accordingly, we have filed an application with the Securities and
Exchange Commission requesting approval of the delisting.

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|ITEM 10. | ADDITIONAL INFORMATION
|-------- | ----------------------

Memorandum and Articles of Association

General

TiS is
registered with the Israeli Registrar of Companies. The registration number
issued to TiS by the Registrar of Companies is 52-004294-6. The objectives for
which we were founded are set out in Section 2 of the Memorandum of Association
as follows: The Company is permitted to deal with any activity that is meant
to advance the interests of the Company and to act in any field which the
Companys management believes is beneficial to the Company. In our December
18, 2003 shareholders meeting, we adopted new Articles of Association to
provide for changes in the Companies Law.

Directors
and other Office Holders

General

A
directors ability to vote on a proposal, arrangement or contract in which the
director is materially interested is codified, along with the fiduciary duties
of all office holders, in the Israeli Companies Law. Under the Israeli
Companies Law, the term office holders, is defined to mean, a director, chief
executive officer, president, chief business manager, deputy chief executive
officer, vice chief executive officer, executive vice president, vice
president, another manager directly subordinate to the managing director or any
other person assuming the responsibilities of any of the forgoing positions
without regard to such persons title. An office holders fiduciary duties
consist of a duty of care and a duty of loyalty. The duty of care includes
avoiding negligent acts and acting skillfully as a reasonable office holder would
act. The duty of loyalty includes avoiding any conflict of interest between the
office holders position in the company and his personal affairs, avoiding any
competition with the company, avoiding exploiting any business opportunity of
the company in order to receive personal advantage for himself or others, and
revealing to the company any information or documents relating to the companys
affairs which the office holder has received due to his position as an office
holder of the company.

The Israeli
Companies Law requires that an office holder promptly disclose any personal
interest that he or she may have and all related material information known to
him or her, in connection with any existing or proposed transaction by the
company.

In the case
of a transaction in which an office holder has a personal interest, that is not
an extraordinary transaction, as defined under Israeli law, and after the
office holder complies with the above disclosure requirement, only board
approval is required unless our Articles of Association provide otherwise.
Members of the board having a personal interest should not be present at the
vote or exercise their vote unless a majority of the board has a personal
interest. The transaction must not be adverse to the companys interest. If
such transaction is an extraordinary transaction or if we intend to provide an
undertaking to indemnify, exempt or insure an office holder, with regard to
their duties, then, in addition to any approval required by the board of
directors or by the Articles of Association, it also must be approved by the
audit committee prior to the approval by the board of directors, and, under
specified circumstances, by a meeting of the shareholders. An office holder who
has a personal interest in the approval of a transaction brought before the
board of directors or the audit committee may not be present at this meeting or
vote on this matter unless most of the members have a personal interest in
approving the transaction or the occurrence of specific circumstances defined
in the law.

With the
exception of Fixed Amounts compensation to external directors, arrangements
regarding the compensation of directors of a public company (whether regarding
in their capacity as directors or regarding the provision of other services)
require audit committee, board of directors and shareholder approval.

External
Directors

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Under the
Israeli Companies Law which took effect on February 1, 2000, companies
registered under the laws of Israel whose shares have been offered to the
public in or outside of Israel are required to appoint two external directors.
Any committee having the power to act on behalf of a companys board (as
opposed to an advisory committee) must have at least one external director as a
member. All of the external directors must be members of the Audit Committee. An external director must be an
individual resident of Israel, who is qualified to serve as a director.
However, companies such as ours whose shares have been offered to the public
outside of Israel may appoint external directors who are not residents of
Israel according to special allowances provided in relevant regulations. No
person may be appointed as an external director if the person or the persons
relative, partner, employer or any entity under the persons control, has or
had, on or within the two years preceding the date of the persons appointment
to serve as external director, any affiliation with the company or any entity
controlling, controlled by or under common control with the company. The term
affiliation includes:

| |  | an
  employment relationship;                                           
| | - | ------------------------------------------------------------------------
| |   |                                                                         
| |  | a business
  or professional relationship maintained on a regular basis;
| |   |                                                                         
| |  | control; and                                                            
| |   |                                                                         
| |  | service as
  an office holder.                                          

No person
may serve as an external director if the persons position or other business
creates, or may create, a conflict of interest with the persons
responsibilities as an external director or may otherwise interfere with the
persons ability to serve as an external director. A director of one company
may not be appointed as an external director in another, if at the same time, a
director of the other company serves as an external director of the first.
Other limitations exist with regard to various types of memberships and
positions, whose holders may not serve as external directors. If, at the time
external directors are to be appointed, all current members of the board of
directors are of the same gender, then at least one external director must be
of the other gender.

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

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

The initial
term of an external director under the current law is three years and may be
extended for an additional term of three years. External directors may be
removed only by the same percentage of shareholders as is required for their
election, or by a court, and then only if the external directors cease to meet
the statutory qualifications for their appointment or if they violate their
duty of loyalty to the company.

Notwithstanding
the foregoing, Israeli companies whose shares have only been offered to the
public outside of Israel or that are registered solely on a stock market
outside of Israel are entitled to some allowances in accordance with applicable
regulations with respect to the requirements for an external director.
(Regulations for allowances for public companies whose shares are registered
for trade on a stock market external of Israel  2000.)

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

Alternate
Directors

Under the
Israeli Companies Law, the Articles of Association of a company may entitle a
director to appoint another person to serve as an alternate director. Our
Articles entitle our directors by written notice to us to make such an
appointment and to cancel any such appointment. Our Articles also provide that
any person may act as an alternate director. The Israeli Companies Law now
prohibits incumbent directors from acting as alternate directors and a single
person acting as an alternate director for more than one incumbent director.

The term of
appointment of a substitute director may be for one meeting of the board of
directors or for a specified period or until notice is given of the
cancellation of the appointment. To our knowledge, no director currently
intends to appoint any other person as a substitute director, except if the
director is unable to attend a meeting of the board of directors.

Internal
Auditor and Certified Public Accountant

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Under the
Israeli Companies Law, the board of directors must appoint an internal auditor,
nominated by the audit committee. The role of the internal auditor is to
examine, among other matters, whether the companys actions comply with the law
and orderly business procedure. Under the Israeli Companies Law, the internal
auditor may be an employee of the company but not an office holder (as defined
above), or an affiliate, or a relative of an office holder or affiliate, and he
may not be the companys independent accountant or its representative. In
addition, the internal auditor may not be a person who holds 5% or more of the
companys outstanding share capital or voting rights, or a person who has the
right to appoint one or more directors or the general manager. The Companys
internal auditor is Mr. Eyal Weitzman of Fahn Kanne Control Management Ltd., a
member firm of Grant Thornton International.

In
addition, under the Israeli Companies Law, all companies must appoint a
certified public accountant to audit the companys financial statements and to
report to the chairman of the board of directors any material improprieties
that it may discover with respect to the accounting control of the company. In
our last shareholders meeting, on December 21, 2004, we appointed Kost Forrer
Gabbay and Kasierer, a member firm of Ernst & Young Global and certified
public accountants in Israel, as our certified public accountant for auditing
services.

Indemnification
of Directors and Officers

The Israeli
Companies Law provides that an Israeli company cannot exempt an officer from
liability with respect to a breach of his fiduciary responsibilities. While the
Companies Ordinance, in effect through 1999, provided that an Israeli company
could not exempt an officer from liability with respect to a breach of his duty
of care or his duty of loyalty, the Israeli Companies Law now permits such
exemption if formulated in accordance with such law. The Israeli Companies Law
also permits entitling an office holder to indemnification subject to certain
conditions. At the shareholders meeting on December 18, 2003, the Company
adopted new Articles of Association which allow for insurance and
indemnification for office holders for future liabilities. At the same meeting,
the shareholders approved indemnification of the officers and directors of the
Company, in the form described herein.

The
procurement of director and officer liability insurance or the provision of any
such indemnification, as the case may be, must be approved by our Audit
Committee and otherwise as required by law. We may not indemnify an office
holder or enter into an insurance contract which would provide coverage for any
monetary liability incurred as a result of the following: (i) a breach by the
office holder of his duty of care if such breach was done intentionally or in
disregard of the circumstances of the breach of its consequences; (ii) a breach
by the office holder of his duty of loyalty unless he acted in good faith and
had a reasonable basis to believe that his act or omission would not prejudice
our interests; (iii) any act or omission done with the intent to derive an
illegal personal benefit; or (iv) any fine levied against the office holder as
a result of a criminal offense.

Currently, we
hold an insurance policy for our office holders that provides coverage limited
to $10,000,000 in aggregate for the policy period, ending on December 31, 2004,
and was renewed until December 31, 2005.

Rights,
Preferences, Restrictions of Shares

We
currently utilize one type of share, this being ordinary shares. Subject to
Israeli law, dividends may be declared at a general meeting, following a
recommendation by the directors. We may decide to declare a dividend in an
amount that is less than that recommended by the directors or decide not to
declare a dividend at all, despite a directors recommendation, but may not
increase the amount of the dividend to more than the amount recommended by the
directors. The directors may invest or use otherwise for our benefit, any
dividends that are not demanded within one year of their being declared. The
directors shall pay such dividends upon receipt of a valid demand; however we
are not liable to pay any interest on dividends.

Each shareholder
is entitled to one vote for each ordinary share held. Except for the external
directors, each director is elected to serve until the next annual general
meeting of shareholders and until his successor has been elected. Our Articles
do not grant shareholders any rights to share in our profits other than through
dividends. In the event that we go into liquidation, any surplus is distributed
to the shareholders in proportion to the amount paid by each on account of the
nominal value of the shares paid. No account is taken of any premiums paid in
excess of the nominal value.

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We may
issue and redeem redeemable shares and redeemable warrants. There are no
sinking fund provisions recorded in our Articles. The directors may only make
calls upon shareholders in respect of sums unpaid on their shares. Our Articles
contain no provisions which discriminate against any existing or future
shareholder as a result of said shareholder holding a substantial number of
shares.

If at any
time our share capital is divided into different classes of shares, we may
change the rights of shareholders following receipt in writing of the agreement
of 75% of the affected shareholders or following the passing of a resolution at
a general meeting which is supported by 75% of the affected shareholders. Any
holder of shares the rights of which we propose to change may demand a secret
ballot on this issue.

Meetings
of Shareholders

An annual
general meeting must be held once in each year and not later than fifteen
months after the preceding annual general meeting. All shareholders are
entitled to attend and vote or vote by proxy at annual general meetings. Notice
of annual general meetings may be sent by us by personal delivery, post, facsimile
or telex to shareholders at the address recorded in our records. Any notice
sent by post to a shareholders address that is situated outside of Israel must
be sent by airmail. Any general meeting that is not an annual general meeting
is called an extraordinary general meeting. All shareholders are entitled to
attend and vote or vote by proxy at extraordinary general meetings.

Our board
of directors may convene an extraordinary general meeting when and as it sees
fit. In addition the Board must, according to statute, convene an extraordinary
general meeting if it receives a demand to do so from either (i) at least two
directors, (ii) at least one quarter of the directors of the Board or (iii) one
or more shareholders who hold (A) an aggregate of at least five percent of our
issued share capital and one percent of all voting rights, or (B) at least five
percent of all voting rights. Any demand by a person or persons, as described
in (i), (ii) and/or (iii) of this paragraph, who wish to demand that an
extraordinary general meeting be convened must be made in writing and sent to
our registered office. The demand must detail the objects of the meeting and
must be signed by all those making the demand.

Notice of
an annual general meeting and of an extraordinary general meeting must be sent
at least 21 days in advance to all shareholders recorded in our register of
shareholders. Such notice must include the place, date and hour of the meeting,
the agenda for the meeting, the proposed resolutions and instructions for proxy
voting.

Notwithstanding
the foregoing, Israeli companies whose shares have only been offered to the
public outside of Israel or that are registered solely on a stock market
outside of Israel are entitled to some allowances in accordance with applicable
regulations with respect to the requirements for notice of shareholder meetings
if there is compliance with applicable rules of the country in which such
shares have been offered or such a stock market is located.

Limitations
of Shareholders

No
limitations exist or are imposed by Israeli law or our constituent documents
with regard to the right to own our shares, including any limitations upon the
rights of non-resident or foreign shareholders to hold or exercise voting
rights.

Limitations
on a Change of Control

There are
no provisions in our Articles or other constituent documents other than as
required by law that would have an effect of delaying, deferring or preventing
a change in control of us. The holders of the warrants to be issued in
connection with the private placement which is described under the heading
Liquidity and Capital Resources have certain rights upon certain types of
transactions that could make consummating such a transaction more expensive.

Provisions Relating to Major Shareholders

We are
required by law to maintain a separate register of shareholders that hold five
percent, or over five percent, of either our issued shares or voting rights.

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The Israeli
Companies Law applies the same disclosure requirements to a controlling
shareholder of a public company, which includes a shareholder that holds 25% or
more of the voting rights if no other shareholder owns more than 50% of the
voting rights in the company, as it does to office holders in the context of
a related party transaction. For the purposes of this definition, the law deems
two or more shareholders who hold voting rights in the company and each of
which has a personal interest in the approval of a transaction being brought to
the company for approval, as jointly holding such shares. See the section
entitled Directors-General in this report. Extraordinary transactions with a
controlling shareholder or in which a controlling shareholder has a personal
interest, and agreements relating to employment and compensation terms of a
controlling shareholder, require the approval of the audit committee, the board
of directors and the shareholders of the company.

The
shareholder approval must either include at least one-third of the shares held
by disinterested shareholders who are present, in person or by proxy, at the
meeting, or, alternatively, the total shareholdings of the disinterested
shareholders who vote against the transaction must not represent more than one
percent of the voting rights in the company. In addition, a private placement
of securities that will increase the relative holdings of a shareholder that
holds five percent or more of the companys outstanding share capital, assuming
the exercise of all of the securities convertible into shares held by that
person, or that will cause any person to become, as a result of the issuance, a
holder of more than five percent of the companys outstanding share capital,
requires approval by the board of directors and the shareholder of the company.
A private placement in which our securities are traded only in a foreign market
entitles us to certain allowances as to the approvals necessary for such placement.

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

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

In
addition, any controlling shareholder who can determine the outcome of a
shareholder vote and any shareholder who, under a companys Articles of
Association, can appoint or prevent the appointment of an office holder, is
under a duty to act with fairness towards the company. The Israeli Companies
Law does not describe the substance of this duty.

Contracts

Neither we
nor any of our subsidiaries has entered into any material contracts, other than
contracts entered into in the ordinary course of business, during the two years
immediately preceding publication of this document excepting the agreements
relating to the investment of Charter and the related arrangements with Mr.
Nakar. See the sections entitled Major Shareholders and Related Party
Transactions and Compensation in the section entitled Directors, Senior
Management and Employees in this report

Israeli Exchange Control Laws

The
Government of Israel has promulgated a general permit under the Israeli
Currency Control Law. Pursuant to such general permit, substantially all
transactions in foreign currency are permitted. Any dividends or other
distributions paid in respect of ordinary shares and any amounts payable upon
our dissolution, liquidation or winding up of our affairs, as well as the
proceeds of any sale in Israel of our securities to an Israeli resident are
freely exchangeable into non-Israeli currencies at the appropriate rate of
exchange prevailing at the time of conversion, provided that Israeli income tax
has been paid on (or withheld from) such payments. Because exchange rates
between the NIS and the U.S. dollar fluctuate continuously, U.S. shareholders
will be subject to any such currency fluctuation during the period from when
such dividend is declared through the date payment is made in U.S.
dollars.

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Taxation

Israeli Tax Considerations

The
following is a summary of the current tax law applicable to companies in
Israel, with special reference to its effect on us. The following also contains
a discussion of specified Israeli Government programs benefiting us. To the
extent that the discussion is based on tax legislation that has not been
subject to judicial or administrative interpretation, we cannot assure you that
the views expressed in the discussion will be accepted by the authorities in
question.

The Law for
Amendment of the Income Tax Ordinance (Amendment No. 132) came into effect on
January 1, 2003. The reform significantly changed the taxation basis of
corporate and individual taxpayers from a territorial basis to a worldwide
basis. From such date an Israeli resident taxpayer will be taxed on income
produced and derived both in and out of Israel.

The tax
reform, aimed at broadening the categories of taxable income and reducing the
tax rates imposed on employment income, introduced the following, among other
things:

| |  | Reduction of
  the tax rate levied on capital gains (other than gains deriving from the sale
  of listed securities) derived after January 1, 2003, to a general rate of 25%
  for both individuals and corporations. Regarding assets acquired prior to
  January 1, 2003, the reduced tax rate will apply to a proportionate part of
  the gain, in accordance with the holding periods of the asset, before or
  after January 1, 2003, on a linear basis;                                                                                                                                                                 
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |  | Imposition
  of Israeli tax on all income of Israeli residents, individuals and
  corporations, regardless of the territorial source of income, including
  income derived from passive sources such as interest, dividends and
  royalties;                                                                                                                                                                                                                                                                                                                                                                                  
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |  | Introduction
  of controlled foreign corporation, or CFC, rules into the Israeli tax
  structure. Generally, under such rules, an Israeli resident who holds,
  directly or indirectly, 10% or more of the rights in a foreign corporation
  whose shares are not publicly traded, in which more than 50% of the rights
  are held directly or indirectly by Israeli residents, and a majority of whose
  income in a tax year is considered passive income, will be liable for tax on
  the portion of such income attributed to his holdings in such corporation, as
  if such income were distributed to him as a dividend;
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |  | Imposition
  of capital gains tax on capital gains realized by individuals as of January
  1, 2003, from the sale of shares of publicly traded companies (such gain was
  previously exempt from capital gains tax in Israel). For information with
  respect to the applicability of Israeli capital gains taxes on the sale of
  ordinary shares, see Capital Gains Tax below;                                                                                                                                                                                                                                            
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |  | Introduction
  of a new regime for the taxation of shares and options issued to employees
  and officers (including directors).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               

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.

The Israeli
statutory corporate tax rate on taxable business income until the fiscal year
of 2003 was 36%. On June 29, 2004, the Israeli Parliament passed the Amendment
to the Income Tax Ordinance (No. 140 and Temporary Provision), which
progressively reduces the tax rates applicable to companies from 35% in 2004 to
a rate of 30% in 2007. Notwithstanding the foregoing, the effective tax rate
payable by a company (such as us), which derives income from an Approved
Enterprise may be considerably less. See the section entitled Law for the
Encouragement of Capital Investments, 1959 in this report.

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As of
December 31, 2004, we had net operating loss carryforwards of approximately
$12,125,097, available to utilize against our taxable business income in future
tax years. A portion of such losses expires over a period from 2005 through
2017 and the rest remains available indefinitely.

Law for the Encouragement of Capital Investments, 1959

General

The Law for
the Encouragement of Capital Investments, 1959 (the Investment Law) provides
that capital investments in certain production facilities (or other eligible
assets) may, upon application to the Israel Investment Center, be designated as
an Approved Enterprise. Each certificate of approval for an Approved
Enterprise relates to a specific investment program in the Approved Enterprise,
delineated both by the financial scope of the investment and by the physical characteristics
of the facility or other asset.

Tax
Benefits

Income
derived from an Approved Enterprise is taxed at lower company tax rates than
would otherwise be applicable. The period of reduced taxation commences in the
first year in which the Approved Enterprise generates taxable income and
continues for a maximum of seven consecutive years, but such period ends not
later than the twelfth year from commencement of production or the fourteenth
year from the date of approval of such enterprise, whichever is earlier. Since
we have not yet generated taxable income, the period of benefits to which we
are entitled as an Approved Enterprise has not yet begun.

We have
elected to apply the so-called Alternative Benefits Program with respect to
our income from Approved Enterprises. Under this program, the undistributed
income derived from the Approved Enterprise is exempt from company tax with
respect to business income for a defined period of time. The period of tax
exemption ranges between 2 and 10 years, depending upon the location within
Israel and the type of the Approved Enterprise. Because we are located in Tel
Aviv, the period of tax exemption applicable is two years. On expiration of the
exemption period, the Approved Enterprise would be eligible for beneficial tax
rates otherwise available for Approved Enterprises under the Investment Law
for the remainder of the otherwise applicable
benefits period.

In
addition, a company that qualifies as a Foreign Investors Company is
entitled to further reductions in the tax rate otherwise applicable to Approved
Enterprises. Subject to certain conditions, a Foreign
Investors Company is a company, which has more than 25% of its share capital
(in terms of rights to profits, voting and the appointment of directors) and of
its combined share and loan capital owned by persons who are not residents of
Israel. The benefits enjoyed by a Foreign Investors Company depend on the
percentage of share capital owned by non-residents, which percentage is
determined for any tax year by the lowest percentage of any of the above rights
held by non-residents during that year. A Foreign Investors Company pays tax
at reduced rates ranging from 25% to 10% over a ten-year period, commencing the
year in which each such Approved Enterprise first generates taxable income
(rather than the otherwise applicable seven-year period discussed above).  As of December 31, 2004, we qualified as a Foreign Investors Company.

For a
company with foreign investment of:

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

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Dividends
paid out of income derived by an Approved Enterprise are generally subject to
withholding tax at the rate of 15% (compared to the standard rate of 25%), and
the same rate will also be applicable to distributions made by a company out of
dividends which it had received out of income derived by an Approved
Enterprise. The rate of 15% is limited to those dividends and distributions
paid out of income earned during the seven-year benefits period provided that
such dividends and distributions are actually received by the shareholders at
any time up to 12 years after the expiration of the seven-year period discussed
above. A company such as us, which has elected to participate in the
Alternative Benefits Program and pays a dividend from income derived by an
Approved Enterprise during the tax exemption period under the Alternative
Benefits Program, would be liable for company tax in respect of the gross
amount distributed (i.e., the amount of the dividend grossed-up to include
corporate and income tax payable or withheld with respect to the dividend) at
the rate that would have been applicable had the Alternative Benefits Program
not been elected (25%).  The tax rate on dividends distributed by the Company to foreign residents may be reduced according to the tax rate of the tax
treaty between Israel and the country in which such individuals reside.

The tax
benefits derived from a certificate of approval for an Approved Enterprise
relate only to taxable income attributable to the Approved Enterprise and are
conditioned upon fulfillment of the conditions stipulated by the Investment
Law, the regulations promulgated thereunder and the criteria set forth in the
certificate of approval. In the event of our failure to comply with these
conditions, the tax benefits could be cancelled in whole or in part, and we
would be required to refund the amount of the cancelled benefits with the
addition of CPI linkage differences and interest. We believe that our Approved
Enterprises operate in substantial compliance with all such conditions and
criteria.

In the
event that only a part of a companys taxable income is derived from an
Approved Enterprise or the company operates under more than one approval, its
effective corporate tax rate is equal to a weighted average of the various
applicable rates. A company owning mixed enterprises (i.e., a company whose
income is derived from both an Approved Enterprise and other sources) may not
distribute a dividend attributable only to the Approved Enterprise alone.
Subject to certain provisions concerning income subject to the Alternative
Benefits Program, all dividends are considered to be attributable to the entire
enterprise, and the effective tax rate is equal to a weighted combination of
the various applicable tax rates. We anticipate that the Law for the
Encouragement of Capital Investments will be subject to substantial revision
during 2005.

On December
19, 2004, the Israeli government extended the term of the legislation pursuant
to which the Ministry of Industry and Trade administers the Approved Enterprise
programs for an additional three months. Unless extended again, future
entitlements to the benefits under the statute shall expire on March 31, 2005.
The government has extended the term of the legislation on previous occasions
for three-month periods. Termination of the entitlement may affect our ability
to make effective use of the benefits to which we are or may become entitled to
as a result of our Approved Enterprise status. In the event that the term of
the statute is extended beyond March 31, 2005, we anticipate that the statute
will be substantially amended. An amendment could affect our eligibility for
benefits.

Law for the Encouragement of Industry (Taxes),
1969

We
currently qualify as an Industrial Company within the definition of the Law
for the Encouragement of Industry (Taxes), 1969 and are, therefore, entitled to
certain benefits, which are described below.

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Under the
Industry Encouragement Law, a company qualifies as an Industrial Company if
it is resident in Israel and at least 90% of its income in any tax year,
determined in NIS (exclusive of income from government compulsory defense
loans, capital gains, interest, and dividends), is derived from Industrial
Enterprises owned by  that company. An Industrial Enterprise is defined as an enterprise
whose major activity in a particular tax year is industrial production
activity. Pursuant to the Industry Encouragement Law, an Industrial Company is
entitled, under certain conditions, to an annual deduction of 12.5% of the purchase
price of patents or certain other intangible property rights for each of the
first eight years from the tax year in which it commenced use of such
intangible property rights.

Eligibility
for the benefits under the Industry Encouragement Law is not conditioned upon
the receipt of prior approval from any Israeli Government authority. No
assurance can be given that we will continue to qualify as an Industrial
Company or will in the future be able to avail ourselves of any benefits under
the Industry Encouragement Law.

Taxation under Inflationary Conditions and Dollar Regulations

Under the
Income Tax (Inflationary Adjustments) Law, 1985 (the Israeli law), results
for tax purposes in Israel are measured in real terms, in accordance with the
changes in the Israeli Consumer Price Index (Israeli CPI). Accordingly, until
2002, results for tax purposes were measured in terms of earnings in NIS after
certain adjustments for increases in the Israeli CPI. Commencing in taxable
year 2003, the Company has elected to measure its taxable income and file its
tax return under the Israeli Income Tax Regulations (Principles Regarding the
Management of Books of Account of Foreign Invested Companies and Certain
Partnerships and the Determination of Their Taxable Income), 1986. Such an
elective obligates the Company for three years. Accordingly, commencing taxable
year 2003, results for tax purposes are measured in terms of earnings in
dollar.

Tax Benefits and Government Support for Research and
Development

Israels
tax law permits, under certain circumstances, a tax deduction for expenditures
(including capital expenditures) in scientific research and development
projects in the year incurred, if the expenditures are approved by the relevant
Israeli Government Ministry (determined by the field of research) and the
research and development is for the promotion of the enterprise and is carried
out by or on behalf of the company seeking such deduction. Expenditures not so
approved are deductible over a three-year period. We have taken such deductions
in the past for research and development costs expended on projects so approved
and expect to continue to have such deductions available to it in the
future.

Capital Gains Tax

Israeli law
generally imposes a capital gains tax on the sale of capital assets located in
Israel, including shares in Israeli companies, by both residents and
non-residents of Israel, unless a specific exemption is available or unless a
tax treaty between Israel and the shareholders country of residence provides
otherwise. The law distinguishes between real gain and inflationary surplus.
The inflationary surplus is equal to the increase in the purchase price of the relevant asset attributable solely to the
increase in the Israeli consumer price index 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.

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Prior to
the tax reform, sales of our ordinary shares by individuals were generally
exempt from Israeli capital gains tax so long as (i) our ordinary shares were
listed on certain stock exchanges, including the NASDAQ SmallCap Market and the
Boston Stock Exchange, or listed on a stock exchange in a country appearing on
a list approved by the Controller of Foreign Currency and (ii) we qualified as
an Industrial Company.

Pursuant to
the tax reform, generally, capital gains tax is imposed at a rate of 15% on
real gains derived on or after January 1, 2003, from the sale of shares in
companies (i) publicly traded on the Tel Aviv Stock Exchange (TASE); or (ii)
(subject to a necessary determination by the Israeli Minister of Finance)
Israeli companies publicly traded on a recognized stock exchange outside of
Israel (such as the company). This tax rate does not apply to: (i) dealers in
securities; (ii) shareholders that report in accordance with the Inflationary
Adjustment Law; or (iii) shareholders who acquired their shares prior to an
initial public offering (that are subject to a different tax arrangement). The
tax basis of shares acquired prior to January 1, 2003 will be determined in
accordance with the average closing share price in the three trading days
preceding January 1, 2003. However, a request may be made to the tax
authorities to consider the actual adjusted cost of the shares as the tax basis
if it is higher than such average price.

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

In any
event, the provisions of the tax reform shall not affect the exemption from
capital gains tax for gains accrued before January 1, 2003, as described
above.

Taxation of Non-Residents of Israel

Individuals
who are non-residents of Israel are subject to a graduated income tax on income
derived from sources in Israel, unless such non-residents are subject to other
rules under an applicable treaty and unless the capital gains were derived from
sales of shares in an Industrial Company, as described above. On the distribution of dividends other than bonus
shares (stock dividends), income tax at the rate of 25% (15% in the case of dividends
distributed from the taxable income attributable to an Approved Enterprise) is
required to be withheld at source unless a different rate is provided for in a
treaty between Israel and the shareholders country of residence. The
U.S.-Israel Tax Treaty provides for a maximum tax of 25% on dividends paid to a
Treaty U.S. Resident.

United States Federal Income Tax
Considerations

Subject to
the limitations described in the next paragraph, the following discussion
describes the material United States federal income tax consequences to a
holder of the companys ordinary shares, referred to for purposes of this
discussion as a U.S. Holder, that is:

| |  | citizen or
  resident of the United States;                                                                                                                                   
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                               
| |  | corporation
  (or entity treated as a corporation for U.S. tax purposes) created or
  organized in the United States or under the laws of the United States or of
  any state;

58

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| |  | an estate,
  the income of which is includible in gross income for United States federal
  income tax purposes regardless of its source; or                                                                                       
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                                                                   
| |  | a trust, if
  a court within the United States is able to exercise primary supervision over
  the administration of the trust and one or more U.S. persons have the
  authority to control all substantial decisions of the trust.

In
addition, certain material aspects of United States federal income tax relevant
to a holder other than a U.S. Holder, referred to as a Non-U.S. Holder, are
discussed below.

This
summary is for general information purposes only. It does not purport to be a
comprehensive description of all of the tax considerations that may be relevant
to each persons decision to purchase ordinary shares.

This
discussion is based on current provisions of the Internal Revenue Code of 1986,
as amended (the Code), current and proposed Treasury regulations promulgated
thereunder, and administrative and judicial decisions as of the date hereof,
all of which are subject to change, possibly on a retroactive basis. This
discussion does not address all aspects of United States federal income
taxation that may be relevant to any particular shareholder based on such
shareholders individual circumstances. In particular, this discussion
considers only U.S. Holders that will own ordinary shares as capital assets and
does not address the potential application of the alternative minimum tax or
United States federal income tax consequences to U.S. Holders that are subject
to special treatment, including U.S. Holders that:

| |  | are
  broker-dealers or insurance companies;                                                               
| | - | -----------------------------------------------------------------------------------------------------------
| |   |                                                                                                            
| |  | have elected
  mark-to-marketing accounting;                                                               
| |   |                                                                                                            
| |  | are
  tax-exempt organizations;                                                                            
| |   |                                                                                                            
| |  | are
  financial institutions or financial services entities;                                             
| |   |                                                                                                            
| |  | hold
  ordinary shares as part of a straddle, hedge or conversion transaction
  with other investments;
| |   |                                                                                                            
| |  | own
  directly, indirectly or by attribution at least 10% of our voting power; or                          
| |   |                                                                                                            
| |  | have a
  functional currency that is not the U.S. dollar.                                                  

In
addition, this discussion does not address any aspect of state, local or
non-United States tax laws.

Additionally,
the discussion does not consider the tax treatment of persons who hold ordinary
shares through a partnership or other pass-through entity or the possible
application of United States federal gift or estate tax.

Each holder
of ordinary shares is advised to consult such persons own tax advisor with
respect to the specific tax consequences to such person of purchasing, holding
or disposing of the companys ordinary shares.

Taxation of ordinary shares

Taxation
of Dividends Paid On Ordinary Shares

A U.S.
Holder will be required to include in gross income as ordinary income the
amount of any distribution paid on ordinary shares, including any Israeli taxes
withheld from the amount paid, to the extent the distribution is paid out of
our current or accumulated earnings and profits as determined for United States
federal income tax purposes. Distributions in excess of such earnings and profits
will be applied against and will reduce the U.S. Holders tax basis in the
ordinary shares and, to the extent in excess of such basis, will be treated as
gain from the sale or exchange of ordinary shares.

59

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A
non-corporate U.S. Holder that meets certain eligibility requirements may
qualify for a 15% or lower rate of U.S. federal income taxation on dividends
paid in taxable years beginning before January 1, 2009 if the Company is a
qualified foreign corporation for U.S. federal income tax purposes. The
Company generally will be treated as a qualified foreign corporation if (i)
the Company is eligible for benefits under the income tax treaty between the
United States and Israel (the Treaty), or (ii) the ordinary shares are listed
on an established securities market in the United States. Because the Company
should be eligible for benefits under the Treaty, the Company should currently
be treated as a qualified foreign corporation, and the Company generally
expects to be a qualified foreign corporation during all taxable years before
2009. However, no assurance can be given that a change in circumstances will
not affect the Companys treatment as a qualified foreign corporation for U.S.
federal income tax purposes in any taxable year. In addition, a non-corporation
U.S. Holder will not be eligible for the reduced rate (a) if such U.S. Holder
has not held the ordinary shares for at least 61 days of the 120-day period
beginning on the date which is 60 days before the ex-dividend rate, (b) to the
extent the U.S. Holder is under an obligation to make related payments on
substantially similar or related property, or (c) with respect to any portion
of a dividend that is taken into account by the U.S. Holder as investment
income under Section 163(d)(4)(B) of the Code. Any days during which the U.S.
Holder has diminished its risk of loss with respect to the ordinary shares (for
example, by holding an option to sell the ordinary shares), are not counted
towards meeting the 61-day holding period. Non-corporate U.S. Holders should
consult their own tax advisors concerning whether dividends received by them
qualify for the reduced rate of tax.

U.S.
Holders will include in their gross income any dividend paid in NIS in an
amount equal to the U.S. dollar value of the NIS received, calculated by
reference to the exchange rate in effect on the date the dividends are
received, regardless of whether the dividend payments are actually converted
into U.S. dollars. U.S. Holders will have a tax basis in any NIS distributed by
the Company equal to the U.S. dollar value of the NIS on the date of receipt.
Generally, any gain or loss resulting from exchange rate fluctuations during
the period from the date the U.S. Holder includes the dividend payment in income
to the date the payment is converted into U.S. dollars will be treated as
ordinary income or loss and will be U.S. source income or loss for U.S. foreign
tax credit purposes.

U.S.
Holders may have the option of claiming the amount of any Israeli income taxes
withheld at source either as a deduction from gross income or as a
dollar-for-dollar credit against their United States federal income tax
liability. Individuals who do not claim itemized deductions, but instead
utilize the standard deduction, may not claim a deduction for the amount of the
Israeli income taxes withheld, but such amount may be claimed as a credit
against the individuals United States federal income tax liability. The amount
of foreign income taxes which may be claimed as a credit in any year is subject
to complex limitations and restrictions, which must be determined on an
individual basis by each shareholder. Distributions of current or accumulated
earnings and profits will be foreign source passive income for United States
foreign tax credit purposes and will not qualify for the dividends received
deduction available to corporations. The total amount of allowable foreign tax
credits in any year cannot exceed regular U.S. tax liability for the year
attributable to foreign source taxable income. A U.S. Holder will be denied a
foreign tax credit with respect to Israeli income tax withheld from dividends
received on the ordinary shares to the extent such U.S. Holder has not held the
ordinary shares for at least 16 days of the 30-day period beginning on the date
which is 15 days before the ex-dividend date or to the extent such U.S. Holder
is under an obligation to make related payments with respect to substantially
similar or related property. Any days during which a U.S. Holder has
substantially diminished its risk of loss on the ordinary shares are not
counted toward meeting the 16-day holding period required by the statute.

Taxation
of the Disposition of Ordinary Shares

Upon the
sale, exchange or other disposition of ordinary shares, a U.S. Holder will
recognize capital gain or loss in an amount equal to the difference between
such U.S. Holders basis in the ordinary shares, which is usually the cost of
such shares, and the amount realized on the disposition. Capital gain from the
sale, exchange or other disposition of ordinary shares held more than one year
is long-term capital gain. Gains and losses recognized by a U.S. Holder on a
sale, exchange or other disposition of ordinary shares will be treated as
United States source

60

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income or loss for United States foreign tax credit purposes. The
deductibility of capital losses is subject to limitations.

Tax
Consequences if the Company is a Passive Foreign Investment Company

The Company
will be a passive foreign investment company, or PFIC, if 75% or more of its
gross income in a taxable year, including the pro rata share of the gross
income of any company, U.S. or foreign, in which it is considered to own 25% or
more of the shares by value, is passive income. Alternatively, the company will
be considered to be a PFIC if at least 50% of its assets in a taxable year,
averaged over the year and ordinarily determined based on fair market value and
including the pro rata share of the assets of any company in which it is
considered to own 25% or more of the shares by value, are held for the
production of, or produce, passive income. Passive income includes amounts
derived by reason of the temporary investment of funds raised in the companys
public offerings. If the company were a PFIC, and a U.S. Holder did not make an
election to treat the company as a qualified electing fund (as described
below):

| |  | Excess
  distributions by us to a U.S. Holder would be taxed in a special way. Excess
  distributions are amounts received by a U.S. Holder with respect to the
  companys stock in any taxable year that exceed 125% of the average
  distributions received by such U.S. Holder from us in the shorter of either
  the three previous years or such U.S. Holders holding period for ordinary
  shares before the present taxable year. Excess distributions must be
  allocated ratably to each day that a U.S. Holder has held the companys
  stock. A U.S. Holder must include amounts allocated to the current taxable
  year in its gross income as ordinary income for that year. A U.S. Holder must
  pay tax on amounts allocated to each prior taxable year at the highest rate
  in effect for that year on ordinary income and the tax is subject to an
  interest charge at the rate applicable to deficiencies for income tax.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |  | The entire
  amount of gain that was realized by a U.S. Holder upon the sale or other
  disposition of ordinary shares will also be rated as an excess distribution
  and will be subject to tax as described above.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |  | A U.S.
  Holders tax basis in shares of the companys stock that were acquired from a
  decedent would not receive a step-up to fair market value as of the date of
  the decedents death but would instead be equal to the decedents basis, if
  lower.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      

The special
PFIC rules described above will not apply to a U.S. Holder if the U.S. Holder
makes an election to treat the company as a qualified electing fund (QEF)
in the first taxable year in which the U.S. Holder owns ordinary shares and if
the company complies with certain reporting requirements. Instead, a
shareholder of a qualified electing fund is required for each taxable year to
include in income a pro rata share of the ordinary earnings of the qualified
electing fund as ordinary income and a pro rata share of the net capital gain
of the qualified electing fund as long-term capital gain, subject to a separate
election to defer payment of taxes, which deferral is subject to an interest
charge. The Company has agreed to supply U.S. Holders with the information
needed to report income and gain pursuant to a QEF election in the event the
company is classified as PFIC. The QEF election is made on a
shareholder-by-shareholder basis and can be revoked only with the consent of
the Internal Revenue Service, or IRS. A shareholder makes a QEF election by
attaching a completed IRS Form 8621, including the PFIC annual information
statement, to a timely filed United States federal income tax return. Even if a
QEF election is not made, a shareholder in a PFIC who is a U.S. person must
file a completed IRS Form 8621 every year.

A U.S.
Holder of PFIC stock which is publicly traded could elect to mark the stock to
market annually, recognizing as ordinary income or loss each year an amount
equal to the difference as of the close of the taxable year between the
holders fair market value of the PFIC stock and the adjusted basis in the PFIC
stock. Losses would be allowed only to the extent of net mark-to-market gain
previously included by the U.S. Holder under the election for prior taxable
years. If the mark-to-market election were made, then the rules set forth above
would not apply for periods covered by the election.

61

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The Company
believes that it was not a PFIC in 2004. However, 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 this
determination. Accordingly, we cannot assure you that the Company will not
become a PFIC. If the company determines that it has become a PFIC, it will
notify its U.S. Holders and provide them with the information necessary to
comply with the QEF rules. U.S. Holders who hold ordinary shares during a
period when the Company is a PFIC will be subject to the foregoing rules, even
if the Company ceases to be a PFIC, subject to certain exceptions for U.S.
Holders who made a QEF election. U.S. Holders are urged to consult their tax
advisors about the PFIC rules, including the consequences to them of making a mark-to-market
or QEF election with respect to the Companys ordinary shares in the event that
the Company qualifies as a PFIC.

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

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

| |  | such item is
  effectively connected with the conduct by the Non-U.S. Holder of a trade or
  business in the United States and, in the case of a resident of a country
  which has a treaty with the United States, such item is attributable to a
  permanent establishment or, in the case of an individual, a fixed place of
  business, in the United States;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                                                                                                                                                                                                  
| |  | the Non-U.S.
  Holder is an individual who holds the ordinary shares as a capital asset and
  is present in the United States for 183 days or more in the taxable year of the
  disposition and does not qualify for an exemption; or                                                                                                                            
| |   |                                                                                                                                                                                                                                                                                                                                                                  
| |  | the Non-U.S.
  Holder is subject to tax pursuant to the provisions of United States tax law
  applicable to U.S. expatriates.                                                                                                                                                                                                                                    

Information
Reporting and Back-up Withholding

U.S.Holders
generally are subject to information reporting requirements with respect to
dividends paid in the United States on ordinary shares. U.S. Holders are also
generally subject to back-up withholding on dividends paid in the United States
on ordinary shares unless the U.S. Holder provides IRS Form W-9 or otherwise
establishes an exemption. U.S. Holders are subject to information reporting and
back-up withholding at a rate of 28% on proceeds paid from the disposition of
ordinary shares unless the U.S. Holder provides IRS Form W-9 or otherwise
establishes an exemption.

Non-U.S.
Holders generally are not subject to information reporting or back-up
withholding with respect to dividends paid on, or upon the disposition of,
ordinary shares, provided that such non-U.S. certifies to its foreign status,
or otherwise establishes an exemption.

The amount
of any back-up withholding will be allowed as a credit against a U.S. or
Non-U.S. Holders United States federal income tax liability and may entitle
such holder to a refund, provided that certain required information is
furnished to the IRS.

62

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|ITEM 11. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
  RISK
|-------- | ------------------------------------------------------------

Market risk
represents the risk of changes in the value of our financial instruments caused
by fluctuations in interest rates, foreign exchange rates and equity
prices.  Because our short-term
investments exceed short-term and long-term debt, our exposure to interest rate
risk and exchange rate fluctuations, relates primarily to our investments.

Our policy
is to conservatively manage our excess currency.  All transactions are approved by Management.

The Company
does not utilize financial instruments for trading purposes and holds no
derivative financial instruments that could expose it to significant market
risk.

Based upon
historical US dollar currency movement, the Company does not believe that
reasonably possible near-term changes in the US dollar currency of 10% will
result in a material effect on future earnings, financial position or cash
flows of the company.

|ITEM 12. | DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
|-------- | ------------------------------------------------------

Not applicable.

63

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PART II

|ITEM 13. | DEFAULTS, DIVIDENDS, ARREARAGES AND DELINQUENCIES
|-------- | -------------------------------------------------

None.

|ITEM 14. | MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS
  AND USE OF PROCEEDS
|-------- | ------------------------------------------------------------------------------

None.

|ITEM 15. | CONTROLS AND PROCEDURES
|-------- | -----------------------

In
designing and evaluating our disclosure controls and procedures and internal
control over financial reporting, we recognize that any such controls and
procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives.

Our
management evaluated, with the participation of our Chief Executive Officer and
Chief Financial Officer, the effectiveness of our disclosure controls and
procedures as of December 31, 2004. 
Based on this evaluation, our Chief Executive Officer and Chief Financial
Officer concluded that our disclosure controls and procedures as of such date
were effective to provide reasonable assurance that information required to be
disclosed by us in the reports we file or submit under the Securities Exchange
Act of 1934, as amended, is recorded, processed, summarized and reported,
within the time periods specified in the SECs rules and forms.

As
described above (under Risk Factors We
could be subject to an enforcement action by the Securities and Exchange
Commission or private lawsuits in connection with our past failure to report as
a United States issuer), in December 2004, we revised our
disclosure controls and procedures to require our controller to evaluate, and
promptly report to our Chief Executive Officer and Chief Financial Officer,
whether we qualify as a foreign private issuer on the last day of each fiscal
quarter and if and when any of the following events occur:

  A
change in the composition of our board of directors or our executive
management;

  A
purchase or sale of any assets by us other than in the ordinary course of
business, or the relocation of any of our material assets to the United States;
or

  A
relocation of the administration of any material part of our business to the
United States.

There has been no change in our internal control over financial
reporting that occurred during the fiscal year ended December 31, 2004, that
has materially affected, or is reasonably likely to materially affect, our
internal control over financial reporting.

|ITEM 16. | [RESERVED]
|-------- | ----------

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

64

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The Board
of Directors has determined that Victor Halpert, a member of our audit
committee, is an audit committee financial expert.  See Mr. Halperts biography in Item 6.

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

We believe
that our corporate conduct is consistent with or exceeds industry ethical
standards.  However, we are in the
process of considering the adoption of a Code of Ethics to formalize existing
practice.

|ITEM 16C. | PRINCIPAL ACCOUNTANT FEE AND SERVICES
|--------- | -------------------------------------

Audit Fees

Our Board
of Directors appointed Somekh Chaikin (A member firm of KPMG International)
(KPMG) Certified Public Accountants (Isr.) 
as independent auditors to audit our financial statements for the fiscal
year ended December 31, 2002.

During
2003, the Board of Directors appointed Kost Forer Gabbay and Kasierer (a member
of Ernst & Young Global) (EY) Certified Public Accountants (Isr.) as
independent auditors to audit our financial statements for the fiscal year
ended December 31, 2003.   EY was
subsequently approved to audit our financial statements for the fiscal year
ended December 31, 2004 in our shareholders annual meeting held on December
21, 2004.

The
aggregate fees billed by EY for professional services rendered for the audit of
our annual financial statements included in this Annual Report and other
services in connection with statutory and regulatory filings or engagements for
the fiscal year ended December 31, 2004 and 2003 were $69,000 and $22,000
respectively.

The
aggregate fees billed by KPMG for professional services rendered for the audit
of our annual financial statements included in this Annual Report and other
services in connection with statutory and regulatory filings or engagements for
the fiscal year ended December 31, 2004 
and December 31, 2003 were $5,000 and $45,898 respectively.

Tax Fees

For the
fiscal year ended December 31, 2004 and 2003 the aggregate fees billed for tax
compliance, tax advice and tax planning by EY were $30,415 and $50,500
respectively

For the
fiscal years ended December 31, 2004 and 2003, 
no fees were billed by KPMG for tax compliance.

Non-Audit services

For the
fiscal year ended December 31, 2004 the aggregate fees billed by EY for other
non-audit professional services, other than those services listed above, were
$44,000.  Such services were comprised
of accounting and other consultation. For the fiscal years ended December 31,
2004 and 2003 no fees were billed by KPMG for tax compliance.

Effective
May 6, 2003, the Securities and Exchange Commission adopted rules that require
that before KPMG and EY are engaged by our subsidiaries or us to render any
auditing or permitted non-audit related service, the engagement be:

| | - approved
  by our audit committee; or                                                                                                                                                                                                                                                                                                                           
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |                                                                                                                                                                                                                                                                                                                                                                   
| | - entered
  into pursuant to pre-approval policies and procedures established by the
  audit committee, provided the policies and procedures are detailed as to the
  particular service, the audit committee is informed of each service, and such
  policies and procedures do not include delegation of the audit committees
  responsibilities to management.
| |                                                                                                                                                                                                                                                                                                                                                                   
| | In certain
  instances, the Securities and Exchange Commission does not require
  pre-approval.                                                                                                                                                                                                                                                                   

65

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The audit
committee has considered the nature and amount of the fees billed by Somekh
Chaikin and Ernst & Young, and believes that the provision of the services
for activities unrelated to the audit is compatible with maintaining Somekh
Chaikins and Ernst & Youngs independence.

|ITEM 16D | EXEMPTIONS FROM THE LISTING STANDARDS OF AUDIT COMMITTEES
|-------- | ---------------------------------------------------------

Not applicable.

|ITEM 16E | PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED
  PURCHASERS
|-------- | ------------------------------------------------------------------------

Not applicable.

66

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PART III

|ITEM 17. | FINANCIAL STATEMENTS
|-------- | --------------------

The Company has elected to provide Financial Statements pursuant to
Item 18.

|ITEM 18. | FINANCIAL STATEMENTS
|-------- | --------------------

See pages F-1 through F-45.

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

|Number |  | Description                                                                                                                                                                                                                    
|------ |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|       |  |                                                                                                                                                                                                                                
|       |  |                                                                                                                                                                                                                                
|1.1    |  | Amended and
  restated Articles of Association of the Company dated October 27, 2003
  (incorporated by reference to exhibit 1.1 to the Companys annual report on
  Form 20-F for the year ended December31, 2003).           
|       |  |                                                                                                                                                                                                                                
|1.2    |  | Memorandum
  of Association of the Company (incorporated by reference to exhibit 3.2 to
  the Companys Registration Statement on Form F-1 (registration number
  333-05718).                                                  
|       |  |                                                                                                                                                                                                                                
|2.1    |  | Form of
  Public Warrant Agreement between the Company, the Warrant Agent and the
  Underwriter(incorporated by reference to exhibit 4.2 to the Companys
  Registration Statement on Form F-1(registration number 333-05718)).
|       |  |                                                                                                                                                                                                                                
|2.2    |  | Form of
  Public Warrant Certificate (incorporated by reference to exhibit 4.3 to the
  Companys Registration Statement on Form F-1 (registration number
  333-05718)).                                                       
|       |  |                                                                                                                                                                                                                                
|2.3    |  | Form of
  Underwriters Warrant Agreement (incorporated by reference to exhibit 4.4 to
  the Companys Registration Statement on Form F-1 (registration number
  333-05718)).                                                  
|       |  |                                                                                                                                                                                                                                
|4.1    |  | Top Image
  Systems, Ltd. Employee Stock Option Plan (1996) (incorporated by reference to
  exhibit10.1 to the Companys Registration Statement on Form S-8 (registration
  number 333-11560)).                                
|       |  |                                                                                                                                                                                                                                
|4.2    |  | Form of
  Stock Option Agreement covering grants to individuals dated August 20, 1996
  (incorporated by reference to exhibit 10.2 to the Companys Registration
  Statement on Form S-8 (registration number 333-11560)).     
|       |  |                                                                                                                                                                                                                                
|4.3    |  | Top Image
  Systems Ltd. Employee Share Option Plan (2000) (incorporated by reference to
  exhibit 4.1                                                                                                                         
|       |  | to the
  Company registration statement on Form S-8 filed on December 19, 2002).                                                                                                                                               
|       |  |                                                                                                                                                                                                                                
|4.4    |  | Employee
  Agreement between the Company and Ofer Comay (incorporated by reference to
  exhibit10.4(a) to the Companys Registration Statement on Form F-1
  (registration number 333-05718)).                                 
|       |  |                                                                                                                                                                                                                                
|4.5    |  | Employee
  Agreement between the Company and Ziv Koren (incorporated by reference to
  exhibit10.4(c) to the Companys Registration Statement on Form F-1
  (registration number 333-05718)).                                  
|       |  |                                                                                                                                                                                                                                
|4.6    |  | Employee
  Agreement between the Company and Stuart Melnick (incorporated by reference
  to exhibit10.4(d) to the Companys Registration Statement on Form F-1
  (registration number 333-05718)).                             

67

---

---

|4.7  |  | Employee
  Agreement between the Company and Izhak Nakar (incorporated by reference to
  exhibit10.4(e) to the Companys Registration Statement on Form F-1 (registration
  number 333-05718)).                                                                                                         
|---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|     |  |                                                                                                                                                                                                                                                                                                         
|4.8  |  | Employee
  Agreement between the Company and Ido Schechter (incorporated by reference to
  exhibit10.4(f) to the Companys Registration Statement on Form F-1
  (registration number 333-05718)).                                                                                                       
|     |  |                                                                                                                                                                                                                                                                                                         
|4.9  |  | Employee
  Agreement between the Company and Yehezkel Yeshurun (incorporated by
  reference to exhibit 10.4(g) to the Companys Registration Statement on Form
  F-1 (registration number 333-05718)).                                                                                                  
|     |  |                                                                                                                                                                                                                                                                                                         
|4.10 |  | English
  translation of an Employment Agreement between the Company and Arie Rand
  (incorporated by reference to exhibit 3.25 to the Companys annual report on
  Form 20-F (registration number 001-14552)).                                                                                         
|     |  |                                                                                                                                                                                                                                                                                                         
|4.11 |  | English
  translation of a Personal Employment Agreement between the Company and Tal
  Marom(incorporated by reference to exhibit 3.26 to the Companys annual
  report on Form 20-F (registration number 001-14552)).                                                                                  
|     |  |                                                                                                                                                                                                                                                                                                         
|4.12 |  | English
  translation of an Amendment to Employment Agreement between the Company and
  Tal Marom (re: updating of compensation and position for 2001) (incorporated
  by reference to exhibit 3.27 to the Companys annual report on Form 20-F
  (registration number 001-14552)).                     
|     |  |                                                                                                                                                                                                                                                                                                         
|4.13 |  | English
  translation of a Personal Employment Agreement between the Company and Norman
  Kreger(incorporated by reference to exhibit 3.28 to the Companys annual
  report on Form 20-F (registration number 001-14552)).                                                                              
|     |  |                                                                                                                                                                                                                                                                                                         
|4.14 |  | English
  translation of a Salary Adjustment letter for Norman Kreger (incorporated by
  reference to exhibit 3.29 to the Companys annual report on Form 20-F (registration
  number 001-14552)).                                                                                                      
|     |  |                                                                                                                                                                                                                                                                                                         
|4.15 |  | Share
  Purchase Agreement, dated as of February 11, 2000, by and between Charter-TIS
  LLC and the Company, as amended by Amendment #1 thereto, dated as of April
  28, 2000 (incorporated by reference to exhibit 3.32 to the Companys annual
  report on Form 20-F (registration number 001-14552)).
|     |  |                                                                                                                                                                                                                                                                                                         
|4.16 |  | Registration
  Rights Agreement, dated as of May 8, 2000, among the Company, Charter-TIS LLC
  and Izhak Nakar (incorporated by reference to exhibit 3.33 to the Companys
  annual report on Form 20-F(registration number 001-14552)).                                                                
|     |  |                                                                                                                                                                                                                                                                                                         
|4.17 |  | Preemptive
  Rights Agreement, dated as of May 8, 2000, between the Company and Izhak
  Nakar(incorporated by reference to exhibit 3.34 to the Companys annual
  report on Form 20-F (registration number 001-14552)).                                                                                 
|     |  |                                                                                                                                                                                                                                                                                                         
|4.18 |  | English
  translation of Employment Agreement between the Company and Oded Leiba dated
  March 19, 2001 (incorporated by reference to exhibit 3.37 to the Companys
  annual report on Form 20-F for the fiscal year ended December 31, 2001).                                                          
|     |  |                                                                                                                                                                                                                                                                                                         
|4.19 |  | English
  translation of Employment Agreement between the Company and Dan Inbar dated
  December31, 2001 (incorporated by reference to exhibit 3.38 to the Companys
  annual report on Form 20-F for the fiscal year ended December 31, 2001).                                                         
|     |  |                                                                                                                                                                                                                                                                                                         
|4.20 |  | Value-Added
  Reseller Agreement for ODT Document Technologies Products between the
  Company and Océ Document Technologies dated August 2, 2001 (incorporated by
  reference to exhibit 3.39 to the Companys annual report on Form 20-F for the
  fiscal year ended December 31, 2001).              

68

---

---

|4.21 |  | OEM License
  Agreement between the Company and CharacTell Ltd. dated July 16,
  2001(incorporated by reference to exhibit 3.40 to the Companys annual report
  on Form 20-F for the fiscal year ended December 31, 2001).                                                                                               
|---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|     |  |                                                                                                                                                                                                                                                                                                                           
|4.22 |  | Agreement
  between the Company and Elsag spa regarding software and services for the
  population census of Italy dated March 18, 2002 (incorporated by reference to
  exhibit 3.42 to the Companys annual report on Form 20-F for the fiscal year
  ended December 31, 2001).                                          
|     |  |                                                                                                                                                                                                                                                                                                                           
|4.23 |  | Statement of
  Work to Subcontractor Agreement between the Company and NCR (Cyprus) Ltd.
  regarding software and services for the population census of Italy dated June
  22, 2001 (incorporated by reference to exhibit 3.43 to the Companys annual
  report on Form 20-F for the fiscal year ended December 31, 2001).
|     |  |                                                                                                                                                                                                                                                                                                                           
|4.24 |  | Agreement
  between the Company and CMC Ltd. regarding software and services for the
  population census of India dated December 12, 2001 (incorporated by reference
  to exhibit 3.44 to the Companys annual report on Form 20-F for the fiscal
  year ended December 31, 2001).                                        
|     |  |                                                                                                                                                                                                                                                                                                                           
|4.25 |  | Securities
  Purchase Agreement between the Company and the Purchasers named therein,
  dated as of June 10, 2004 (incorporated by reference to exhibit 99.3 to the
  Companys current report on Form 6-K filed June 10, 2004).                                                                                          
|     |  |                                                                                                                                                                                                                                                                                                                           
|4.26 |  | Form of
  Warrant issuable in connection with the Securities Purchase Agreement between
  the Company and the Purchasers named therein, dated as of June 10, 2004
  (incorporated by reference to exhibit 99.2 to the Companys current report on
  Form 6-K filed June 10, 2004).                                        
|     |  |                                                                                                                                                                                                                                                                                                                           
|4.27 |  | Top Image
  Systems Ltd. Israeli Share Option Plan (2003) (incorporated by reference to
  exhibit 4.48 to the Companys annual report on Form 20-F for the year ended December 31, 2003).                                                                                                                                 
|     |  |                                                                                                                                                                                                                                                                                                                           
|4.28 |  | Business Transfer Agreement between the Company and Toyo Ink
  Mfg. Co., Ltd., dated as of August, 2004.                                                                                                                                                                                                                  
|     |  |                                                                                                                                                                                                                                                                                                                           
|8    |  | List of
  Subsidiaries.                                                                                                                                                                                                                                                                                                   
|     |  |                                                                                                                                                                                                                                                                                                                           
|12.1 |  | Certification
  of the Chief Executive Officer pursuant to 15 U.S.C. Section 7241, as adopted
  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                
|     |  |                                                                                                                                                                                                                                                                                                                           
|12.2 |  | Certification
  of the Chief Financial Officer pursuant to 15 U.S.C. Section 7241, as adopted
  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                
|     |  |                                                                                                                                                                                                                                                                                                                           
|13.1 |  | Certification
  of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted
  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                
|     |  |                                                                                                                                                                                                                                                                                                                           
|13.2 |  | Certification
  of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted
  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                
|     |  |                                                                                                                                                                                                                                                                                                                           
|14.1 |  | Consent of
  Somekh Chaikin  member firm of KPMG International.                                                                                                                                                                                                                                                          
|     |  |                                                                                                                                                                                                                                                                                                                           
|14.2 |  | Consent of
  Kost Forer Gabbay & Kasierer  member of Ernst & Young Global.                                                                                                                                                                                                                                               
|     |  |                                                                                                                                                                                                                                                                                                                           
|15.1 |  | Audit
  Committee Charter (incorporated by reference to exhibit 14.3 to Companys
  annual report on Form 20-F for the year ended December 31, 2003.)                                                                                                                                                                     

69

---

---

SIGNATURES

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

|                      | TOP IMAGE
  SYSTEMS LTD.
|--------------------- | ------------------------
|                      |                         
|                      | By:                     
|                      |                         
|                      |                         
|                      |                         
|                      |                         
|Date:  March 31, 2005 |                         

70

---

---

TOP IMAGE SYSTEMS LTD. AND ITS SUBSIDIARIES

CONSOLIDATED FINANCIAL STATEMENTS

AS OF DECEMBER 31, 2004

IN U.S. DOLLARS

INDEX

|                                                          |  | Page      
|--------------------------------------------------------- |  | ----------
|                                                          |  |           
|                                                          |  |           
|Report of Independent Registered Public Accounting
  Firm |  | F-2 - F-3 
|                                                          |  |           
|Consolidated Balance Sheets                               |  | F-4 - F-5 
|                                                          |  |           
|Consolidated Statements of Operations                     |  | F-6       
|                                                          |  |           
|Statements of Changes in Shareholders
  Equity           |  | F-7       
|                                                          |  |           
|Consolidated Statements of Cash Flows                     |  | F-8       
|                                                          |  |           
|Notes to Consolidated Financial Statements                |  | F-9 - F-45

---

---



REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM

To the Shareholders of

TOP IMAGE SYSTEMS LTD.

We have
audited the accompanying consolidated balance sheets of Top Image Systems Ltd.
(the Company) and its subsidiaries as of December 31, 2004 and 2003, and the
related consolidated statements of operations, changes in shareholders equity
and cash flows for each of the two years then ended. These consolidated
financial statements are the responsibility of the Companys management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

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

In our
opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of the
Company and its subsidiaries as of December 31, 2004 and 2003,  and the consolidated results of their
operations and their cash flows for each of the two years in the period ended
December 31, 2004, in conformity with Israeli generally
accepted accounting principles, which differ in certain respects from U.S. generally
accepted accounting principles, as described in Note 19 to the consolidated
financial statements.

|Tel-Aviv,
  Israel |  | KOST FORER GABBAY & KASIERER    
|------------------ |  | --------------------------------
|March 13,
  2005   |  | A Member of Ernst & Young Global

F-2

---

---

# Report of Independent
Registered Public Accounting Firm

Board of Directors and
Shareholders of  
Top Image Systems Ltd. and its Consolidated Subsidiaries

We have audited the accompanying
Consolidated Statements of Operations, Changes in Shareholders Equity, and Cash
Flows of Top Image Systems Ltd. and subsidiaries (the Company) for year ended
December 31, 2002. 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 audit.

We conducted our audit in accordance
with the standards of the Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain reasonable assurance that
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 Board of Directors and by 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
results of their operations and their cash flows for the year ended December 31, 2002, in
conformity with accounting principles generally accepted (GAAP) 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 summarized in Note 19 to the consolidated financial
statements.

Somekh Chaikin Tel Aviv,
IsraelCertified Public Accountants (Isr.) Amember firm of KPMG International

March 11, 2003

F-3

---

---



|TOP IMAGE SYSTEMS LTD.
AND ITS SUBSIDIARIES
|-------------------------------------------
|CONSOLIDATED BALANCE SHEETS                
|                                           
|In U.S. dollars                            

|                          |                                   |      |     | December
  31, | 
|------------------------- | --------------------------------- | ---- | --- | -------------- | 
|                          |                                   |      |     |                | 
|                          |                                   | Note |     | 2004           | 
|                          |                                   |      |     |                | 
|                          | ASSETS                            |      |     |                | 
|                          |                                   |      |     |                | 
|CURRENT
  ASSETS:         |                                   |      |     |                | 
|                          | Cash and
  cash equivalents       |      |     |                | 
|                          | Marketable
  securities           |      |     | 3              | 
|                          | Trade
  receivables, net          |      |     | 4              | 
|                          | Other
  current assets            |      |     | 5              | 
|                          |                                   |      |     |                | 
|                          |                                   |      |     |                | 
|Total
  current assets    |                                   |      |     |                | 
|                          |                                   |      |     |                | 
|                          |                                   |      |     |                | 
|LONG-TERM
  DEPOSITS      |                                   |      | 11b | (2)            | 
|                          |                                   |      |     |                | 
|                          |                                   |      |     |                | 
|PROPERTY AND
  EQUIPMENT: |                                   |      | 6   |                | 
|                          | Cost                              |      |     |                | 
|                          | Less -
  accumulated depreciation |      |     |                | 
|                          |                                   |      |     |                | 
|                          |                                   |      |     |                | 
|                          |                                   |      |     |                | 
|                          |                                   |      |     |                | 
|                          |                                   |      |     |                | 
|INTANGIBLE
  ASSETS:      |                                   |      | 7   |                | 
|                          | Goodwill,
  net                   |      |     |                | 
|                          | Other
  intangible assets, net    |      |     |                | 
|                          |                                   |      |     |                | 
|                          |                                   |      |     |                | 
|                          |                                   |      |     |                | 
|Total assets              |                                   |      |     |                | 
|                          |                                   |      |     |                | 
|                          |                                   |      |     |                | 

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

F-4

---

---

|TOP IMAGE SYSTEMS LTD.
AND ITS SUBSIDIARIES
|-------------------------------------------
|CONSOLIDATED BALANCE SHEETS                
|                                           
|In U.S. dollars (except share data)        

|                                             |                                                                                                                                                                                                                                 |      |    | December 31, |  
|-------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ---- | -- | ------------ | -
|                                             |                                                                                                                                                                                                                                 |      |    |              |  
|                                             |                                                                                                                                                                                                                                 | Note |    | 2004         |  
|                                             |                                                                                                                                                                                                                                 |      |    |              |  
|                                             | LIABILITIES
  AND SHAREHOLDERS EQUITY                                                                                                                                                                                          |      |    |              |  
|                                             |                                                                                                                                                                                                                                 |      |    |              |  
|CURRENT
  LIABILITIES:                       |                                                                                                                                                                                                                                 |      |    |              |  
|                                             | Short-term
  bank loans                                                                                                                                                                                                         |      | 8  |              |  
|                                             | Trade
  payables                                                                                                                                                                                                                |      |    |              |  
|                                             | Other
  accounts payable and accruals                                                                                                                                                                                           |      | 9  |              |  
|                                             |                                                                                                                                                                                                                                 |      |    |              |  
|                                             |                                                                                                                                                                                                                                 |      |    |              |  
|Totalcurrent
  liabilities                   |                                                                                                                                                                                                                                 |      |    |              |  
|                                             |                                                                                                                                                                                                                                 |      |    |              |  
|                                             |                                                                                                                                                                                                                                 |      |    |              |  
|LONG-TERM
  LIABILITIES:                     |                                                                                                                                                                                                                                 |      |    |              |  
|                                             | Accrued
  severance pay, net                                                                                                                                                                                                    |      | 10 |              |  
|                                             |                                                                                                                                                                                                                                 |      |    |              |  
|                                             |                                                                                                                                                                                                                                 |      |    |              |  
|COMMITMENTS,
  CONTINGENCIES AND CHARGES     |                                                                                                                                                                                                                                 | 11   |    |              |  
|                                             |                                                                                                                                                                                                                                 |      |    |              |  
|SHAREHOLDERS
  EQUITY:                      |                                                                                                                                                                                                                                 | 12   |    |              |  
|                                             | Share
  capital:                                                                                                                                                                                                                |      |    |              |  
|                                             | Ordinary
  shares of NIS 0.04 par value -
     Authorized: 125,000,000 shares at December 31, 2004
     and 2003; Issued and outstanding: 8,753,991 and 
     6,120,765 shares at December 31, 2004 and 2003,
     respectively |      |    |              |  
|                                             | Additional
  paid-in capital                                                                                                                                                                                                    |      |    |              |  
|                                             | Accumulated
  deficit                                                                                                                                                                                                           |      |    |              |  
|                                             |                                                                                                                                                                                                                                 |      |    |              |  
|                                             |                                                                                                                                                                                                                                 |      |    |              |  
|Total
  shareholders equity                 |                                                                                                                                                                                                                                 |      |    |              |  
|                                             |                                                                                                                                                                                                                                 |      |    |              |  
|                                             |                                                                                                                                                                                                                                 |      |    |              |  
|Total
  liabilities and shareholders equity |                                                                                                                                                                                                                                 |      |    |              | $
|                                             |                                                                                                                                                                                                                                 |      |    |              |  

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

F-5

---

---

|TOP IMAGE SYSTEMS LTD.
  AND ITS SUBSIDIARIES
|---------------------------------------------
|CONSOLIDATED STATEMENTS OF OPERATIONS        
|                                             
|In U.S. dollars (except share data)          

|                                                                                               |                                           |      |    | Year ended
  December 31, |           
|---------------------------------------------------------------------------------------------- | ----------------------------------------- | ---- | -- | ------------------------- | ----------
|                                                                                               |                                           |      |    |                           |           
|                                                                                               |                                           | Note |    | 2004                      |           
|                                                                                               |                                           |      |    |                           |           
|                                                                                               |                                           |      |    |                           |           
|Revenues:                                                                                      |                                           |      |    |                           |           
|                                                                                               | Product revenues                          |      | 16 |                           | $         
|                                                                                               | Service
  revenues                        |      |    |                           |           
|                                                                                               |                                           |      |    |                           |           
|                                                                                               |                                           |      |    |                           |           
|Total
  revenues                                                                               |                                           |      |    |                           | 11,178,448
|                                                                                               |                                           |      |    |                           |           
|                                                                                               |                                           |      |    |                           |           
|Cost of
  revenues:                                                                            |                                           |      |    |                           |           
|                                                                                               | Product
  costs                           |      |    |                           |           
|                                                                                               | Service
  costs                           |      |    |                           |           
|                                                                                               |                                           |      |    |                           |           
|                                                                                               |                                           |      |    |                           |           
|Total
  cost of revenues                                                                       |                                           |      |    |                           | 3,472,099 
|                                                                                               |                                           |      |    |                           |           
|                                                                                               |                                           |      |    |                           |           
|Gross profit                                                                                   |                                           |      |    |                           | 7,706,349 
|                                                                                               |                                           |      |    |                           |           
|                                                                                               |                                           |      |    |                           |           
|Operating
  costs and expenses:                                                                |                                           |      |    |                           |           
|                                                                                               | Research and
  development                |      |    |                           |           
|                                                                                               | Selling and
  marketing                   |      |    |                           |           
|                                                                                               | General and administrative                |      |    |                           |           
|                                                                                               | Restructuring
  and other special charges |      | 13 |                           |           
|                                                                                               |                                           |      |    |                           |           
|                                                                                               |                                           |      |    |                           |           
|Total
  operating costs and expenses                                                           |                                           |      |    |                           | 8,064,141 
|                                                                                               |                                           |      |    |                           |           
|                                                                                               |                                           |      |    |                           |           
|Operating
  loss                                                                               |                                           |      |    |                           | (357,792  
|                                                                                               |                                           |      |    |                           |           
|Financial
  income, net                                                                        |                                           | 14   |    |                           | 179,400   
|Other
  expenses, net                                                                          |                                           |      |    |                           | -         
|                                                                                               |                                           |      |    |                           |           
|                                                                                               |                                           |      |    |                           |           
|Net loss                                                                                       |                                           |      |    | $                         | (178,392  
|                                                                                               |                                           |      |    |                           |           
|                                                                                               |                                           |      |    |                           |           
|Net loss per
  share                                                                           |                                           | 18   |    | $                         | (0.03     
|                                                                                               |                                           |      |    |                           |           
|                                                                                               |                                           |      |    |                           |           
|                                                                                               |                                           |      |    |                           |           
|Weighted
  average number of shares outstanding
     used in the computation of loss per share |                                           | 18   |    |                           | 7,092,434 
|                                                                                               |                                           |      |    |                           |           

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

F-6

---

---

|TOP IMAGE SYSTEMS LTD.
  AND ITS SUBSIDIARIES
|---------------------------------------------
|STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY
|                                             
|In U.S. dollars (except share data)          

|                                                   |  | Share
  capital    |           | Additional |   |                   |  |                       |            |       |  
|-------------------------------------------------- |  | ------------------ | --------- | ---------- | - | ----------------- |  | --------------------- | ---------- | ----- | -
|                                                   |  |                    |           |            |   |                   |  |                       |            |      
|                                                   |  | Number of
  shares |           | Amount     |   | paid-in
  capital |  | Accumulated
  deficit |            | Total |  
|                                                   |  |                    |           |            |   |                   |  |                       |            |       |  
|                                                   |  |                    |           |            |   |                   |  |                       |            |       |  
|Balance at
  January 1, 2002                       |  |                    | 6,098,890 |            | $ | 73,079            |  | $                     | 22,329,513 |       | $
|                                                   |  |                    |           |            |   |                   |  |                       |            |       |  
|Amortization
  of deferred stock                   |  |                    |           |            |   |                   |  |                       |            |       |  
|compensation                                       |  |                    | -         |            |   | -                 |  |                       | 9,456      |       |  
|Net loss                                           |  |                    | -         |            |   | -                 |  |                       | -          |       |  
|                                                   |  |                    |           |            |   |                   |  |                       |            |       |  
|                                                   |  |                    |           |            |   |                   |  |                       |            |       |  
|Balance at
  December 31, 2002                     |  |                    | 6,098,890 |            |   | 73,079            |  |                       | 22,338,969 |       |  
|                                                   |  |                    |           |            |   |                   |  |                       |            |       |  
|Exercise of
  stock options                        |  |                    | 21,875    |            |   | 195               |  |                       | 40,761     |       |  
|Amortization
  of deferred stock
     compensation |  |                    | -         |            |   | -                 |  |                       | 532        |       |  
|Net loss                                           |  |                    | -         |            |   | -                 |  |                       | -          |       |  
|                                                   |  |                    |           |            |   |                   |  |                       |            |       |  
|                                                   |  |                    |           |            |   |                   |  |                       |            |       |  
|Balance at
  December 31, 2003                     |  |                    | 6,120,765 |            |   | 73,274            |  |                       | 22,380,262 |       |  
|                                                   |  |                    |           |            |   |                   |  |                       |            |       |  
|Issuance of
  shares and
     warrants, net        |  |                    | 2,524,351 |            |   | 22,519            |  |                       | 6,959,647  |       |  
|Exercise of
  stock options                        |  |                    | 108,875   |            |   | 973               |  |                       | 239,072    |       |  
|Net loss                                           |  |                    | -         |            |   | -                 |  |                       | -          |       |  
|                                                   |  |                    |           |            |   |                   |  |                       |            |       |  
|                                                   |  |                    |           |            |   |                   |  |                       |            |       |  
|Balance at
  December 31, 2004                     |  |                    | 8,753,991 |            | $ | 96,766            |  | $                     | 29,578,981 |       | $
|                                                   |  |                    |           |            |   |                   |  |                       |            |       |  

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

F-7

---

---

|TOP IMAGE SYSTEMS LTD.
  AND ITS SUBSIDIARIES
|---------------------------------------------
|CONSOLIDATED STATEMENTS OF CASH FLOWS        
|                                             
|In U.S. dollars                              

|                                                                                      |                                                              | Year ended
  December 31, |           
|------------------------------------------------------------------------------------- | ------------------------------------------------------------ | ------------------------- | ----------
|                                                                                      |                                                              |                           |           
|                                                                                      |                                                              | 2004                      |           
|                                                                                      |                                                              |                           |           
|Cash flows
  from operating activities:                                               |                                                              |                           |           
|                                                                                      |                                                              |                           |           
|Net loss                                                                              |                                                              | $                         | (178,392  
|Adjustments
  to reconcile net loss to net cash used in operating
        activities: |                                                              |                           |           
|                                                                                      | Amortization
  of deferred stock compensation                |                           |           
|                                                                                      | Depreciation
  and amortization                              |                           |           
|                                                                                      | Accrued
  severance pay, net                                 |                           |           
|                                                                                      | Loss from
  sale of property and equipment, net              |                           |           
|                                                                                      | Currency
  fluctuations on marketable securities             |                           |           
|                                                                                      | Loss (gain)
  from marketable securities, net                |                           |           
|                                                                                      | Decrease
  (increase) in trade receivables, net              |                           |           
|                                                                                      | Decrease
  (increase) in other current assets                |                           |           
|                                                                                      | Increase
  (decrease) in trade payables                      |                           |           
|                                                                                      | Increase
  (decrease) in other accounts payable and accruals |                           |           
|                                                                                      |                                                              |                           |           
|                                                                                      |                                                              |                           |           
|Net cash
  used in operating activities                                               |                                                              |                           | (1,073,040
|                                                                                      |                                                              |                           |           
|                                                                                      |                                                              |                           |           
|Cash flows
  from investing activities:                                               |                                                              |                           |           
|                                                                                      |                                                              |                           |           
|                                                                                      | Acquisition
  of business activity (a)                       |                           |           
|                                                                                      | Purchase of
  property and equipment                         |                           |           
|                                                                                      | Proceeds
  from sale of property and equipment               |                           |           
|                                                                                      | Proceeds
  from sale of marketable securities                |                           |           
|                                                                                      | Purchase of
  marketable securities                          |                           |           
|                                                                                      | Decrease
  (increase) in long-term deposits                  |                           |           
|                                                                                      |                                                              |                           |           
|                                                                                      |                                                              |                           |           
|Net cash
  provided by (used in) investing activities                                 |                                                              |                           | (2,239,772
|                                                                                      |                                                              |                           |           
|                                                                                      |                                                              |                           |           
|Cash flows
  from financing activities:                                               |                                                              |                           |           
|                                                                                      |                                                              |                           |           
|                                                                                      | Proceeds from
  exercise of stock options                    |                           |           
|                                                                                      | Increase in
  short-term bank loans, net                     |                           |           
|                                                                                      | Proceeds
  from issuance of shares and warrants, net         |                           |           
|                                                                                      |                                                              |                           |           
|                                                                                      |                                                              |                           |           
|Net cash
  provided by financing activities                                           |                                                              |                           | 7,594,517 
|                                                                                      |                                                              |                           |           
|                                                                                      |                                                              |                           |           
|Increase
  (decrease) in cash and cash equivalents                                    |                                                              |                           | 4,281,705 
|Cash and
  cash equivalents at beginning of the year                                  |                                                              |                           | 5,854,436 
|                                                                                      |                                                              |                           |           
|                                                                                      |                                                              |                           |           
|Cash and
  cash equivalents at end of the year                                        |                                                              | $                         | 10,136,141
|                                                                                      |                                                              |                           |           
|                                                                                      |                                                              |                           |           
|Non-cash
  activities:                                                                |                                                              |                           |           
|                                                                                      |                                                              |                           |           
|                                                                                      | Accrued
  issuance expenses                                  |                           | $         
|                                                                                      |                                                              |                           |           
|                                                                                      |                                                              |                           |           
|                                                                                      | Accrued
  expenses on account of acquisition                 |                           | $         
|                                                                                      |                                                              |                           |           
|                                                                                      |                                                              |                           |           

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

F-8

---

---

|TOP IMAGE SYSTEMS LTD.
  AND ITS SUBSIDIARIES
|---------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   
|                                             
|In U.S. dollars                              

|    |                                                                                      |                                   | Year
  ended
  December 31, |  
|--- | ------------------------------------------------------------------------------------ | --------------------------------- | --------------------------- | -
|    |                                                                                      |                                   |                             |  
|    |                                                                                      |                                   | 2004                        |  
|    |                                                                                      |                                   |                             |  
|(a) | Acquisition of business activity:                                                    |                                   |                             |  
|    |                                                                                      |                                   |                             |  
|    | Net fair
  value of assets acquired and liabilities assumed at the acquisition date: |                                   |                             |  
|    |                                                                                      |                                   |                             |  
|    |                                                                                      | Identifiable in
  tangible assets |                             |  
|    |                                                                                      | Goodwill                          |                             |  
|    |                                                                                      |                                   |                             |  
|    |                                                                                      |                                   |                             |  
|    |                                                                                      |                                   |                             |  
|    |                                                                                      |                                   |                             |  
|    |                                                                                      |                                   |                             |  
|    | Accrued
  expenses on account of acquisition                                         |                                   |                             |  
|    |                                                                                      |                                   |                             |  
|    |                                                                                      |                                   |                             |  
|    |                                                                                      |                                   |                             | $
|    |                                                                                      |                                   |                             |  

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

F-9

---

---

|TOP IMAGE SYSTEMS LTD.
  AND ITS SUBSIDIARIES
|---------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   
|                                             
|In U.S. dollars                              

|NOTE 1:- | BUSINESS AND ORGANIZATION
|-------- | -------------------------
|         |                          
|         | a.                       
|         |                          
|         |                          
|         |                          
|         | b.                       
|         |                          
|         |                          
|         |                          
|         |                          
|         |                          
|         |                          
|         |                          
|         |                          
|         |                          
|         |                          
|         |                          
|         |                          
|         |                          
|         | c.                       
|         |                          
|         |                          
|         |                          
|         |                          
|         |                          
|         |                          
|         |                          
|         |                          
|         |                          
|         |                          
|         |                          
|         |                          
|         |                          
|         |                          
|         |                          
|         |                          
|         |                          

F-10

---

---

|TOP IMAGE SYSTEMS LTD.
  AND ITS SUBSIDIARIES
|---------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   
|                                             
|In U.S. dollars                              

|NOTE 1:- | BUSINESS AND ORGANIZATION (Cont.)
|-------- | ---------------------------------
|         |                                  
|         | d.                               
|         |                                  
|         |                                  
|         |                                  
|         |                                  
|         |                                  
|         |                                  

| | Identifiable
  intangible assets |  | $ | 1,500,000 | 
| | -------------------------------- |  | - | --------- | 
| | Goodwill                         |  |   | 465,214   | 
| |                                  |  |   |           | 
| |                                  |  |   |           | 
| | Total assets
  acquired          |  | $ | 1,965,214 | 
| |                                  |  |   |           | 

| |  | The
  following are the identifiable intangible assets acquired and the respective
  periods over which the assets will be amortized on a straight-line basis:
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                      |  | Amount |           | Amortization
  period
  (in years) | 
| | -------------------- |  | ------ | --------- | ---------------------------------- | 
| |                      |  |        |           |                                    | 
| |                      |  |        |           |                                    | 
| | Technology           |  | $      | 750,000   |                                    | 
| | Customer
  relations |  |        | 750,000   |                                    | 
| |                      |  |        |           |                                    | 
| |                      |  |        |           |                                    | 
| |                      |  | $      | 1,500,000 |                                    | 
| |                      |  |        |           |                                    | 

| |  | See Note 7
  for expected amortization expenses.
| |  | ------------------------------------------------

| | For
the year ended December 31, 2004 the revenues and net income included in the consolidated
financial statements in respect of the acquired business amounted to $ 530,872 and $
135,917, respectively.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | e. | On September
  24, 2004, the Company sold 2,524,351 Ordinary shares of the Company at a
  purchase price of $ 3.16 per share to institutional investors for gross
  proceeds of approximately $ 8 million (see Note 12a).
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-11

---

---

|TOP IMAGE SYSTEMS LTD.
  AND ITS SUBSIDIARIES
|---------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   
|                                             
|In U.S. dollars                              

|NOTE 2:- | SIGNIFICANT ACCOUNTING POLICIES                                                                                                                                                                                                            
|-------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|         |                                                                                                                                                                                                                                            
|         | These
  consolidated financial statements have been prepared in conformity with
  generally accepted accounting principles in Israel, which differ in certain
  respects from those followed in the United States, as described in Note 19.
|         |                                                                                                                                                                                                                                            
|         | a.                                                                                                                                                                                                                                         
|         |                                                                                                                                                                                                                                            
|         |                                                                                                                                                                                                                                            
|         |                                                                                                                                                                                                                                            
|         | b.                                                                                                                                                                                                                                         
|         |                                                                                                                                                                                                                                            
|         |                                                                                                                                                                                                                                            
|         |                                                                                                                                                                                                                                            
|         |                                                                                                                                                                                                                                            
|         |                                                                                                                                                                                                                                            
|         |                                                                                                                                                                                                                                            
|         |                                                                                                                                                                                                                                            
|         |                                                                                                                                                                                                                                            
|         |                                                                                                                                                                                                                                            
|         |                                                                                                                                                                                                                                            
|         |                                                                                                                                                                                                                                            
|         |                                                                                                                                                                                                                                            
|         |                                                                                                                                                                                                                                            
|         |                                                                                                                                                                                                                                            
|         |                                                                                                                                                                                                                                            
|         | c.                                                                                                                                                                                                                                         
|         |                                                                                                                                                                                                                                            
|         |                                                                                                                                                                                                                                            
|         |                                                                                                                                                                                                                                            

F-12

---

---

|TOP IMAGE SYSTEMS LTD.
  AND ITS SUBSIDIARIES
|---------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   
|                                             
|In U.S. dollars                              

|NOTE 2:- | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|-------- | ---------------------------------------
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         | d.                                     
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         | e.                                     
|         |                                        
|         |                                        
|         |                                        
|         | f.                                     
|         |                                        
|         |                                        
|         |                                        
|         | g.                                     
|         |                                        
|         |                                        
|         |                                        
|         | h.                                     
|         |                                        
|         |                                        
|         |                                        
|         | i.                                     
|         |                                        
|         |                                        
|         |                                        
|         |                                        

F-13

---

---

|TOP IMAGE SYSTEMS LTD.
  AND ITS SUBSIDIARIES
|---------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   
|                                             
|In U.S. dollars                              

|NOTE 2:- | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|-------- | ---------------------------------------
|         |                                        
|         | j.                                     
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         | Computers                              
|         | Furniture
  and office equipment       
|         | Leasehold
  improvements               
|         |                                        
|         |                                        
|         |                                        
|         | k.                                     
|         |                                        
|         |                                        
|         |                                        
|         | l.                                     
|         |                                        
|         |                                        
|         |                                        
|         |                                        

F-14

---

---

|TOP IMAGE SYSTEMS LTD.
  AND ITS SUBSIDIARIES
|---------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   
|                                             
|In U.S. dollars                              

|NOTE 2:- | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|-------- | ---------------------------------------
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         | m.                                     
|         |                                        
|         |                                        
|         |                                        
|         | n.                                     
|         |                                        
|         |                                        

F-15

---

---

|TOP IMAGE SYSTEMS LTD.
  AND ITS SUBSIDIARIES
|---------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   
|                                             
|In U.S. dollars                              

|NOTE 2:- | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|-------- | ---------------------------------------
|         |                                        
|         | o.                                     
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         | p.                                     
|         |                                        
|         |                                        
|         |                                        
|         | q.                                     
|         |                                        
|         |                                        
|         |                                        
|         | r.                                     
|         |                                        
|         |                                        
|         |                                        
|         |                                        

F-16

---

---

|TOP IMAGE SYSTEMS LTD.
  AND ITS SUBSIDIARIES
|---------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   
|                                             
|In U.S. dollars                              

|NOTE 2:- | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|-------- | ---------------------------------------
|         |                                        
|         | s.                                     
|         |                                        
|         |                                        
|         |                                        
|         | t.                                     
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|         |                                        
|NOTE 3:- | MARKETABLE SECURITIES                  

| |                                          |  | December
  31, |        
| | ---------------------------------------- |  | -------------- | -------
| |                                          |  |                |        
| |                                          |  | 2004           |        
| |                                          |  |                |        
| | Mutual fund
  participation certificates |  | $              | 278,635
| |                                          |  |                |        

F-17

---

---

|TOP IMAGE SYSTEMS LTD.
  AND ITS SUBSIDIARIES
|---------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   
|                                             
|In U.S. dollars                              

|NOTE 4:- | TRADE RECEIVABLES, NET            |                                  |                |          
|-------- | --------------------------------- | -------------------------------- | -------------- | ---------
|         |                                   |                                  | December
  31, |          
|         |                                   |                                  |                |          
|         |                                   |                                  | 2004           |          
|         |                                   |                                  |                |          
|         |                                   |                                  |                |          
|         | Trade
  receivables               |                                  | $              | 6,195,181
|         | Allowance
  for doubtful accounts |                                  |                | (654,175 
|         |                                   |                                  |                |          
|         |                                   |                                  |                |          
|         |                                   |                                  | $              | 5,541,006
|         |                                   |                                  |                |          
|         |                                   |                                  |                |          
|NOTE 5:- | OTHER CURRENT ASSETS              |                                  |                |          
|         |                                   |                                  |                |          
|         | Employees                         |                                  | $              | 19,663   
|         | Government
  authorities          |                                  |                | 318,170  
|         | Prepaid
  expenses                |                                  |                | 203,721  
|         | Other                             |                                  |                | 24,704   
|         |                                   |                                  |                |          
|         |                                   |                                  |                |          
|         |                                   |                                  | $              | 566,258  
|         |                                   |                                  |                |          
|         |                                   |                                  |                |          
|NOTE 6:- | PROPERTY AND EQUIPMENT            |                                  |                |          
|         |                                   |                                  |                |          
|         | Cost:                             |                                  |                |          
|         |                                   | Computers                        |                | $        
|         |                                   | Furniture
  and office equipment |                |          
|         |                                   | Leasehold
  improvements         |                |          
|         |                                   |                                  |                |          
|         |                                   |                                  |                |          
|         |                                   |                                  |                | 2,194,509
|         |                                   |                                  |                |          
|         | Accumulated
  depreciation:       |                                  |                |          
|         |                                   | Computers                        |                |          
|         |                                   | Furniture
  and office equipment |                |          
|         |                                   | Leasehold
  improvements         |                |          
|         |                                   |                                  |                |          
|         |                                   |                                  |                |          
|         |                                   |                                  |                | 1,576,285
|         |                                   |                                  |                |          
|         |                                   |                                  |                |          
|         | Depreciated
  cost                |                                  | $              | 618,224  
|         |                                   |                                  |                |          

| | As to
  charges, see Note 11c(1).                                                                                                        |  |  |  |  |  |  | 
| | ---------------------------------------------------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
| |                                                                                                                                          |  |  |  |  |  |  | 
| | Depreciation
  expense amounted to $189,287, $214,523 and $304,390 for the years ended
  December 31, 2004, 2003 and 2002, respectively.

F-18

---

---

|TOP IMAGE SYSTEMS LTD.
  AND ITS SUBSIDIARIES
|---------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   
|                                             
|In U.S. dollars                              

|NOTE 7:- | GOODWILL AND OTHER INTANGIBLE ASSETS                                                                                       
|-------- | ---------------------------------------------------------------------------------------------------------------------------
|         |                                                                                                                            
|         | Goodwill and
  other intangible assets arose from the acquisition of the business from Toyo
  in August 2004 (see Note 1d).
|         |                                                                                                                            
|         | a.                                                                                                                         

| |    |                                   |                       | December
  31, |          
| | -- | --------------------------------- | --------------------- | -------------- | ---------
| |    |                                   |                       |                |          
| |    |                                   |                       | 2004           |          
| |    |                                   |                       |                |          
| |    |                                   |                       |                |          
| |    | Original
  amount                 |                       | $              | 465,214  
| |    | Accumulated
  amortization        |                       |                | 11,630   
| |    |                                   |                       |                |          
| |    |                                   |                       |                |          
| |    | Amortized
  cost                  |                       | $              | 453,584  
| |    |                                   |                       |                |          
| |    |                                   |                       |                |          
| | b. | Identifiable
  intangible assets: |                       |                |          
| |    |                                   |                       |                |          
| |    | Original
  amount:                |                       |                |          
| |    |                                   | Customer
  relations  |                | $        
| |    |                                   | Acquired
  technology |                |          
| |    |                                   |                       |                |          
| |    |                                   |                       |                |          
| |    |                                   |                       |                | 1,500,000
| |    |                                   |                       |                |          
| |    |                                   |                       |                |          
| |    | Accumulated
  amortization:       |                       |                |          
| |    |                                   | Customer
  relations  |                |          
| |    |                                   | Acquired
  technology |                |          
| |    |                                   |                       |                |          
| |    |                                   |                       |                |          
| |    |                                   |                       |                | 81,250   
| |    |                                   |                       |                |          
| |    |                                   |                       |                |          
| |    | Amortized
  cost                  |                       | $              | 1,418,750
| |    |                                   |                       |                |          
| |    |                                   |                       |                |          

| | c. | Amortization
  expenses for the year ended December 31, 2004 amounted to $ 11,630 and $
  81,250 for the goodwill and for other intangible assets, respectively.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                 
| | d. | Estimated
  amortization expenses for the year ended:                                                                                                           

| | December 31,          |  | Goodwill |   | Other
  intangible assets | 
| | --------------------- |  | -------- | - | ------------------------- | 
| |                       |  |          |   |                           | 
| |                       |  |          |   |                           | 
| | 2005                  |  |          | $ | 46,521                    | 
| | 2006                  |  |          | $ | 46,521                    | 
| | 2007                  |  |          | $ | 46,521                    | 
| | 2008                  |  |          | $ | 46,521                    | 
| | 2009 and
  thereafter |  |          | $ | 267,498                   | 

F-19

---

---

|TOP IMAGE SYSTEMS LTD.
  AND ITS SUBSIDIARIES
|---------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   
|                                             
|In U.S. dollars                              

|NOTE 8:- | SHORT-TERM BANK LOANS
|-------- | ---------------------
|         |                      
|         | a.                   

| |                                        |  | December
  31, |          
| | -------------------------------------- |  | -------------- | ---------
| |                                        |  |                |          
| |                                        |  | 2004           |          
| |                                        |  |                |          
| |                                        |  |                |          
| | Short-term
  bank loans in NIS (1)     |  | $              | 397,086  
| | Short-term
  bank loans in dollars (2) |  |                | 1,310,065
| |                                        |  |                |          
| |                                        |  |                |          
| |                                        |  | $              | 1,707,151
| |                                        |  |                |          

| |    |                                                                                                          | The Company
  has a revolving line of credit with banks for total borrowings of up to $
  1,500,000, based on 75% of its trade receivables. The line of credit is
  secured by a charge (see Note 11c(2)).                                                                                                                            
| | -- | -------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                          |                                                                                                                                                                                                                                                                                                                                       
| |    | (1)                                                                                                      | The balance
  includes both borrowing under the revolving line of credit in NIS bearing
  interest at a rate of prime + 1% for 2004 and 2003 (as of December 31, 2004
  and 2003, the prime rate is 5.2% and 6.7%, respectively) and borrowings under the
  on-call line of credit in NIS bearing interest of 1.7% + bank cost (3.6%).
| |    |                                                                                                          |                                                                                                                                                                                                                                                                                                                                       
| |    | (2)                                                                                                      | Borrowings under the revolving line
of credit in dollars bearing interest at a rate of LIBOR + 2% for 2004 and 2003 (as of
December 31, 2004 and 2003, the LIBOR rate is 2.375% and 1.125%, respectively).                                                                                                                            
| |    |                                                                                                          |                                                                                                                                                                                                                                                                                                                                       
| | b. | Interest
  expenses amounted to $ 72,404 and $ 68,119 for the years ended 2004 and 2003,
  respectively.

|NOTE 9:- | OTHER ACCOUNTS PAYABLE AND ACCRUALS
|-------- | -----------------------------------

| |                                                          |  | December
  31, |          
| | -------------------------------------------------------- |  | -------------- | ---------
| |                                                          |  |                |          
| |                                                          |  | 2004           |          
| |                                                          |  |                |          
| |                                                          |  |                |          
| | Employees                                                |  | $              | 170,859  
| | Government
  authorities                                 |  |                | 398,403  
| | Accrued
  expenses                                       |  |                | 1,035,750
| | Provision  for accrued  vacation pay                     |  |                | 243,207  
| | Deferred
  revenues                                      |  |                | 299,732  
| | Other
  payables                                         |  |                | 30,000   
| | Provision
  for accrued non-recurring retirement benefit |  |                | -        
| |                                                          |  |                |          
| |                                                          |  |                |          
| |                                                          |  | $              | 2,177,951
| |                                                          |  |                |          

|NOTE 10:- | ACCRUED SEVERANCE PAY, NET
|--------- | --------------------------
|          |                           
|          | a.                        

F-20

---

---

|TOP IMAGE SYSTEMS LTD.
  AND ITS SUBSIDIARIES
|---------------------------------------------
|NOTES
  TO CONSOLIDATED FINANCIAL STATEMENTS 
|                                             
|In U.S. dollars                              

NOTE 10:- ACCRUED SEVERANCE PAY, NET (Cont.)

| | The
  Companys liability for required severance payments is covered by insurance
  policies. The accrual for severance pay reflected in the balance sheets is in
  respect of the uncovered liability.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |                                                                                                                                                                                                        
| | The amounts
  deposited with insurance companies are not under the control of the Company,
  and therefore, are not included in the Companys financial statements.                                    
| |                                                                                                                                                                                                        
| | The balance
  of the liability is presented net of the amount deposited with a recognized
  severance pay fund as follows:                                                                             

| |                       |  | December 31, |        
| | --------------------- |  | ------------ | -------
| |                       |  |              |        
| |                       |  | 2004         |        
| |                       |  |              |        
| |                       |  |              |        
| | Accrued severance pay |  | $            | 757,727
| | Less - amounts funded |  |              | 571,213
| |                       |  |              |        
| |                       |  |              |        
| |                       |  | $            | 186,514
| |                       |  |              |        

| | b. | Severance
  pay expenses amounted to $94,043, $56,839 and $234,819 for the years ended
  December 31, 2004, 2003 and 2002, respectively.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------

NOTE
11:- COMMITMENTS, CONTINGENCIES AND CHARGES

| | a. | Legal
  proceedings:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    | During 2003,
  the Company was named as a defendant in a case brought by Millennium LP
  (Millennium), in the District Court for the Southern District of New York.
  In the case, Millennium asserted that certain image processing systems sold
  or offered for sale by the Company in the United States infringed on certain
  U.S. patents held by Millennium. In 2004, the Company settled the matter for
  $250,000, of which the Company paid $100,000 at the time the settlement
  agreement was finalized. The remainder is being paid in monthly installments
  of $6,250 over a period of 24 months. Pursuant to the settlement agreement,
  Millennium released the Company from any past and future infringement claims
  until the expiration of the patents.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | b. | Commitments:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    | 1.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               

F-21

---

---

|TOP IMAGE SYSTEMS LTD.
  AND ITS SUBSIDIARIES
|---------------------------------------------
|NOTES
  TO CONSOLIDATED FINANCIAL STATEMENTS 
|                                             
|In U.S. dollars                              

NOTE
11:- COMMITMENTS, CONTINGENCIES AND CHARGES (Cont.)

| |  | 2. | The Company
  has entered into an operating lease with Eldan Ltd. for the lease of a fleet
  of 32 motor vehicles. The leasing deposits are presented in the long-term deposits.
  Each lease is for a period of three years with monthly payments linked to the
  Israeli CPI. As of December 31, 2004, commitments are as follows:
| |  | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2005  |  | $ | 211,094 | 
| | ----- |  | - | ------- | 
| | 2006  |  |   | 201,804 | 
| | 2007  |  |   | 80,718  | 
| |       |  |   |         | 
| |       |  |   |         | 
| | Total |  | $ | 493,616 | 
| |       |  |   |         | 

| |  | 3. | The Company
  leases offices for its activities. The remaining obligation periods range
  from one year to three years including extension periods. As of December 31,
  2004, commitments for such leases are as follows:
| |  | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2005  |  | $ | 551,762   | 
| | ----- |  | - | --------- | 
| | 2006  |  |   | 315,327   | 
| | 2007  |  |   | 202,824   | 
| |       |  |   |           | 
| |       |  |   |           | 
| | Total |  | $ | 1,069,913 | 
| |       |  |   |           | 

| |    |          | Part of the
  lease agreements is secured by a bank guarantee in the amount of
  $ 52,928.                                                                                                                                                                                                                                                          
| | -- | -------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |          |                                                                                                                                                                                                                                                                                                                                                     
| |    | 4.       | In 2004 the
  Company renewed an engagement under which it has the right to use third party
  software during fiscal years 2005 and 2006. Pursuant to the agreement, the
  Company agreed to pay an annual license fee equal to the greater of
  $ 300,000 and 2.75% of related sales. The amount is due in four
  quarterly payments for each year.
| |    |          |                                                                                                                                                                                                                                                                                                                                                     
| | c. | Charges:
| |    |          |                                                                                                                                                                                                                                                                                                                                                     
| |    | 1.       | To secure
  compliance with the conditions related to the Companys Approved Enterprise
  status, the Company registered a floating charge on machinery, equipment and
  other assets. The charges are unlimited in amount and it may not be further
  pledged or transferred without prior consent of the beneficiaries.                         
| |    |          |                                                                                                                                                                                                                                                                                                                                                     
| |    | 2.       | To secure
  revolving credit facilities from a bank, the Company recorded a floating
  charge on its plant, assets and goodwill in favor of this bank.                                                                                                                                                                                              
| |    |          |                                                                                                                                                                                                                                                                                                                                                     
| |    | 3.       | To secure
  delivery of services to a customer, the Company issued a bank guarantee in
  the amount of $ 49,415.                                                                                                                                                                                                                                    

F-22

---

---

|TOP IMAGE SYSTEMS LTD.
  AND ITS SUBSIDIARIES
|---------------------------------------------
|NOTES
  TO CONSOLIDATED FINANCIAL STATEMENTS 
|                                             
|In U.S. dollars (except share data)          

NOTE 12:- SHAREHOLDERS
EQUITY

| | a. | On September
  24, 2004, the Company sold 2,524,351 Ordinary shares of the Company at a
  purchase price of $3.16 per share to institutional investors for gross
  proceeds of approximately $8 million. The Company filed a registration
  statement which had become effective by the SEC on March 1, 2005.                                                                                                                                                                                                         
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    | The
  investors also received warrants to purchase up to 1,262,188 Ordinary shares,
  with an exercise price of $4.26 per share. The warrants expire on September
  23, 2007. If the registration statement of the shares and warrants would not
  have become effective by March 24, 2005, the investors could have affected a
  cashless (net issuance) exercise of the warrants.                                                                                                                                   
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    | The Company
  has the right, but not the obligation, to call upon prior notice all or part
  of the warrants if the market price for the Companys Ordinary shares exceeds
  $8.52 for 20 consecutive days. If the Company uses this right, it will issue
  to the holders of the warrants exchange warrants containing the same terms
  and conditions as the warrants redeemed with an exercise price equal to 120%
  of the share price on the day immediately proceeding the call date.                           
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    | In connection with the private
placement, the Company filed a resale registration statement covering the shares purchased
in the private placement (including the shares underlying the warrants). The registration
statement became effective on March 1, 2005. However, the Company did not obtain
effectiveness of the registration statement within the timeframe set forth in its
agreements with the investors, which has subjected the Company to liquidated damages of
approximately $160,000 (plus interest).
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | b. | Stock
  options:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    | 1.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       

F-23

---

---

|TOP IMAGE SYSTEMS LTD.
  AND ITS SUBSIDIARIES
|---------------------------------------------
|NOTES
  TO CONSOLIDATED FINANCIAL STATEMENTS 
|                                             
|In U.S. dollars (except share data)          

NOTE 12:- SHAREHOLDERS EQUITY (Cont.)

| |  |  | c) | Employee
  Stock Option Plan (2000):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |  |  | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  |  |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |  |  |    | The Employee
  Stock Option Plan (2000) (the ESOP 2000) is designed to benefit from, and
  is made pursuant to the provisions of Section 102 of Israel's Income Tax
  Ordinance (New Version), 1961 and the rules promulgated thereunder (Section
  102).                                                                                                                                                                                                                                                                                                                                   
| |  |  |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |  |  |    | A total of
  240,000 shares have been reserved for the purposes of ESOP 2000. As of
  December 31, 2004, 143,500 options are outstanding. All of the options are
  vested over a three-year period, and have exercise prices between $0.99 and
  $ 4.125 per share.                                                                                                                                                                                                                                                                                                                             
| |  |  |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |  |  | d) | Employee
  Stock Option Plan (2003):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |  |  |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |  |  |    | The Employee
  Stock Option Plan (2003) (ESOP 2003) is designed to benefit from, and is
  made pursuant to the provisions of Section 102 of the Israeli Income Tax
  Ordinance.                                                                                                                                                                                                                                                                                                                                                                                                               
| |  |  |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |  |  |    | The Company
  has reserved the minimum number of 181,242 shares, for the purpose of the
  ESOP 2003. The minimum number may be increased by the number of expired
  options from the ESOP 2000 and 96, but not more than 539,242 shares. Any
  shares which remain unissued and which are not subject to the outstanding
  options at the termination of the ESOP 2003 shall cease to be reserved for
  the purpose of the ESOP 2003, but until termination of the ESOP 2003 the
  Company shall at all times reserve a sufficient number of shares to meet the
  requirements of the ESOP 2003.
| |  |  |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |  |  |    | As of December
  31, 2004, 254,000 options are outstanding. All the options have an exercise
  price between $1.31 and $3.27 per share.                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |  |  |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |  |  |    | In May 2004,
  the Board of Directors and the shareholders of the Company approved the
  issuance of options to purchase an additional 650,000 Ordinary shares
  pursuant to ESOP 2003.                                                                                                                                                                                                                                                                                                                                                                                                         
| |  |  |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |  |  | e) | As of
  December 31, 2004, an aggregated amount of 685,917 options is still available
  for future grant under all of  above mentioned plans.                                                                                                                                                                                                                                                                                                                                                                                                                                                   

F-24

---

---

|TOP IMAGE SYSTEMS LTD.
  AND ITS SUBSIDIARIES
|---------------------------------------------
|NOTES
  TO CONSOLIDATED FINANCIAL STATEMENTS 
|                                             
|In U.S. dollars (except share data)          

NOTE 12:- SHAREHOLDERS EQUITY (Cont.)

| |  | 2. | The
  following is a summary of the Companys stock options granted among the
  various plans (not including non-plan grants):
| |  | -- | ------------------------------------------------------------------------------------------------------------------------------

| |                                                                      |  | Year ended December 31, |        
| | -------------------------------------------------------------------- |  | ----------------------- | -------
| |                                                                      |  |                         |        
| |                                                                      |  | 2004                    |        
| |                                                                      |  |                         |        
| |                                                                      |  | Number of options       |        
| |                                                                      |  |                         |        
| | Outstanding at the   beginning of the   year                         |  |                         | 417,875
| | Granted                                                              |  |                         | 153,000
| | Exercised                                                            |  |                         | (23,875
| | Forfeited                                                            |  |                         | (47,625
| |                                                                      |  |                         |        
| | Outstanding at the end   of the year                                 |  |                         | 499,375
| |                                                                      |  |                         |        
| | Exercisable at the end   of the year                                 |  |                         | 260,375
| |                                                                      |  |                         |        
| | Weighted average fair   value of options   granted during the   year |  |                         |        
| |                                                                      |  |                         |        

| |  |  | The options
  outstanding as of December 31, 2004, have been separated into ranges of
  exercise price as follows:
| |  |  | ------------------------------------------------------------------------------------------------------------------

| | Range of
  exercise
  price |  | Options
  Outstanding
  as of
  December 31,
  2004 |  | Weighted
  average
  remaining
  contractual
  life (years) |  | Weighted
  average
  exercise
  price |  | Options
  exercisable
  as of
  December 31,
  2004 |      | Weighted average
  exercise
  price of
  options
  exercisable | 
| | --------------------------- |  | --------------------------------------------------- |  | ----------------------------------------------------------- |  | ------------------------------------- |  | --------------------------------------------------- | ---- | -------------------------------------------------------------- | 
| |                             |  |                                                     |  |                                                             |  |                                       |  |                                                     |      |                                                                | 
| | $0.99-$1.70                 |  |                                                     |  | 157,375                                                     |  |                                       |  |                                                     | 4.92 |                                                                | 
| | $2.08-$2.85                 |  |                                                     |  | 175,000                                                     |  |                                       |  |                                                     | 3.45 |                                                                | 
| | $3-$4.125                   |  |                                                     |  | 151,000                                                     |  |                                       |  |                                                     | 4.95 |                                                                | 
| | $5                          |  |                                                     |  | 16,000                                                      |  |                                       |  |                                                     | 2.00 |                                                                | 
| |                             |  |                                                     |  |                                                             |  |                                       |  |                                                     |      |                                                                | 
| |                             |  |                                                     |  |                                                             |  |                                       |  |                                                     |      |                                                                | 
| |                             |  |                                                     |  | 499,375                                                     |  |                                       |  |                                                     |      |                                                                | 
| |                             |  |                                                     |  |                                                             |  |                                       |  |                                                     |      |                                                                | 

F-25

---

---

|TOP IMAGE SYSTEMS LTD.
  AND ITS SUBSIDIARIES
|---------------------------------------------
|NOTES
  TO CONSOLIDATED FINANCIAL STATEMENTS 
|                                             
|In U.S. dollars (except share data)          

NOTE 12:-  SHAREHOLDERS EQUITY
(Cont.)

| |    | 3.                                                                                                                                                                                                                                                                                                                                   | Share
  purchase agreement:                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                                                                                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    |                                                                                                                                                                                                                                                                                                                                      | In
  consideration of the purchase of 990,000 of E - Mobilis shares, the Board of
  Directors of the Company granted the sellers on November 8, 2001, options to
  purchase 100,000 Ordinary shares that vested immediately, at an exercise
  price of $2 per share. The options will expire three years from the date of
  grant by November 7, 2004. During 2003, 15,000 options were exercised and the
  remaining 85,000 options were exercised during 2004.
| |    |                                                                                                                                                                                                                                                                                                                                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    |                                                                                                                                                                                                                                                                                                                                     
| |    |                                                                                                                                                                                                                                                                                                                                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    | 4.                                                                                                                                                                                                                                                                                                                                   | Options to
  directors:                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |    |                                                                                                                                                                                                                                                                                                                                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    |                                                                                                                                                                                                                                                                                                                                      | On November
  25, 2002, the shareholders of the company approved the grant of an option to
  purchase 20,000 fully vested Ordinary shares at an exercise price of $0.46
  per share, to the Chairman of the Board of Directors. The exercise price was equal
  to the market price of the shares on the date of the grant. As of December
  31, 2004, none of the options were exercised.                                                                       
| |    |                                                                                                                                                                                                                                                                                                                                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | c. | Dividends:                                                                                                                                                                                                                                                                                                                          
| |    |                                                                                                                                                                                                                                                                                                                                     
| |    | Dividends
  may be paid by the Company only out of the Israeli company's earnings and other
  surpluses in Israeli currency as defined in the Companies Law as of the end
  of the most recent fiscal year or as accrued over a period of the last two
  years whichever is higher. Such dividends will be declared and paid in NIS.
| |    |                                                                                                                                                                                                                                                                                                                                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    | The Company
  does not anticipate paying dividends in the foreseeable future.                                                                                                                                                                                                                                                       

NOTE
13:-  RESTRUCTURING COSTS AND OTHER SPECIAL CHARGES

| | a. | As of
  December 31, 2001, in accordance with an agreement with an officer of the
  Company, upon termination of employment, the officer was entitled to receive
  certain benefits which amounted to approximately $706,000 which were paid
  over an 18-month period.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | b. | In October
  2002, the Companys management adopted and began the implementation of a
  restructuring plan. During 2002, the Company observed and experienced the
  effects of the worldwide economic slowdown in IT procurement. Purchasing was
  delayed and decision-making processes on deployment of new resources were
  significantly prolonged as compared with prior periods. Several customers
  delayed or put on hold business opportunities from which the Company expected
  to benefit. The restructuring plan was implemented in order to sustain the
  Companys cash balances and adjust the operations for the revised business
  environment. A key portion of the plan was a reduction in personnel - certain
  positions were eliminated and the descriptions of other positions were
  altered. In accordance with the plan, the Company implemented lay-offs mainly
  in the headquarters located in Israel. The lay-offs included, among others, the
  dismissal of four employees in management positions.

F-26

---

---

|TOP IMAGE SYSTEMS LTD.                    
|------------------------------------------
|AND ITS SUBSIDIARIES                      
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|In U.S. dollars                           

|NOTE 13:- | RESTRUCTURING COSTS AND OTHER SPECIAL CHARGES (Cont.)
|--------- | -----------------------------------------------------
|          |                                                      
|          |                                                      
|          |                                                      
|NOTE 14:- | FINANCIAL INCOME, NET                                

| |                                            |  | Year ended
  December 31, |        
| | ------------------------------------------ |  | ------------------------- | -------
| |                                            |  |                           |        
| |                                            |  | 2004                      |        
| |                                            |  |                           |        
| |                                            |  |                           |        
| | Interest
  income                          |  | $                         | 84,185 
| | Exchange
  rate gain and bank charges      |  |                           | 93,037 
| | Income
  (loss) from marketable securities |  |                           | 2,178  
| |                                            |  |                           |        
| |                                            |  |                           |        
| |                                            |  | $                         | 179,400
| |                                            |  |                           |        

|NOTE 15:- | TAXES ON INCOME
|--------- | ---------------
|          |                
|          | a.             
|          |                
|          |                
|          |                
|          |                
|          |                
|          |                
|          |                
|          |                
|          |                
|          |                

F-27

---

---

|TOP IMAGE SYSTEMS LTD.                    
|------------------------------------------
|AND ITS SUBSIDIARIES                      
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|In U.S. dollars                           

|NOTE 15:- | TAXES ON INCOME (Cont.)
|--------- | -----------------------
|          |                        
|          |                        
|          |                        
|          |                        
|          |                        
|          |                        
|          |                        
|          |                        
|          |                        
|          |                        
|          |                        
|          |                        
|          |                        
|          |                        
|          |                        
|          |                        
|          |                        
|          |                        

F-28

---

---

|TOP IMAGE SYSTEMS LTD.                    
|------------------------------------------
|AND ITS SUBSIDIARIES                      
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|In U.S. dollars                           

|NOTE 15:- | TAXES ON INCOME (Cont.)
|--------- | -----------------------
|          |                        
|          | b.                     
|          |                        
|          | c.                     
|          |                        
|          |                        
|          |                        
|          |                        
|          |                        
|          | d.                     
|          |                        
|          |                        

F-29

---

---

|TOP IMAGE SYSTEMS LTD.                    
|------------------------------------------
|AND ITS SUBSIDIARIES                      
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|In U.S. dollars                           

|NOTE 16:- | SELECTED STATEMENTS OF OPERATIONS DATA
|--------- | --------------------------------------
|          |                                       
|          | a.                                    
|          |                                       
|          |                                       
|          |                                       
|          |                                       
|          |                                       
|          | b.                                    

| |  |                                                          |                                  | Year ended December 31, |           
| |  | -------------------------------------------------------- | -------------------------------- | ----------------------- | ----------
| |  |                                                          |                                  |                         |           
| |  |                                                          |                                  | 2004                    |           
| |  |                                                          |                                  |                         |           
| |  | Product
  sales:                                         |                                  |                         |           
| |  |                                                          | Israel                           |                         | $         
| |  |                                                          | Far East
  (excluding Japan)     |                         |           
| |  |                                                          | Europe                           |                         |           
| |  |                                                          | North
  America                  |                         |           
| |  |                                                          | South
  America                  |                         |           
| |  |                                                          | Africa                           |                         |           
| |  |                                                          | Middle East
  (excluding Israel) |                         |           
| |  |                                                          | Japan                            |                         |           
| |  |                                                          | Other                            |                         |           
| |  |                                                          |                                  |                         |           
| |  |                                                          |                                  |                         |           
| |  |                                                          |                                  |                         | 6,964,418 
| |  |                                                          |                                  |                         |           
| |  | Service
  revenues:                                      |                                  |                         |           
| |  |                                                          | Israel                           |                         |           
| |  |                                                          | Far East
  (excluding Japan)     |                         |           
| |  |                                                          | Europe                           |                         |           
| |  |                                                          | North
  America                  |                         |           
| |  |                                                          | South
  America                  |                         |           
| |  |                                                          | Africa                           |                         |           
| |  |                                                          | Middle East
  (excluding Israel) |                         |           
| |  |                                                          | Japan                            |                         |           
| |  |                                                          |                                  |                         |           
| |  |                                                          |                                  |                         |           
| |  |                                                          |                                  |                         | 4,214,030 
| |  |                                                          |                                  |                         |           
| |  |                                                          |                                  |                         |           
| |  | Total
  revenues                                         |                                  | $                       | 11,178,448
| |  |                                                          |                                  |                         |           
| |  |                                                          |                                  |                         |           
| |  | Sales to
  single customers exceeding 10% of
     sales: |                                  |                         |           
| |  |                                                          | Customer A                       |                         |           
| |  |                                                          |                                  |                         |           
| |  |                                                          |                                  |                         |           
| |  |                                                          | Customer B                       |                         |           
| |  |                                                          |                                  |                         |           

| |  | The
  Companys substantial long-lived assets are located in Israel.
| |  | --------------------------------------------------------------------

F-30

---

---

|TOP IMAGE SYSTEMS LTD.                    
|------------------------------------------
|AND ITS SUBSIDIARIES                      
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|In U.S. dollars                           

|NOTE 17:- | TRANSACTIONS AND BALANCES WITH RELATED PARTIES                                                                  
|--------- | ----------------------------------------------------------------------------------------------------------------
|          |                                                                                                                 
|          | The
  following transactions between the Company and related parties are included
  in the financial statements:

| |    |                                                                                    |  | Year ended December 31, |       
| | -- | ---------------------------------------------------------------------------------- |  | ----------------------- | ------
| |    |                                                                                    |  |                         |       
| |    |                                                                                    |  | 2004                    |       
| |    |                                                                                    |  |                         |       
| | a. | Salaries and  benefit expenses to officers who      are directors and shareholders |  | $                       | -     
| |    |                                                                                    |  |                         |       
| |    |                                                                                    |  |                         |       
| |    | Directors
  fees *)                                                                |  | $                       | 62,162
| |    |                                                                                    |  |                         |       

| |    | *)                                                                                                                                                                                                                                                                         | The Company
  has eight directors.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ----------------------------------
| |    |                                                                                                                                                                                                                                                                           
| | b. | Based on a resolution of the
shareholders of the Company, one of its directors was entitled to an amount of $ 253,777
for consulting fees during the year 2004, in regard to the acquisition of the business in
Japan which was recorded as part of the acquisition costs.

F-31

---

---

|TOP IMAGE SYSTEMS LTD. 
  AND ITS SUBSIDIARIES
|----------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS    
|                                              
|In U.S. dollars (except share data)           

|NOTE 18:- | LOSS PER SHARE                                                                                  
|--------- | ------------------------------------------------------------------------------------------------
|          |                                                                                                 
|          | a.                                                                                              
|          |                                                                                                 
|          |                                                                                                 
|          |                                                                                                 
|          |                                                                                                 
|          |                                                                                                 
|          |                                                                                                 
|          |                                                                                                 
|          | Number of shares and loss,
  according to the 
     statement of operations                     
|          | Effect of options whose
  exercise is probable                                                  
|          |                                                                                                 
|          | Number of shares and net loss  used for calculation of     basic and diluted net loss per share.
|          |                                                                                                 
|          |                                                                                                 
|          | b.                                                                                              
|          |                                                                                                 
|          | c.                                                                                              
|          |                                                                                                 

F-32

---

---

|TOP IMAGE SYSTEMS LTD.
  AND ITS SUBSIDIARIES
|---------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   
|                                             
|In U.S. dollars                              

|NOTE 19:- | EFFECT OF MATERIAL DIFFERENCES BETWEEN GENERALLY ACCEPTED ACCOUNTING
  PRINCIPLES IN ISRAEL AND IN THE UNITED STATES
|--------- | --------------------------------------------------------------------------------------------------------------------
|          |                                                                                                                     
|          | a.                                                                                                                  
|          |                                                                                                                     
|          |                                                                                                                     
|          |                                                                                                                     
|          |                                                                                                                     
|          |                                                                                                                     
|          |                                                                                                                     
|          |                                                                                                                     
|          |                                                                                                                     
|          |                                                                                                                     
|          |                                                                                                                     
|          |                                                                                                                     
|          |                                                                                                                     
|          |                                                                                                                     
|          |                                                                                                                     
|          |                                                                                                                     
|          |                                                                                                                     
|          |                                                                                                                     
|          |                                                                                                                     
|          |                                                                                                                     
|          |                                                                                                                     

F-33

---

---

|TOP IMAGE SYSTEMS LTD.
  AND ITS SUBSIDIARIES
|---------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   
|                                             
|In U.S. dollars                              

|NOTE 19:- | EFFECT OF MATERIAL DIFFERENCES BETWEEN GENERALLY ACCEPTED ACCOUNTING
  PRINCIPLES IN ISRAEL AND IN THE UNITED STATES (Cont.)
|--------- | ----------------------------------------------------------------------------------------------------------------------------
|          |                                                                                                                             
|          |                                                                                                                             
|          |                                                                                                                             
|          |                                                                                                                             
|          |                                                                                                                             
|          |                                                                                                                             
|          |                                                                                                                             
|          |                                                                                                                             

F-34

---

---

|TOP IMAGE SYSTEMS LTD. 
  AND ITS SUBSIDIARIES
|----------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS    
|                                              
|In U.S. dollars                               

|NOTE 19:- | EFFECT OF MATERIAL DIFFERENCES BETWEEN GENERALLY ACCEPTED ACCOUNTING
  PRINCIPLES IN ISRAEL AND IN THE UNITED STATES (Cont.)
|--------- | ----------------------------------------------------------------------------------------------------------------------------
|          |                                                                                                                             
|          |                                                                                                                             
|          |                                                                                                                             
|          |                                                                                                                             
|          |                                                                                                                             
|          |                                                                                                                             
|          |                                                                                                                             
|          | Loss:                                                                                                                       
|          | U.S. GAAP as
  reported in Note 19b(2)                                                                                      
|          |                                                                                                                             
|          | Deduct -
  Stock-based employee
     compensation - intrinsic value                                                         
|          |                                                                                                                             
|          | Add -
  Stock-based compensation 
     expense determined under fair value 
     method for all awards                      
|          |                                                                                                                             
|          |                                                                                                                             
|          | Pro forma
  loss                                                                                                            
|          |                                                                                                                             
|          |                                                                                                                             
|          | Pro forma
  basic and diluted net loss per 
     share                                                                      
|          |                                                                                                                             
|          |                                                                                                                             
|          | Basic and
  diluted net loss per share as 
     reported under U.S. GAAP in Note 
     19b(3)                               
|          |                                                                                                                             
|          |                                                                                                                             
|          |                                                                                                                             
|          |                                                                                                                             
|          |                                                                                                                             
|          |                                                                                                                             

F-35

---

---

|TOP IMAGE SYSTEMS LTD.
 AND ITS SUBSIDIARIES
|--------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  
|                                            
|In U.S. dollars                             

| | 4. | Impairment
 of long-lived assets:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |    | According to
 U.S. GAAP, the Companys long-lived assets are reviewed for impairment in
 accordance with Statement of Financial Accounting Standard No. 144,
 Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS No.
 144), whenever events or changes in circumstances indicate that the carrying
 amount of an asset may not be recoverable. Recoverability of assets to be
 held and used is measured by a comparison of the carrying amount of an asset
 to the future undiscounted cash flows expected to be generated by the assets.
 If such assets are considered to be impaired, the impairment to be recognized
 is measured by the amount by which the carrying amount of the assets exceeds
 the fair value of the assets.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

|NOTE 19:- | EFFECT OF MATERIAL DIFFERENCES BETWEEN GENERALLY ACCEPTED ACCOUNTING
 PRINCIPLES IN ISRAEL AND IN THE UNITED STATES (Cont.)
|--------- | ---------------------------------------------------------------------------------------------------------------------------

| |    | The accounting treatment according to Israeli GAAP is described in Note 2k.                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    | There was no
 impairment loss due to either Israeli GAAP or U.S. GAAP.                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | 5. | Accrued
 severance pay:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    | Under U.S.
 GAAP, the Company applies EITF 88-1, Determination of Vested Benefit
 Obligation for a Defined Benefit Pension Plan under which deferred vested
 benefits should record the obligation as if it was payable at each balance
 sheet date. Accrued severance pay is included in the balance sheet under
 total liabilities. Amounts funded through provident funds and insurance
 policies are included as an asset on the Companys balance sheet. Income from
 earnings on amounts funded is added to the severance pay fund.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    | According to Israeli GAAP, accrued severance pay is included in the balance sheets net of severance pay fund.                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    | See Note 10
 for the related presentation in the balance sheets.                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

F-36

---

---

|TOP IMAGE SYSTEMS LTD.
 AND ITS SUBSIDIARIES
|--------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  
|                                            
|In U.S. dollars                             

| | 6. | Comprehensive
 income:                                                                                                                                                                                                                                 
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                        
| |    | Under U.S. SFAS 130, Reporting
Comprehensive Income, the Company should include and display the specific income
component as comprehensive income as part of the shareholders equity. Under Israeli
GAAP, there are no such disclosure requirements.
| |    |                                                                                                                                                                                                                                                        
| |    | See 4 below for the presentation of the statements of changes in shareholders' equity under U.S. GAAP.                                                                                                                                                 
| |    |                                                                                                                                                                                                                                                        
| |    | Comprehensive
 income consists of net loss and net unrealized gain (losses) on securities
 and is presented as a separate component in the statement of changes in
 shareholders equity.                                                              
| |    |                                                                                                                                                                                                                                                        
| | 7. | Treatment of
 deferred income taxes:                                                                                                                                                                                                                   
| |    |                                                                                                                                                                                                                                                        
| |    | Under U.S.
 GAAP, deferred tax assets are reduced by a valuation allowance if based on
 the weight of available evidences it is more likely than not that some portion
 or all of the deferred tax assets will not be realized.                        
| |    |                                                                                                                                                                                                                                                        
| |    | Under
 Israeli GAAP, deferred tax assets are not recognized when it is not probable
 that the deferred tax assets will be realized.                                                                                                                    
| |    |                                                                                                                                                                                                                                                        
| |    | All deferred
 tax assets under U.S. GAAP were fully reduced by a valuation allowance and
 therefore there is no effect of the difference between Israeli GAAP and U.S.
 GAAP.                                                                          

F-37

---

---

|TOP IMAGE SYSTEMS LTD.
 AND ITS SUBSIDIARIES
|--------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  
|                                            
|In U.S. dollars                             

|NOTE 19:- | EFFECT OF MATERIAL DIFFERENCES BETWEEN GENERALLY ACCEPTED ACCOUNTING
 PRINCIPLES IN ISRAEL AND IN THE UNITED STATES (Cont.)
|--------- | ---------------------------------------------------------------------------------------------------------------------------
|          |                                                                                                                            
|          |                                                                                                                            

| |                                                                           |  | December
 31, |           
| | ------------------------------------------------------------------------- |  | ------------- | ----------
| |                                                                           |  |               |           
| |                                                                           |  | 2004          |           
| |                                                                           |  |               |           
| |                                                                           |  |               |           
| | Carryforward
 losses                                                      |  | $             | 3,920,167 
| | Accrued severance pay                                                     |  |               | 63,415    
| | Accrued vacation pay                                                      |  |               | 82,690    
| | Allowance
 for doubtful accounts                                          |  |               | 311,697   
| | Provision
 for restructuring costs, bonuses and
    other special charges |  |               | 44,426    
| |                                                                           |  |               |           
| |                                                                           |  |               |           
| | Net deferred
 tax assets before valuation
    allowance                   |  |               | 4,422,395 
| | Valuation
 allowance                                                      |  |               | (4,422,395
| |                                                                           |  |               |           
| |                                                                           |  |               |           
| | Net deferred
 tax assets                                                  |  | $             | -         
| |                                                                           |  |               |           

| |  |  | The deferred
 taxes are calculated using the tax rates expected to apply at the year they
 will be utilized, as known as of the balance sheet date.                                                                                                                                            
| |  |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  |  |                                                                                                                                                                                                                                                                                                
| |  |  | The Group
 provided valuation allowances in respect of deferred tax assets resulting from
 losses carryforward and other temporary differences, since it has a history
 of losses. Management currently believes that it is more likely than not that
 the deferred taxes will not be realized.

| | 8. | Loss before
 taxes on income:                   
| | -- | ------------------------------------------------
| |    |                                                 
| |    | Additional
 disclosure required under U.S. GAAP:

| |          |  | Year ended
 December 31, |         
| | -------- |  | ------------------------ | --------
| |          |  |                          |         
| |          |  | 2004                     |         
| |          |  |                          |         
| |          |  |                          |         
| | Domestic |  | $                        | (85,538 
| | Foreign  |  |                          | (92,854 
| |          |  |                          |         
| |          |  |                          |         
| |          |  | $                        | (178,392
| |          |  |                          |         

| | 9. | Segment
 information:                                                                                                                                                                                                                                                                                                                                                                                                                   
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |    | According to
 Israeli GAAP, segment disclosures are provided in accordance with the
 Accounting Standard No. 11, Segment Reporting, which defines a business
 segment as a distinguishable component of an enterprise that is engaged in
 providing an individual product or service (or a group of related products or
 services) and that is subject to risks and returns that are different from
 those of other business segments.

F-38

---

---

|TOP IMAGE SYSTEMS LTD.
 AND ITS SUBSIDIARIES
|--------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  
|                                            
|In U.S. dollars                             

|NOTE 19:- | EFFECT OF MATERIAL DIFFERENCES BETWEEN GENERALLY ACCEPTED ACCOUNTING
 PRINCIPLES IN ISRAEL AND IN THE UNITED STATES (Cont.)
|--------- | ---------------------------------------------------------------------------------------------------------------------------

| |     | According to
 U.S. GAAP, segment disclosures are provided in accordance with the guidance
 of Statement of Financial Accounting Standard No. 131, Segment Reporting
 (SFAS No. 131), which defines a business as a component of an enterprise
 that (a) engages in business activities from which it may earn revenues and
 incur expenses (including revenues and expenses relating to transactions with
 other components of the same enterprise); (b) whose operating results are
 regularly reviewed by the enterprises chief operating decision-maker to make
 decisions about resources to be allocated to the segment and assess its
 performance; and (c) for which discreet financial information is available.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |     | For all
 years presented, there were no material differences between those two
 disclosure requirements, as both definitions resulted in the same one
 reportable segment.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | 10. | Loss per
 share:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |     | According to
 Israeli GAAP, in accordance with Statement No. 55 of the Institute of
 Certified Public Accountants in Israel, the dilutive effect of options,
 warrants and other convertible securities is included in the computation of
 basic net loss per share if their being exercised is considered to be
 probable, based on the ordinary relationship between the market price of the
 shares issuable upon the exercise of the options, warrants and other
 convertible securities, and the discounted present value of the future
 proceeds derived from the exercise of such options, warrants and convertible
 securities.                                                                                      
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |     | According to
 U.S. GAAP, basic net loss per share is computed based on the weighted average
 number of Ordinary shares outstanding during each year. Diluted net income
 per share is computed based on the weighted average number of Ordinary shares
 outstanding during each year, plus dilutive potential Ordinary shares
 considered outstanding during the year, in accordance with FASB Statement No.
 128, Earnings per Share.                                                                                                                                                                                                                                                                                     
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |     | See Note
 19b.(3) for the reconciliation of EPS.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | 11. | Business
 combination:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |     | a)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              

F-39

---

---

|TOP IMAGE SYSTEMS LTD.
 AND ITS SUBSIDIARIES
|--------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  
|                                            
|In U.S. dollars                             

|NOTE 19:- | EFFECT OF MATERIAL DIFFERENCES BETWEEN GENERALLY ACCEPTED ACCOUNTING
 PRINCIPLES IN ISRAEL AND IN THE UNITED STATES (Cont.)
|--------- | ---------------------------------------------------------------------------------------------------------------------------
|          |                                                                                                                            

| |  |    | SFAS No. 142
 requires goodwill to be tested for impairment on adoption and at least
 annually thereafter or between annual tests in certain circumstances, and
 written down when impaired, rather than being amortized as previous
 accounting standards required. Goodwill attributable to each of the reporting
 units is tested for impairment by comparing the fair value of each reporting
 unit with its carrying value. Fair value is determined using discounted cash
 flows, market multiples and market capitalization. Significant estimates used
 in the methodologies include estimates of future cash flows, future
 short-term and long-term growth rates, weighted average cost of capital and
 estimates of market multiples for each of the reportable units.
| |  | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |  |    | As of
 December 31, 2004, the effect of the accounting difference on the financial
 statements was $11,630 which were recorded as goodwill amortization under
 Israeli GAAP and will not be recorded as expenses under U.S. GAAP.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |  |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |  | b) | Pro forma
 disclosure:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |  |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |  |    | Under
 Statement of Financial Accounting Standards No. 141, Business Combinations
 (SFAS No. 141), pro forma information is required for business
 combinations.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |  |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |  |    | Under
 Israeli GAAP, no pro forma disclosure is required for a business combination,
 but rather it is required to provide a disclosure of the impact of the acquisition
 (see Note 1(d)).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       

F-40

---

---

|TOP IMAGE SYSTEMS LTD.
 AND ITS SUBSIDIARIES
|--------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  
|                                            
|In U.S. dollars (except share data)         

|NOTE 19:- | EFFECT OF MATERIAL DIFFERENCES BETWEEN GENERALLY ACCEPTED ACCOUNTING
 PRINCIPLES IN ISRAEL AND IN THE UNITED STATES (Cont.)
|--------- | ---------------------------------------------------------------------------------------------------------------------------

| |  |                                                                                                                                                                                                                                                                                                                       
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The
 following unaudited pro forma information represents what the Companys
 results of operations would have been had the acquisitions of Toyo (see Note
 1(d)) occurred on January 1, 2003 and 2004. The information does not purport
 to represent the results of operations of the Company for any future period.

| |                                                                                                   |  | Year ended
 December 31, |           
| | ------------------------------------------------------------------------------------------------- |  | ------------------------ | ----------
| |                                                                                                   |  |                          |           
| |                                                                                                   |  | 2004                     |           
| |                                                                                                   |  |                          |           
| |                                                                                                   |  |                          |           
| | Revenues                                                                                          |  | $                        | 11,178,448
| |                                                                                                   |  |                          |           
| |                                                                                                   |  |                          |           
| | Net loss
 U.S. GAAP                                                                              |  | $                        | (167,927  
| |                                                                                                   |  |                          |           
| |                                                                                                   |  |                          |           
| | Basic and diluted net loss per share for continuing    operations                                 |  | $                        | (0.02     
| |                                                                                                   |  |                          |           
| |                                                                                                   |  |                          |           
| | Weighted average number of Ordinary shares in computation of basic and diluted net loss per share |  |                          | 6,905,559 
| |                                                                                                   |  |                          |           

| | b. | The effect
 of the material differences between Israeli and U.S. GAAP of the
 aforementioned items on the financial statements is as follows:
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                              
| |    | 1.                                                                                                                                           

| |                                                      |  | December
 31, 2004 |   | December
 31, 2003 |  
| | ---------------------------------------------------- |  | ------------------ | - | ------------------ | -
| |                                                      |  |                    |   |                    |  
| |                                                      |  | As per IsraeliGAAP |   | Adjustment         |  
| |                                                      |  |                    |   |                    |  
| | Assets:                                              |  |                    |   |                    |  
| | Amounts funded with    respect of
 severance
    pay |  |                    | $ | -                  |  
| | Goodwill                                             |  |                    |   | 453,584            |  
| |                                                      |  |                    |   |                    |  
| |                                                      |  |                    |   |                    |  
| | Total assets                                         |  |                    | $ | 19,159,663         |  
| |                                                      |  |                    |   |                    |  
| | Liabilities:                                         |  |                    |   |                    |  
| | Amounts funded with
    respect of severance
    pay |  |                    | $ | (571,213           | )
| | Shareholders equity                                 |  |                    |   | (14,683,525        | )
| |                                                      |  |                    |   |                    |  
| |                                                      |  |                    |   |                    |  
| | Total liabilities and
    Shareholders equity       |  |                    | $ | (19,159,663        | )
| |                                                      |  |                    |   |                    |  

F-41

---

---

TOP IMAGE SYSTEMS LTD.
AND ITS SUBSIDIARIES

|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|------------------------------------------
|                                          
|In U.S. dollars (except share data)       

|NOTE 19:- | EFFECT OF MATERIAL DIFFERENCES BETWEEN
  GENERALLY ACCEPTED ACCOUNTING PRINCIPLES IN ISRAEL AND IN THE UNITED STATES
  (Cont.)
|--------- | ------------------------------------------------------------------------------------------------------------------------------
|          |                                                                                                                               

| |  | 2. | On statements of operations items:                                                                               
| |  | -- | -----------------------------------------------------------------------------------------------------------------
| |  |    |                                                                                                                  
| |  |    | Loss from
  securities defined as available for sale and goodwill amortization should be
  reconciled as follows:

| |                                                                                                         |  | Year ended
  December 31, |         
| | ------------------------------------------------------------------------------------------------------- |  | ------------------------- | --------
| |                                                                                                         |  |                           |         
| |                                                                                                         |  | 2004                      |         
| |                                                                                                         |  |                           |         
| |                                                                                                         |  |                           |         
| | Net loss -
  Israeli GAAP                                                                               |  | $                         | (178,392
| | Net adjustment to comprehensive income in respect of unrealized losses (gains) on marketable securities |  |                           | (1,165  
| | Goodwill
  amortization expenses                                                                        |  |                           | 11,630  
| |                                                                                                         |  |                           |         
| |                                                                                                         |  |                           |         
| | Net loss - U.S.
  GAAP                                                                                  |  | $                         | (167,927
| |                                                                                                         |  |                           |         

| |  | 3. | On net loss per
  Ordinary share:                                                          
| |  | -- | -------------------------------------------------------------------------------------------
| |  |    |                                                                                            
| |  |    | The
  following table sets forth the computation of basic and diluted net loss per
  share:

| |                                                                                              |  | Year ended
  December 31, |          
| | -------------------------------------------------------------------------------------------- |  | ------------------------- | ---------
| |                                                                                              |  |                           |          
| |                                                                                              |  | 2004                      |          
| |                                                                                              |  |                           |          
| |                                                                                              |  |                           |          
| | Numerator  for basic and diluted net loss per     share - net loss available to shareholders |  | $                         | (167,927 
| |                                                                                              |  |                           |          
| | Weighted
  average shares outstanding:                                                       |  |                           |          
| |                                                                                              |  |                           |          
| | Denominator  for basic net loss per share                                                    |  |                           | 6,905,559
| | Effect of
  dilutive securities                                                              |  |                           | *) -     
| |                                                                                              |  |                           |          
| |                                                                                              |  |                           |          
| | Denominator  for diluted net loss per share                                                  |  |                           | 6,905,559
| |                                                                                              |  |                           |          
| |                                                                                              |  |                           |          
| | Basic and  diluted net loss per share                                                        |  | $                         | (0.02    
| |                                                                                              |  |                           |          

| |  |  | *)     Anti
  dilutive.
| |  |  | -----------------------

F-42

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TOP IMAGE SYSTEMS LTD.
AND ITS SUBSIDIARIES

|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|------------------------------------------
|                                          
|In U.S. dollars (except share data)       

|NOTE 19:- | EFFECT OF MATERIAL DIFFERENCES BETWEEN
  GENERALLY ACCEPTED ACCOUNTING PRINCIPLES IN ISRAEL AND IN THE UNITED STATES
  (Cont.)
|--------- | ------------------------------------------------------------------------------------------------------------------------------

| |  | 4. | Statement of
  changes in shareholders equity and comprehensive income (loss):
| |  | -- | -------------------------------------------------------------------------------

| |                                                                  |  | Amount |        | Additional
  paid-in
  capital |   | Accumulated
  other
  comprehensive
  income (loss) |  | Accumulated
  deficit |   | Comprehensive
  income (loss) |   | Total | 
| | ---------------------------------------------------------------- |  | ------ | ------ | ------------------------------ | - | --------------------------------------------------- |  | --------------------- | - | ----------------------------- | - | ----- | 
| |                                                                  |  |        |        |                                |   |                                                     |  |                       |   |                               |   |       | 
| |                                                                  |  |        |        |                                |   |                                                     |  |                       |   |                               |   |       | 
| | Balance at January 1, 2002                                       |  | $      | 73,079 |                                | $ | 22,329,513                                          |  |                       | $ | 10,179                        |   |       | 
| |                                                                  |  |        |        |                                |   |                                                     |  |                       |   |                               |   |       | 
| |                                                                  |  |        |        |                                |   |                                                     |  |                       |   |                               |   |       | 
| | Net unrealized losses on
     available-for-sale
     securities |  |        | -      |                                |   | -                                                   |  |                       |   | (2,243                        | ) |       | 
| | Net Loss                                                         |  |        | -      |                                |   | -                                                   |  |                       |   | -                             |   |       | 
| |                                                                  |  |        |        |                                |   |                                                     |  |                       |   |                               |   |       | 
| | Comprehensive loss                                               |  |        |        |                                |   |                                                     |  |                       |   |                               |   |       | 
| |                                                                  |  |        |        |                                |   |                                                     |  |                       |   |                               |   |       | 
| | Amortization of deferred
     stock compensation                 |  |        | -      |                                |   | 9,456                                               |  |                       |   | -                             |   |       | 
| |                                                                  |  |        |        |                                |   |                                                     |  |                       |   |                               |   |       | 
| |                                                                  |  |        |        |                                |   |                                                     |  |                       |   |                               |   |       | 
| | Balance at December 31,
     2002                                |  |        | 73,079 |                                |   | 22,338,969                                          |  |                       |   | 7,936                         |   |       | 
| | Net unrealized losses on
     available-for-sale
     securities |  |        | -      |                                |   | -                                                   |  |                       |   | (10,459                       | ) |       | 
| | Net loss                                                         |  |        | -      |                                |   | -                                                   |  |                       |   | -                             |   |       | 
| |                                                                  |  |        |        |                                |   |                                                     |  |                       |   |                               |   |       | 
| | Comprehensive loss                                               |  |        |        |                                |   |                                                     |  |                       |   |                               |   |       | 
| |                                                                  |  |        |        |                                |   |                                                     |  |                       |   |                               |   |       | 
| | Exercise of stock options                                        |  |        | 195    |                                |   | 40,761                                              |  |                       |   | -                             |   |       | 
| | Amortization of deferred
     stock compensation                 |  |        | -      |                                |   | 532                                                 |  |                       |   | -                             |   |       | 
| |                                                                  |  |        |        |                                |   |                                                     |  |                       |   |                               |   |       | 
| |                                                                  |  |        |        |                                |   |                                                     |  |                       |   |                               |   |       | 
| | Balance at December 31,
     2003                                |  |        | 73,274 |                                |   | 22,380,262                                          |  |                       |   | (2,523                        | ) |       | 
| | Net unrealized gains on
     available-for-sale
     securities  |  |        | -      |                                |   | -                                                   |  |                       |   | 1,165                         |   |       | 
| | Net loss                                                         |  |        | -      |                                |   | -                                                   |  |                       |   | -                             |   |       | 
| |                                                                  |  |        |        |                                |   |                                                     |  |                       |   |                               |   |       | 
| | Comprehensive loss                                               |  |        |        |                                |   |                                                     |  |                       |   |                               |   |       | 
| |                                                                  |  |        |        |                                |   |                                                     |  |                       |   |                               |   |       | 
| | Issuance of shares and
     warrants, net                        |  |        | 22,519 |                                |   | 6, 959,647                                          |  |                       |   | -                             |   |       | 
| | Exercise of stock options                                        |  |        | 973    |                                |   | 239,072                                             |  |                       |   | -                             |   |       | 
| |                                                                  |  |        |        |                                |   |                                                     |  |                       |   |                               |   |       | 
| |                                                                  |  |        |        |                                |   |                                                     |  |                       |   |                               |   |       | 
| | Balance at December 31,
     2004                                |  | $      | 96,672 |                                | $ | 29,579,075                                          |  |                       | $ | (1,358                        | ) |       | 
| |                                                                  |  |        |        |                                |   |                                                     |  |                       |   |                               |   |       | 

F-43

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TOP IMAGE SYSTEMS LTD.
AND ITS SUBSIDIARIES

|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|------------------------------------------
|                                          
|In U.S. dollars                           

|NOTE 19:- | EFFECT OF MATERIAL DIFFERENCES BETWEEN
  GENERALLY ACCEPTED ACCOUNTING PRINCIPLES IN ISRAEL AND IN THE UNITED STATES
  (Cont.)
|--------- | ------------------------------------------------------------------------------------------------------------------------------

| |  | 5. | Statements
  of cash flows:
| |  | -- | ---------------------------
| |  |    |                            

| |  |  | a) | Cash paid
  for taxes on income during the years ended December 31, 2004, 2003 and 2002
  amounted to $ 0, $ 0 and $ 33,296, respectively.                                                                                                                                                                                                                                                       
| |  |  | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  |  |    |                                                                                                                                                                                                                                                                                                                                                                                                  
| |  |  |    |                                                                                                                                                                                                                                                                                                                                                                                                  
| |  |  | b) | Cash paid
  for interest during the years ended December 31, 2004, 2003 and 2002 amounted
  to $ 72,404, $ 20,226 and $ 123,692, respectively.                                                                                                                                                                                                                                                   
| |  |  |    |                                                                                                                                                                                                                                                                                                                                                                                                  
| |  |  | c) | For U.S.
  GAAP - SFAS 95, the effect of exchange rate changes on cash balances held in
  other non-dollar currencies shall be reported as a separate part of the
  reconciliation of the change in cash and cash equivalents during the period.
  The effect of exchange rate changes during the years ended December 31, 2004,
  2003 and 2002 was $ 1,689, $ (237) and $ (5,000) respectively.
| |  |  |    |                                                                                                                                                                                                                                                                                                                                                                                                  
| |  |  |    | For Israeli
  GAAP, no such disclosures are necessary.                                                                                                                                                                                                                                                                                                                                           

|NOTE 20:- | RECENT ACCOUNTING PRONOUNCEMENTS
|--------- | --------------------------------

| |  | On December 16, 2004, the Financial
Accounting Standards Board (FASB) issued SFAS No. 123 (revised 2004), Share-Based
Payment (SFAS 123(R)), which is a revision of SFAS 123. Generally, the
approach in SFAS 123(R) is similar to the approach described in SFAS 123. However, SFAS
123 permitted, but did not require, share-based payments to employees to be recognized
based on their fair values while SFAS 123(R) requires all share-based payments to
employees to be recognized based on their fair values. SFAS 123(R) also revises, clarifies
and expands guidance in several areas, including measuring fair value, classifying an
award as equity or as a liability and attributing compensation cost to reporting periods.
The new Standard will be effective for the Company in the first interim period beginning
after June 15, 2005. The adoption of SFAS 123(R) will have a significant effect on the
Companys results of operations.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |  | SFAS 123(R)
  must be adopted no later than July 1, 2005. Early adoption is permitted in
  periods in which financial statements have not yet been issued. The Company
  expects to adopt SFAS 123(R) on July 1, 2005.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |  | SFAS 123(R)
  permits companies to adopt its requirements using one of the following two
  methods:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |  | 1.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

F-44

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---

TOP IMAGE SYSTEMS LTD.
AND ITS SUBSIDIARIES

|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|------------------------------------------
|                                          
|In U.S. dollars (except share data)       

|NOTE 20:- | RECENT ACCOUNTING PRONOUNCEMENTS (Cont.)
|--------- | ----------------------------------------

| |  | 2.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        | The
  modified retrospective method, which includes the requirements of the
  modified prospective method described above, but also permits entities to
  restate based on the amounts previously recognized under SFAS 123, for
  purposes of pro forma disclosures either (i) all prior periods presented or
  (ii) the prior interim period of the year of adoption.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |                                                                                                                                                                                                                                                                                                                                                                          
| |  | As permitted by SFAS 123, the
Company currently accounts for share-based payments to employees using APB 25, The
Intrinsic Value Method, and, as such, recognizes no compensation cost for employee
stock options. Accordingly, the adoption of the SFAS 123(R)s fair value method will
have a significant impact on the Companys results of operations, although it will
have no impact on the Companys overall financial position. The impact of the
adoption of SFAS 123(R) cannot be predicted at this time, as it depends on levels of
share-based payments for future grant. However, had the Company adopted SFAS 123(R) in
prior periods, the impact of that Standard would have approximated the impact of SFAS 123,
as described in the disclosure of the pro forma net loss and net loss per share above.
| |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |                                                                                                                                                                                                                                                                                                                                                                          

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

F-45

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