---

---

UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

FORM 20-F

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

OR

|  |                                                                                                                                
|- | -------------------------------------------------------------------------------------------------------------------------------
|x | ANNUAL REPORT PURSUANT
  TO SECTION 13 OR 15(d) OF
  THE SECURITIES EXCHANGE ACT OF 1934the fiscal year ended December 31, 2006

OR

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

OR

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

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 Hahayal, Tel Aviv
69710, Israel(Address of principal executive offices)



---

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

|                                                    |  |                         
|--------------------------------------------------- |  | ------------------------
|                                                    |  | Name of each exchange on
|Title of each class                                 |  | which registered        
|                                                    |  |                         
|Ordinary Shares, nominal
  value NIS 0.04 per share |  | NASDAQ Capital Market   

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

None

Securities for which there is a reporting
obligation pursuant to Section 15(d) of the Act:

None

---

---



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

8,845,241 Ordinary Shares

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

Yes o No x

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

Yes o No x

Note 
Checking the box above will not relieve any registrant required to file reports
pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from
their obligations under those Sections.

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

Yes x
No o

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

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

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

Item 17 o
Item 18 x

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

Yes o No x

---

---



TABLE OF CONTENTS

|         |           |  |                                                                                |     
|-------- | --------- |  | ------------------------------------------------------------------------------ | ----
|         |           |  |                                                                                | Page
|         |           |  |                                                                                |     
|PART I   |           |  |                                                                                | 1   
|         |           |  |                                                                                |     
|         | ITEM 1.   |  | IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS                          | 1   
|         |           |  |                                                                                |     
|         | ITEM 2.   |  | OFFER STATISTICS AND EXPECTED TIMETABLE                                        | 1   
|         |           |  |                                                                                |     
|         | ITEM 3.   |  | KEY INFORMATION                                                                | 1   
|         |           |  |                                                                                |     
|         | ITEM 4.   |  | INFORMATION ABOUT THE COMPANY                                                  | 11  
|         |           |  |                                                                                |     
|         | ITEM 5.   |  | OPERATING AND FINANCIAL REVIEW AND PROSPECTS                                   | 23  
|         |           |  |                                                                                |     
|         | ITEM 6.   |  | DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES                                     | 36  
|         |           |  |                                                                                |     
|         | ITEM 7.   |  | MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS                              | 43  
|         |           |  |                                                                                |     
|         | ITEM 8.   |  | FINANCIAL INFORMATION                                                          | 44  
|         |           |  |                                                                                |     
|         | ITEM 9.   |  | LISTING                                                                        | 45  
|         |           |  |                                                                                |     
|         | ITEM 10.  |  | ADDITIONAL INFORMATION                                                         | 47  
|         |           |  |                                                                                |     
|         | ITEM 11.  |  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                     | 62  
|         |           |  |                                                                                |     
|PART II  |           |  |                                                                                | 62  
|         |           |  |                                                                                |     
|         | ITEM 13.  |  | DEFAULTS, DIVIDENDS, ARREARAGES AND DELINQUENCIES                              | 62  
|         |           |  |                                                                                |     
|         | ITEM 14.  |  | MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF
  PROCEEDS | 62  
|         |           |  |                                                                                |     
|         | ITEM 15.  |  | CONTROLS AND PROCEDURES                                                        | 62  
|         |           |  |                                                                                |     
|         | ITEM 16A. |  | AUDIT COMMITTEE FINANCIAL EXPERT                                               | 63  
|         |           |  |                                                                               
|         | ITEM 16B. |  | CODE OF ETHICS                                                                 | 63  
|         |           |  |                                                                               
|         | ITEM 16C. |  | PRINCIPAL ACCOUNTANT FEE AND SERVICES                                          | 63  
|         |           |  |                                                                               
|         | ITEM 16D. |  | EXEMPTIONS FROM THE LISTING STANDARDS OF AUDIT COMMITTEES                      | 64  
|         |           |  |                                                                               
|         | ITEM 16E. |  | PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED
PURCHASERS         | 64  
|         |           |  |                                                                               
|PART III |           |  | 64                                                                            
|         |           |  |                                                                               
|         | ITEM 17.  |  | FINANCIAL STATEMENTS                                                           | 64  
|         |           |  |                                                                               
|         | ITEM 18.  |  | FINANCIAL STATEMENTS                                                           | 64  
|         |           |  |                                                                               
|         | ITEM 19.  |  | EXHIBITS                                                                       | 64  

- i -

---

---



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.
From time to time, we also provide forward-looking statements in other
materials we release to the public as well as oral forward-looking statements.
The words or phrases will likely result, are expected to, will continue,
is anticipated, estimate, intend, project, believe, plan or
similar
expressions identify some, but not all, of these forward-looking statements.
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.

Use of Certain Terms

In
this report, we, us, our, TIS and the Company refer to Top Image
Systems Ltd. and its consolidated subsidiaries, collectively. References to $
and U.S. dollars are to the lawful currency of the United States of America.

PART I

|        |                                                      
|------- | -----------------------------------------------------
|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 are presented in accordance with
generally accepted accounting policies in the United States, or U.S. GAAP. The
Israeli Securities Law  1968 allows Israeli companies, such as us, whose
securities are listed both on the Tel Aviv Stock Exchange and on certain stock
exchanges in the United States (including NASDAQ), to report to the Israel
Securities Authority and the Tel Aviv Stock Exchange in accordance with the
reporting requirements under SEC rules and U.S. GAAP. All financial statements included
in this annual report and all financial information released in Israel are
presented solely under U.S. GAAP. 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.

|                                    |  |                                                                  |        |      |   |       |   |      |        |      |   |        |   |   |        |  
|----------------------------------- |  | ---------------------------------------------------------------- | ------ | ---- | - | ----- | - | ---- | ------ | ---- | - | ------ | - | - | ------ | -
|                                    |  | Year Ended December 31,                                          |       
|                                    |  |                                                                  |       
|                                    |  | 2002                                                             |        | 2003 |   | 2004  |   | 2005 |        | 2006 |  
|                                    |  |                                                                  |        |      |   |       |   |      |        |      |  
|                                    |  | In
  thousands except for weighted average number of shares data |       
|Statement of Operations Data:       |  |                                                                  |        |      |   |       |   |      |        |      |   |        |   |   |        |  
|Revenues                            |  | $                                                                | 7,799  |      | $ | 8,319 |   | $    | 11,178 |      | $ | 16,820 |   | $ | 20,224 |  
|Cost of revenues                    |  |                                                                  | 3,005  |      |   | 2,340 |   |      | 3,472  |      |   | 6,763  |   |   | 7,648  |  
|Gross profit                        |  |                                                                  | 4,794  |      |   | 5,979 |   |      | 7,706  |      |   | 10,057 |   |   | 12,576 |  
|Research and development, net       |  |                                                                  | 1,340  |      |   | 863   |   |      | 929    |      |   | 1,312  |   |   | 1,792  |  
|Selling, administrative and general |  |                                                                  | 7,465  |      |   | 5,819 |   |      | 7,123  |      |   | 9,030  |   |   | 10,263 |  
|Operating profit (loss)             |  |                                                                  | (4,011 | )    |   | (703  | ) |      | (346   | )    |   | (285   | ) |   | 521    |  
|Financial expense (income), net     |  |                                                                  | (187   | )    |   | (109  | ) |      | (178   | )    |   | 146    |   |   | (325   | )
|Other (income) expense              |  |                                                                  | 4      |      |   | -     |   |      | -      |      |   | -      |   |   | -      |  
|Tax on income                       |  |                                                                  |        |      |   |       |   |      |        |      |   | 30     |   |   | 45     |  

---

---



|                                                                                          |  |                                                                  |           |      |   |           |   |      |           |      |   |           |   |  |           | 
|----------------------------------------------------------------------------------------- |  | ---------------------------------------------------------------- | --------- | ---- | - | --------- | - | ---- | --------- | ---- | - | --------- | - |  | --------- | 
|                                                                                          |  | Year Ended December 31,                                          |          
|                                                                                          |  |                                                                  |          
|                                                                                          |  | 2002                                                             |           | 2003 |   | 2004      |   | 2005 |           | 2006 |  
|                                                                                          |  |                                                                  |           |      |   |           |   |      |           |      |  
|                                                                                          |  | In
  thousands except for weighted average number of shares data |          
|Net income (loss)                                                                         |  |                                                                  | (3,828    | )    |   | (594      | ) |      | (168      | )    |   | (461      | ) |  | 801       | 
|Net basic and dilutive income (loss) per
share                                            |  | $                                                                | (0.627    | )    | $ | (0.11     | ) | $    | (0.024    | )    | $ | (0.053    | ) |  | 0.091     | 
|Weighted average number of shares outstanding for
basic and dilutive
  net loss per share |  |                                                                  | 6,098,890 |      |   | 6,102,496 |   |      | 6,905,559 |      |   | 8,764,222 |   |  | 8,819,857 | 

|                               |  |                   |        |      |   |        |  |      |        |      |   |        |  |   |        | 
|------------------------------ |  | ----------------- | ------ | ---- | - | ------ |  | ---- | ------ | ---- | - | ------ |  | - | ------ | 
|                               |  | As ofDecember 31, |       
|                               |  |                   |       
|                               |  | 2002              |        | 2003 |   | 2004   |  | 2005 |        | 2006 |  
|                               |  |                   |        |      |   |        |  |      |        |      |  
|                               |  | In
  thousands    |       
|                               |  |                   |       
|Summary of Balance Sheet Data: |  |                   |        |      |   |        |  |      |        |      |   |        |  |   |        | 
|Cash and cash equivalents      |  | $                 | 7,400  |      | $ | 5,854  |  | $    | 10,136 |      | $ | 8,200  |  | $ | 6,195  | 
|Working capital                |  |                   | 7,739  |      |   | 7,353  |  |      | 12,232 |      |   | 12,137 |  |   | 26,852 | 
|Total Assets                   |  |                   | 12,488 |      |   | 12,130 |  |      | 19,742 |      |   | 20,360 |  |   | 34,295 | 
|Long Term debt                 |  |                   | -      |      |   | -      |  |      | -      |      |   | -      |  |   | 14,197 | 
|Total liabilities              |  |                   | 4,286  |      |   | 4,490  |  |      | 5,047  |      |   | 6,142  |  |   | 18,915 | 
|Shareholders equity           |  |                   | 8,202  |      |   | 7,639  |  |      | 14,695 |      |   | 14,218 |  |   | 15,380 | 

RISK FACTORS

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 industries could adversely impact the sale of our products and our
prospects of achieving or maintaining profitability.

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.                                   

- 2 -

---

---



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 state-of-the-art
products 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, 1998 and 2006, and our losses may continue. For the year
ended December 31, 2006, we had accumulated deficit of $14.6 million. 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.

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                                                  

- 3 -

---

---



| |   |                                                                                                                                             
| | - | --------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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.

Large customers
constitute a significant portion of our orders.

Sales
to large customers have historically accounted for a significant part of our
sales. For example, a sale to CSC Australia Pty. Ltd. accounted for 10% of our
sales in 2005, and sales to Swiss PostFinance accounted for 10% of our sales
in 2004. In 2006, we had no customer who accounted for more than 10% of our sales.
If we are unable in the future to complete sales to large customers, our
business, prospects and financial results could be adversely affected.

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.

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 13, 2003 (EP 0976092). Although the patent was not enforced against us,
we became aware of the patent and, in May 2004, filed a Notice of Opposition
with the European Patent Office requesting that the patent be revoked in its
entirety. After a number of written exchanges, the dispute was heard on March
8, 2007 in a proceeding at the European Patent Office in Germany. At the end of
the oral proceeding, ReadSofts patent was revoked in its entirety. There
remains a risk that Readsoft might appeal this decision and petition for the
patent to be reinstated. Although we do not believe that any of our products
would infringe upon this patent, if ReadSoft were to prevail on any appeal, and
it subsequently was decided that we infringed the patent, there could be a
material adverse effect on our business, prospects and financial condition.

- 4 -

---

---



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; 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.

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.

- 5 -

---

---



Our products may
contain defects, damaging our reputation, causing a loss of customers,
requiring us to allocate significant time and financial resources to correct,
and potentially resulting in 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:

| |   |                                                                                       
| | - | --------------------------------------------------------------------------------------
| |  | damage to
  brand reputation;                                                         
| |   |                                                                                       
| |  | loss of
  customers;                                                                  
| |   |                                                                                       
| |  | delay in
  market acceptance of current and future products;                          
| |   |                                                                                       
| |  | diversion of
  development and engineering resources to correct defects or errors; and
| |   |                                                                                       
| |  | warranty or
  product liability claims.                                               

Defects,
errors or successful product liability claims 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, which we may expand in the future
to new geographic regions, we are subject to the risks associated with
international sales, including license requirements, economic and political
instability, terrorism, 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.

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.

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, the most recent confrontation taking
place in July-August 2006. 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. In addition, we
cannot predict the effect on Israel or the Middle East
generally of
the recent elections in the Palestinian Authority in which Hamas, an Islamic
movement responsible for many attacks against Israelis, has formed the new
government. Continuing or escalating hostilities in the region or curtailment
of trade between Israel and its present trading partners may have an adverse
effect on our business conditions, including our ability to develop,
manufacture and market our products.

- 6 -

---

---



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 36 days of military reserve duty annually. Moreover, in light of the varying
levels of hostilities and threats of armed conflict which have marked 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.

We may be adversely
impacted by fluctuations in currency exchange rates.

We
maintain operations and generate revenues in a number of countries. The results
of operations and the financial position of our local operations are generally
reported in the relevant local currencies and then translated into U.S. dollars
at the applicable exchange rates for inclusion in our consolidated financial
statements, exposing us to currency translation risk. In addition, we are
exposed to currency transaction risk because some of our expenses are incurred
in a different currency from the currency in which our revenues are received.
Our most significant currency exposures are to the Euro, New Israeli Shekel, UK
Pound and Japanese yen. In periods when the U.S. dollar strengthens against
these other currencies, our reported results of operations may be adversely
affected. Although from time to time we purchase forward exchange contracts to
reduce currency transaction risk, these purchases will not eliminate
translation risk or all currency risk.

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.

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. In 2004, we 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. In December 2006, we raised net proceeds of $13,505,000
through the issuance of convertible debentures. We may use some or all of the
proceeds of this issuance to pursue acquisition opportunities. 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. 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.

- 7 -

---

---



Additionally,
we may not succeed in retaining or hiring 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, or lose key personnel from
our new Japanese business or other 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, under the Law for the Encouragement of Industrial Research and
Development, 1984 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 Governmental Regulation in Item 4 herein.

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 under The Law for the Encouragement of Capital
Investments, 1959, or the Investment Law. 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 us in
the future.

On
April 1, 2005, an amendment to the Investment Law came into effect (the
Amendment) that significantly changed the provisions of the Investment Law.
The Amendment limits the scope of enterprises which may be approved by the
Investment Center by setting criteria for the approval of a facility as an
Approved Enterprise, such as provisions generally requiring that at least 25%
of the Approved Enterprises income will be derived from export. Additionally,
the Amendment enacted major changes in the manner in which tax benefits are
awarded under the Investment Law so that companies no longer require Investment
Center approval in order to qualify for tax benefits.

However,
the Investment Law provides that terms and benefits included in any certificate
of approval already granted will remain subject to the provisions of the law as
they were on the date of such approval. Therefore, our existing Approved
Enterprise status will generally not be subject to the provisions of the
Amendment. As a result of the amendment, tax-exempt income generated under the
provisions of the new law will subject us to taxes upon distribution or
liquidation and we may be required to record deferred tax liability with
respect to such tax-exempt income. As of December 31, 2006, we did not generate
income subject to the provisions of the new law.

- 8 -

---

---



The resale of the
ordinary shares and related warrants to purchase ordinary shares we issued in
2004 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. (Charter), 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. Some of the shares issued in the private placement
have already been sold. 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 ordinary shares
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 Capital Market, and have been subject
to frequent significant price fluctuations, due in part to speculative
activity.

In
addition, trading in shares of companies listed on the NASDAQ Capital Market in
general and trading in shares of technology companies in particular have
experienced extreme price and volume fluctuations that have often been
unrelated or disproportionate to operating performance. These broad market and
industry factors may depress our share price, regardless of our actual
operating results. In addition, if we issue additional shares in financings or
acquisitions, our shareholders will experience additional dilution and the
existence of more shares could decrease the amount that purchasers are willing
to pay for our ordinary shares.

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 Capital Market. If our securities are delisted from the NASDAQ Capital
Market, investors liquidity in our securities could be reduced. Delisting or
suspension of trading of our ordinary shares on the NASDAQ Capital 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 Capital 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.

Our ordinary shares
are traded on more than one market and this may result in price variations.

Our
ordinary shares are traded on the NASDAQ Capital Market and on the Tel Aviv
Stock Exchange. Trading in our ordinary shares on these markets is effected in
different currencies (dollars on the NASDAQ Capital Market, and New Israeli
Shekels on the Tel Aviv Stock Exchange) and at different times (resulting from different
time zones, different trading days and different public holidays in the United
States and Israel). Consequently, the trading prices of our ordinary shares on
these two markets often differ, resulting from the factors described above as
well as differences in exchange rates and from political events and economic
conditions in the United States and Israel. Any decrease in the trading price
of our ordinary shares on one of these markets could cause a decrease in the
trading price of our ordinary shares on the other market.

- 9 -

---

---



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.

We may not be able
to make our debt payments in the future.

In
December 2006 through the issuance of convertible debentures, we raised net
proceeds of $13,505,000. Our ability to meet our obligations under the
convertible notes and our other debt obligations will depend on whether we can
successfully implement our strategy, as well as on financial, competitive, and
other factors, including some factors that are beyond our control. If we are
unable to generate sufficient cash flow from operations to meet principal and
interest payments on our debt, we may have to refinance all or part of our
indebtedness. In addition, cash flows from our operations may be insufficient
to repay in full at maturity the convertible notes, in which case the
convertible notes may need to be refinanced. Our ability to refinance our
indebtedness, including the convertible notes, will depend on, among other
things:

| |   |                                                     
| | - | ----------------------------------------------------
| |  | our
  financial condition at the time;              
| |   |                                                     
| |  | restrictions
  in agreements governing our debt; and
| |   |                                                     
| |  | other
  factors, including market conditions        

We
cannot ensure that any such refinancing would be possible on terms that we
could accept or that we could obtain additional financing. If refinancing will
not be possible or if additional financing will not be available, we may have
to sell our assets under circumstances that might not yield the highest prices,
or default on our debt obligations, including the convertible notes, which
would permit our noteholders and holders of other outstanding indebtedness to
accelerate their maturity dates.

Our indebtedness and
debt service obligations have increased with the issuance of the convertible
notes, which may adversely affect our cash flow, cash position and share price.

We
intend to fulfill our debt service obligations from existing cash, investments
and our operations. In the future, if we are unable to generate cash or raise
additional cash financings sufficient to meet these obligations and need to use
existing cash or liquidate investments in order to fund these obligations, we
may have to delay or curtail research and development programs.

Our
indebtedness could have significant additional negative consequences,
including, without limitation:

| |   |                                                                                                                                                                                                                                                                                 
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | requiring
  the dedication of a portion of our expected cash flow to service our
  indebtedness, thereby reducing the amount of our expected cash flow available
  for other purposes, including funding our research and development programs
  and other capital expenditures;
| |   |                                                                                                                                                                                                                                                                                 
| |  | increasing
  our vulnerability to general adverse economic conditions;                                                                                                                                                                                                          

- 10 -

---

---



| |   |                                                                                                                                                  
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------
| |  | limiting our
  ability to obtain additional financing; and                                                                                       
| |   |                                                                                                                                                  
| |  | placing us
  at a possible competitive disadvantage to less leveraged competitors and
  competitors that have better access to capital resources.

Conversion of the
convertible notes would dilute the ownership interest of our existing
shareholders.

The
conversion of some or all of the convertible notes would dilute the ownership
interests of our existing shareholders. Any sales in the public market of our
ordinary shares issuable upon such conversion could adversely affect the
prevailing market prices of our ordinary shares. In addition, the existence of
the convertible notes may encourage short selling by market participants
because the conversion of the convertible notes could depress the price of our
ordinary shares.

We
have not yet evaluated our internal control over financial reporting in
compliance with Section 404 of the Sarbanes-Oxley Act.

Pursuant
to the rules and regulations issued under Section 404 of the Sarbanes-Oxley Act
of 2002, we must begin providing a report by management assessing the
effectiveness of our internal control over financial reporting beginning with
our annual report for our fiscal year ending on December 31, 2007, and must
begin providing an auditors attestation report on internal control over
financial reporting in our annual report for our fiscal year ending on December
31, 2008. We are in the process of determining whether our existing internal
control over financial reporting systems are compliant with Section 404. This
process may divert internal resources and will take a significant amount of
time and effort to complete. If it is determined that we are not in compliance
with Section 404, we may be required to implement new internal control procedures
and reevaluate our financial reporting. We may experience higher than
anticipated operating expenses as well as higher independent auditor fees
during the implementation of these changes and thereafter. Further, we may need
to hire additional qualified personnel in order for us to be compliant with
Section 404. If we are unable to implement these changes effectively or
efficiently, it could harm our operations, financial reporting or financial
results and could result in our being unable, when required under applicable
SEC rules, to obtain an unqualified report on internal control from our
independent auditors.

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

History and Development

We
were incorporated in March of 1991, are domiciled in Israel and exist as a
company with a limited share capital subject to Israeli law. Our legal name is
Top Image Systems Ltd. and 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).

Our
ordinary shares began trading on the NASDAQ Capital Market in November 1996 and
on the Tel Aviv Stock Exchange in December 2006.

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.

- 11 -

---

---



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 eFLOW platform 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, eFLOW facilitates the development of
applications ranging from desktop, stand-alone applications to high-volume,
network-based systems.

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
is 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).

eFLOW
offers 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. Our 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
3.0 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
includes 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.

Smart for Unstructured Content, a
Mailroom Classification Solution

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.

- 12 -

---

---



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.

Freedom for Semi-Structured
Content, a Complete Invoices and Related AP Documents Processing Solution

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, Freedom is 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.

By
automating the entire process of invoice handling, Freedom allows companies to improve efficiency, reduce
cost,
limit process cycles and eliminate errors, while improving business
relationships with suppliers. Seamlessly integrating with any financial
workflow and ERP systems such as SAP, Oracle and JD Edwards, eFLOW Freedom provides support throughout
the entire invoice processing. eFLOW Freedom
captures and classifies all kinds of invoices in paper or electronic formats.
Line items are extracted and interpreted in both single and multi-page
invoices.

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.

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.

eFLOW Ability for SAP-users

eFLOW
Ability is an integrated
module interfacing with SAP systems for automated parking, approval and posting
of invoices and any other document within SAP systems. eFLOW
Ability
improves invoice processing, reduces the time it takes for an invoice to be
approved for payment and eliminates double payments, lost invoices and other
human mistakes along the way.

In
addition, eFLOW Ability offers a complete SAP-oriented
business workflow and an accounts payable document processing, approval, and
validation solution.

eFLOW
Ability is a result of a successful
cooperation between TIS and KPS-concepts, a German based company specialized in
the development and integration of SAP business workflow solutions. The ability
to seamlessly integrate into SAP R/3 creates a high-performance product line
that companies can utilize to increase productivity, enhance the precision of
entries and optimize cash management.

eFLOW
Ability empowers users to
streamline and accelerate the processing of invoices and any other document,
take advantage of efficient accounts receivable and accounts payable
management, eliminate periodic posting peaks, reduce errors and increase
financial reporting accuracy and transparency.

- 13 -

---

---



eFLOW
Invoice Reader

eFLOW
Invoice Reader is a standard, generic and easy-to-implement
invoice capture and approval solution. This solution can be deployed and
integrated in any enterprise accounting environment including SAP, Oracle and
other financial systems.

eFLOW
Invoice Reader is pre-adapted to specific country
regulations and business practices, and thus can be implemented in a relatively
short timeframe. eFLOW Invoice Reader
minimizes resources for operating an effective invoice capturing process,
shortens delivery time and purchase-to-pay cycle, employs the most advanced
character recognition technology for fast data capture, and automatically
verifies the vendor data and PO information on the incoming invoices.

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.

Principal
Markets

As
of December 31, 2006, we operated branch offices in the United States, the
United Kingdom, Germany and Japan through subsidiaries. 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, which contributed to the organic increase in sales in
2005 and 2006. 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 2004, in order to expand our already strong presence and market
position in Japan and utilized a portion of the proceeds from our 2004 private
placement 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(U.S. Dollars in thousands)

|                             |  |                         |       |      |  |      |   |   |       |   |  |     |   |  |        |  |  |     |  
|---------------------------- |  | ----------------------- | ----- | ---- |  | ---- | - | - | ----- | - |  | --- | - |  | ------ |  |  | --- | -
|                             |  | Year Ended December 31, |      
|                             |  |                         |      
|                             |  | 2004                    |       | 2005 |  | 2006 |  
|                             |  |                         |       |      |  |      |  
|                             |  | $                       |       | %    |  | $    |   | % |       | $ |  | %   |  
|Europe                       |  |                         | 5,356 |      |  | 77   | % |   | 5,604 |   |  | 57  | % |  | 6,711  |  |  | 55  | %
|Far East
  (excluding Japan) |  |                         | 598   |      |  | 9    | % |   | 2,020 |   |  | 20  | % |  | 1,844  |  |  | 15  | %
|Africa                       |  |                         | 166   |      |  | 2    | % |   | 512   |   |  | 5   | % |  | 461    |  |  | 4   | %
|North and
  South America    |  |                         | 607   |      |  | 9    | % |   | 944   |   |  | 9   | % |  | 1,191  |  |  | 10  | %
|Israel                       |  |                         | 142   |      |  | 2    | % |   | 60    |   |  | 1   | % |  | 69     |  |  | 1   | %
|Japan                        |  |                         | 95    |      |  | 1    | % |   | 748   |   |  | 8   | % |  | 1,868  |  |  | 15  | %
|                             |  |                         |       |      |  |      |   |   |       |   |  |     |   |  |        |  |  |     |  
|Total                        |  |                         | 6,964 |      |  | 100  | % |   | 9,888 |   |  | 100 | % |  | 12,144 |  |  | 100 | %
|                             |  |                         |       |      |  |      |   |   |       |   |  |     |   |  |        |  |  |     |  

- 14 -

---

---



Service
Revenues by Region(U.S. Dollars in thousands)

|                             |  |                         |       |      |  |     |      |   |       |   |  |     |   |  |       |  |  |     |  
|---------------------------- |  | ----------------------- | ----- | ---- |  | --- | ---- | - | ----- | - |  | --- | - |  | ----- |  |  | --- | -
|                             |  | Year Ended December 31, |      
|                             |  |                         |      
|                             |  | 2004                    |       | 2005 |  |     | 2006 |  
|                             |  |                         |       |      |  |     |     
|                             |  | $                       |       | %    |  | $   |      | % |       | $ |  | %   |  
|Europe                       |  |                         | 2,610 |      |  | 62  | %    |   | 3,396 |   |  | 49  | % |  | 4,675 |  |  | 58  | %
|North and
  South America    |  |                         | 647   |      |  | 15  | %    |   | 883   |   |  | 13  | % |  | 962   |  |  | 12  | %
|Far East
  (excluding Japan) |  |                         | 326   |      |  | 8   | %    |   | 375   |   |  | 5   | % |  | 598   |  |  | 7   | %
|Africa                       |  |                         | 14    |      |  | 0   | %    |   | 53    |   |  | 1   | % |  | 75    |  |  | 1   | %
|Japan                        |  |                         | 575   |      |  | 14  | %    |   | 2,147 |   |  | 31  | % |  | 1,765 |  |  | 22  | %
|Israel                       |  |                         | 42    |      |  | 1   | %    |   | 78    |   |  | 1   | % |  | 5     |  |  | 0   | %
|Total                        |  |                         | 4,214 |      |  | 100 | %    |   | 6,932 |   |  | 100 | % |  | 8,080 |  |  | 100 | %
|                             |  |                         |       |      |  |     |      |   |       |   |  |     |   |  |       |  |  |     |  

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.
Nevertheless, in Japan, fiscal years generally end on March 31, thus activity
in the Japanese market reduces the seasonality of our business. See the section
of Item 5 herein entitled 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 (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 eFLOW across 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. 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.
When cooperating with partners in these territories, we can offer an expanded
solution.

Currently,
in approximately 30 countries worldwide where we do not sell directly to
customers, we sell through a network of value-added resellers, distributors and
systems integrators. 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 -

---

---



In
March 2007, we announced an extended worldwide technology and sales alliance
with ARX (Algorithmic Research), a leading global provider of standards-based
electronic signatures (digital signatures) and data security solutions. Through
this partnership, our joint customers can expedite data capture processes,
improve internal controls and enhance compliance with regulations. ARXs CoSign
is a non-forgeable, simple-to-use, standards-based electronic-signature
solution that is tightly integrated with our eFLOW. CoSign provides
organizations with a solution that enables users to electronically sign
documents, records, files, forms, and other electronic transactions. The
combination of these complimentary technologies offers a compelling solution
for any financial, commercial and governmental organization wishing to comply
with the growing number of compliance reports required by federal and state
government regulatory organizations.

In
August 2006, we announced the first joint project with d.velop AG, the
established provider of integral innovative solutions for document and workflow
management, as well as digital archiving. The combination of d.3, d.velop AGs
platform and our eFLOW helps customers manage their entire flow of
information more efficiently. This partnership provides customers with an
advanced complete digital business information process solution. This combined
solution reduces the costs of incoming information processing and distribution
across the organization. It also improves productivity and efficiency while
decreasing the turnaround time of incoming information availability for ongoing
operations.

In
February 2006, we teamed up with Asiasoft, a regional business consultancy and
technology service powerhouse in the Asia Pacific region. Asiasofts business
focuses on Information Lifecycle Management (ILM), providing Enterprise Content
Management technologies to organizations, to capture, manage, store, preserve
and distribute information. Within its commitment to provide best-practice
information processing solutions, Asiasoft has integrated advanced Chinese
recognition engines, with full Chinese graphical interface, into our eFLOW solution. We expect Asiasoft to
utilize its strong presence in the Pacific Rim and vast experience in providing
solutions to major enterprises in the finance, logistics, manufacturing,
government, and telecommunications industries to introduce our solutions to
this market.

In
January 2006, we formed an extended worldwide technology and sales alliance
with 170 Systems, Inc., a company that delivers software solutions that manage
and optimize financial processes. Through this partnership, joint customers are
provided with an automated financial capture solution for invoices and purchase
orders, from purchase to payment, which reduces invoice-processing costs. 170
MarkView Financial Suite captures and manages financial information and
integrates it seamlessly with customers enterprise resource planning (ERP)
systems. The combination of these complimentary technologies offers a
compelling solution for Oracle and PeopleSoft enterprise resources planning
(ERP) users looking to further leverage their investment in that technology.

In
October 2005, we introduced eFLOW Ability, a new integrated module into SAP
systems for automated parking, approval and posting of invoices and any other
document within SAP systems. eFLOW
Abilityis a result of a
successful cooperation between TIS and KPS-concepts, a German based company
specialized in the development and integration of SAP business workflow
solutions. eFLOW Abilityimproves invoice processing, reduces the time it takes for
an invoice to be approved for payment and eliminates double payments, lost
invoices and other human mistakes along the way. eFLOW Abilityoffers a complete SAP-oriented business workflow and an accounts payable
document processing, approval, and validation solution.

In
September 2005, we signed a European-wide partnership agreement with Xerox, a
global leader in document management services. We and Xerox had been working
successfully together for the last 8 years on projects in France, Germany and
Latin America and extended the agreement across 13 more countries in Europe. Combining Xeroxs vast experience,
knowledge and presence in the market with the state-of-the-art recognition
capabilities of eFLOW provides
our end users with the ultimate solution for complex and large data collection
projects

- 16 -

---

---



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 3.0 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
Version 3.0 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.

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 file for or
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.

- 17 -

---

---



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 13, 2003 (EP 0976092). Although the patent was not enforced against us,
we became aware of the patent and, in May 2004, filed a Notice of Opposition
with the European Patent Office requesting that the patent be revoked in its
entirety. After a number of written exchanges, the dispute was heard on March
8, 2007 in a proceeding at the European Patent Office in Germany. At the end of
the oral proceeding, Readsofts patent was revoked in its entirety. There
remains a risk that Readsoft might appeal this decision and petition for the
patent to be reinstated. Although we do not believe that any of our products
would infringe upon this patent, if ReadSoft were to prevail on any appeal, and
it subsequently was decided that we infringed the patent, 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 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:

| |   |                                                                                                                                                                                                                                                                                                                                                               
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | In November
  2006, Oracle acquired Stellent, a global provider of enterprise content
  management (ECM) software solutions. Earlier that year, Stellent acquired
  Bitform, a provider of content cleansing technologies, and Sealed Media, a
  provider of enterprise digital rights management solutions addressing content
  security and compliance risk.

- 18 -

---

---



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | In October
  2006, ReadSoft acquired Ebydos AG, a German SAP specialist. The acquisition
  strengthened ReadSofts position in the electronic invoice processing
  products for the SAP business system. With 45 employees, the acquired units
  in Germany, Poland and the United States reported sales of approximately 4.4
  million Euros in 2005. A large part of Ebydos sales come directly from the
  cooperation with ReadSoft. Ebydos has shown good profit and the acquisition
  is expected to increase ReadSofts earnings per share already this year.
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |  | Also in
  October 2006, Bottomline Technologies, a provider of collaborative payment
  and invoice automation solutions to corporations, financial institutions and
  banks around the world, acquired Formscape, an Output Management Vendor.
  Earlier that year, Bottomline Technologies acquired Tranmit, a provider of
  web-based purchase-to-pay automation solutions.                                                                                                                                                                                       
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |  | In August
  2006, IBM acquired FileNet, an ECM vendor.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |  | Also in
  August 2006, Open Text acquired Hummingbird. This merger between two large,
  global providers of ECM software formed the largest independent provider of
  ECM solutions in the world.                                                                                                                                                                                                                                                                                                                                                                   
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |  | In July
  2006, Xerox acquired Amici LLC, a provider of litigation services line of
  electronic discovery and records management services.                                                                                                                                                                                                                                                                                                                                                                                                                         
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |  | In June
  2006, EMC acquired Proactivity, a provider of Content & BPM.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |  | Also in June
  2006, Iron Mountain acquired Digiguard, thus adding data protection services
  to its portfolio.                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |  | In March
  2006, DICOM GROUP acquired LCI, the German provider of advanced learning
  systems for business automation, image classification, forms processing, and
  document analysis.                                                                                                                                                                                                                                                                                                                                                                             
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |  | In January
  2006, Pitney Bowes acquired Emtex Ltd., a provider of document production of
  multi-vendor & multi-site print operations.                                                                                                                                                                                                                                                                                                                                                                                                                             
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |  | Also in
  January 2006, Tower Software acquired Rapid Web Solutions, a provider of web
  content management software.                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |  | In December
  2005, EMC Corporation acquired Captiva Software, a provider of input
  management solutions. The deal could extend EMCs position in information
  lifecycle management, based on abilities in content management and enterprise
  archiving.                                                                                                                                                                                                                                                                                                         
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |  | In December
  2005, SunGard Workflow Solutions, an operating unit of SunGard, acquired
  Recognition Research, Incorporated (RRI). SunGuard has incorporated RRIs
  structured data capture technology into SunGards product line. The
  acquisition could enhance SunGuards market position.                                                                                                                                                                                                                                                                    
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |  | In December
  2005, Autonomy acquired Verity. The combination of the two companies could
  increase the reach of Autonomy and improve its market share by broadening the
  range of content capture solutions it provides.                                                                                                                                                                                                                                                                                                                                          
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |  | In May 2005,
  Captiva acquired SWT SA, a leading provider of automatic data extraction and
  intelligent document capture solutions and technology in France. SWT had a
  strong market presence in the French and Spanish markets. In addition, this
  acquisition strengthened Captivas mailroom and invoice processing expertise,
  providing an installed base of reference sites for those capabilities.                                                                                                                                                     

- 19 -

---

---



| |   |                                                                                                                                                                                                                                                                                                                                                                                                             
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | In February
  2005, ReadSoft completed an acquisition of 50 percent stake in Consit
  Development. Consit is an independent consulting organization that has
  specialized in implementing, developing and servicing solutions based on
  Oracles products and tools. Thus, this acquisition gave ReadSoft an opening
  into the Oracle world, as well as direct access to software and Oracle
  expertise.

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 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
2006, we further strengthened our position as a technology provider for
semi-structured applications, including supplier invoices, purchase orders,
checks and remittances, different financial applications, health claims and
freight bills. Our solutions support customers by standardizing their invoice
circulation, review and approval, as well as by creating a uniform approach to
facing future business needs.We created and installed systems for complicated
semi-structured applications which included automating the capture and process
of information from hundreds of different invoices and other accounts payable,
or AP, documents. Our new customers included, among others: Alcoa, the
world-leading metal producer, which selected eFLOWto streamline its invoice processing; Office Depot, the leading global provider
of office products and services, which has chosen eFLOWto streamline its
incoming fax orders; Worlds Foremost Bank, issuer of the Cabelas Club Visa,
which selected eFLOW3to process,
archive and retrieve client credit applications and dispute forms (Cabelas is
the worlds largest mail-order, retail and internet outdoor outfitter.); MSD,
the major global research-driven pharmaceutical company, which chose eFLOWto
streamline its entire invoice process; the Australian Gold Cost City Council,
which selected eFLOWto automate
its accounts payable process, and HEFAME Spain, which selected eFLOWto
streamline its entire payment process.

- 20 -

---

---



At
the end of 2005, we launched eFLOW Ability,
the integrated module into SAP systems for automated parking, approval and
posting of invoices and any other document within SAP systems. eFLOW Ability improves invoice processing,
reduces the time it takes for an invoice to be approved for payment and
eliminates double payments, lost invoices and other human mistakes along the
way. Since then, we enjoyed a growing number of customers that choose eFLOW Ability to streamline their entire
invoice process. Among them: Altadis, Europes largest cigars manufacturer;
Armstrong, a U.S.-based global leader in the design and manufacture of floors,
ceiling and cabinets; and Diageo, the worlds leading premium drinks business. eFLOW Ability enjoyed special exposure and
success in Germany, Europes largest and most sophisticated market for imaging
technologies, and SAPs back-yard and one of its strongest markets. In Germany
alone, eFLOW Ability was chosen
by more than 10 customers, among them MAN Ferrostaal AG, Gmünder ErsatzKasse
GEK Healthinsurance, Schmitz Cargobull AG, Pilatus Aircraft ltd., Zahnärztekasse
AG Healthinsurance, Koenig & Bauer AG, and Dalli-Werke GmbH & Co. KG.

Smart,
our automatic classification module provides 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 then seamlessly deliver this data to the organizations back-end
enterprise systems. Therefore, many large organizations, especially in the B2C
market where there are large customer bases and extensive communications
between consumer and supplier, have selected Smart. Among the customers
that selected this solution during 2006 are: UWV, the Dutch Department of
Employee Benefits; GEK, a
large German-based health insurance company; Electricité de France; Gaz de France and Bouygues
Telecom, one of the three largest telecom companies in France. Recall, a global
leader in document management solutions, has chosen Smartto sort and dispatch all incoming information in its
Italian operations. In addition, we also won tenders to sell Smart
to major banks in the Asia-Pacific region.

One
of eFLOWsmain technological
strong points is the fact that one platform includes a variety of solutions and
modules that can be used separately but which may also be used as an
integrated, comprehensive solution. In the past year, we have noticed that
growing numbers of customers choose to enjoy the possibilities this kind of a
solution brings, and to purchase an advanced complete digital business
information process solution to reduce the costs of incoming information
processing and distribution across the organization and to improve productivity
and efficiency while decreasing the turnaround time of incoming information
availability for ongoing operations. With our new German partner, d.velop, we
implemented such a solution for Muehlhan, the German surface protection
specialist. We also provided information input solutions for a Philippine
governmental social insurance agency; for the Australian Department of Defence,
which chose to extend eFLOW3to provide the capability to use the technology
within various functions of the Department; a new large Australian pension
fund, AAS, which chose eFLOWto
manage and process checks and pension related documents; and the Australian
operation of Hanson PLC, the international heavy building materials producer,
which chose eFLOWas a core
technology platform in its Australian operation to capture and process large
volumes of vendor invoices and handwritten information on its outgoing dispatch
dockets.

Warranty
and Service

We
generally negotiate our warranty obligations with respect to our products on a
case-by-case basis.

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 $5,000,000 in aggregate for the policy
period ending on September 30, 2007. 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 the integration of our products.

- 21 -

---

---



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, or 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 $ 69,000 as of December 31, 2006.

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.

- 22 -

---

---



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. We are in the
process of dissolving e-Mobilis as a separate entity. For additional
information, see the section herein entitled Related Party Transactions. In
2004, we modified our corporate structure in Europe, and established a new
wholly owned subsidiary in the United Kingdom, Top Image Systems UK Limited,
which owns a subsidiary in Germany, TIS Deutschland GmbH. The activity and
assets of our then-existing European branches were transferred to the new entities.
In August, 2004 we established Top Image Systems Japan Ltd. in order to
strengthen our increased presence in Japan.

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 $11,000. The lease expires in
November 2007 with a further extention until 2012. Our subsidiary in Germany
leases approximately 241 square meters of office space in Cologne, Germany for
a monthly sum of $8,000 which will expire in August 2008 and our UK subsidiary
leases approximately 315 square meters of office space in Uxbridge for the
amount of $15,500 per month, which will expire in August 2007. 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 2008.

|        |                                             
|------- | --------------------------------------------
|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 is 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.

As
a result of our strategy of pursuing strategic alliances with value-added
resellers, distributors and system integrators, a substantial portion of our
revenues is derived from such alliances. During the years ended December 31,
2004, 2005 and 2006, revenues deriving from value-added resellers, distributors
and system integrators accounted for approximately 28%, 46% and 44%,
respectively, of our revenues.

- 23 -

---

---



Historically,
we have recognized a majority of our revenues from product sales. During the
years ended December 31, 2004, 2005 and 2006, product revenues accounted for
approximately 62%, 59% and 60%, respectively, of revenues, while service
revenues accounted for approximately 38% 41% and 40%, respectively, of
revenues. During 2004, we stopped marketing our AFPSPro product. In 2006,
sales of eFLOW
accounted for 86% of our product sales and for approximately 52% of our revenue.

Sales Cycle

Our
sales cycle for eFLOW has 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.

Geographical
Considerations

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

Revenues by
Region

|                             |  |                           |  |      |   |        |  |     |   |        |  |     |  
|---------------------------- |  | ------------------------- |  | ---- | - | ------ |  | --- | - | ------ |  | --- | -
|                             |  | Year Ended
  December 31, | 
|                             |  |                          
|                             |  | 2004                      |  | 2005 |   | 2006   | 
|                             |  |                           |  |      |   |        | 
|                             |  | $                         |  | %    |   | $      |  | %   |   | $      |  | %   |  
|Europe                       |  | 7,966                     |  | 71   | % | 9,000  |  | 54  | % | 11,386 |  | 56  | %
|North and
  South America    |  | 1,254                     |  | 11   | % | 1,827  |  | 11  | % | 2,153  |  | 11  | %
|Far East
  (excluding Japan) |  | 924                       |  | 8    | % | 2,395  |  | 14  | % | 2,442  |  | 12  | %
|Africa                       |  | 180                       |  | 2    | % | 565    |  | 3   | % | 536    |  | 3   | %
|Japan                        |  | 670                       |  | 6    | % | 2,895  |  | 17  | % | 3,633  |  | 18  | %
|Israel                       |  | 184                       |  | 2    | % | 138    |  | 1   | % | 74     |  | 0   | %
|Total                        |  | 11,178                    |  | 100  | % | 16,820 |  | 100 | % | 20,224 |  | 100 | %
|                             |  |                           |  |      |   |        |  |     |   |        |  |     |  

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 the United States, or U.S. GAAP. 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.

- 24 -

---

---



Revenue
Recognition

We derive our revenues  mainly  from sales of products and services. Product
revenues include mainly sales of software and to a lesser extent of related hardware.
Revenues from services include maintenance and technical support, consulting and training.

We account for software sales in
accordance with Statement of Position No. 97-2, Software Revenue Recognition
(SOP No. 97-2), as amended by Statement of Position 98-9, Modifications
of SOP 97-2, Software Revenue Recognition with Respect to Certain Transactions. SOP
No. 97-2 generally requires revenues earned from software arrangements involving multiple
elements to be allocated to each element based on the relative fair values of the elements
determined by the vendors specific objective evidence (VSOE) of fair
value. Revenues are recognized under the residual method when VSOE of fair
value exists for all undelivered elements and VSOE of fair value does not exist for all of
the delivered elements, and when all SOP No. 97-2 criteria for revenue recognition are
met.

Revenue
from license fees is recognized when persuasive evidence of an agreement
exists, delivery of the product has occurred, the fee is fixed or determinable,
and collectibility is probable.

Maintenance
and support revenue is deferred and recognized on a straight-line basis over
the term of the maintenance and support agreement. The VSOE of fair value of
the undelivered elements (maintenance, support and services) included in
multiple element arrangements is determined based on the price charged for the
undelivered element when sold separately or renewed.

Hardware
sales are recognized when the product is delivered to the customer. Because the software
is not essential to the functionality of the unrelated equipment, the equipment is not
considered software-related and, therefore, is excluded from the scope of SOP 97-2,
therefore it is recognized according to SAB 104 when persuasive evidence of an arrangement
exists, delivery has occurred, the vendors fee is fixed or determinable, no further
obligation exists and collectibility is probable.

Arrangements
that include consulting/professional services are evaluated to determine
whether those services are essential to the functionality of other elements of
the arrangement. When consulting services are not considered essential, the
revenue allocable to the consulting services is recognized as the services are
performed.

If
services are considered essential to the functionality of other elements of the
arrangement, revenues from software licenses that require significant customization,
integration and installation are recognized using contract accounting based on Statement
of Position No.81-1, on the percentage of completion method, in accordance with the
Input Method, 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 our ability
to complete the contract and to meet the contractual terms. The percentage of completion
is determined based on the ratio of actual cost to total estimated cost. As for contracts
in which a loss is anticipated, a provision is recorded for the full amount of the
expected loss, in the period in which such losses are first determined. As of December 31,
2006, no such estimated losses were identified.

Deferred
revenues represent mainly unearned amounts received under technical support and
maintenance arrangements that are paid by customers and not yet recognized as
revenues.

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,
2006 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.

- 25 -

---

---



Goodwill
and other intangible assets

Goodwill
represents the excess of the costs over the net assets of businesses acquired.
Under SFAS No. 142, Goodwill and Other Intangible Assets (SFAS No. 142),
goodwill is not amortized as of January 1, 2002.

SFAS
No. 142 requires goodwill to be tested for impairment at least annually or
between annual tests in certain circumstances, and written down when impaired.
Goodwill attributable to one reporting unit is tested for impairment by
comparing the fair value of the reporting unit with its carrying value. Fair
value is determined using discounted cash flows. Significant estimates used in
the methodologies include estimates of future cash flows, future short-term and
long-term growth rates and weighted average cost of capital for each of the
reportable units. As of December 31, 2004, 2005 and 2006, no impairment
indicators have been identified.

Convertible
Debentures

Convertible
debentures are accounted for in accordance with the provisions of EITF Issue
No. 05-2, The Meaning of Conventional Convertible Debt Instruments, APB 14,
Accounting for Convertible Debt and Debt issued with Stock Purchase Warrants,
and related pronouncements.

Under
these pronouncements, we recorded the convertible debentures as long-term liabilities, and
did not bifurcate the conversion option.

The
discount on the convertible debentures will be amortized to interest expenses
from the commitment date to the stated maturity date using the interest method.

Cost
incurred in respect of issuance expenses of debentures is deferred and
amortized as a component of interest expense over the contractual life of the
debenture using the effective interests method.

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.

- 26 -

---

---



Stock-based
compensation

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

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

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

We
recognize compensation expenses for the value of its awards, which have graded vesting
based on the straight line method over the requisite service period of each of the awards,
net of estimated forfeitures. Estimated forfeitures are based on actual historical
pre-vesting forfeitures.

As
a result of adopting SFAS 123(R) on January 1, 2006, our income before income taxes and
net income for the year ended December 31, 2006, is $ 145 lower than if it had continued
to account for stock-based compensation under APB 25. Basic and diluted net loss per share
for the year ended December 31, 2006, are $ 0.03 lower, than if we had continued to
account for share-based compensation under APB 25.

Prior
to January 1, 2006, we applied the intrinsic value method of accounting for stock options
as prescribed by APB 25, whereby compensation expense is equal to the excess, if any, of
the quoted market price of the stock over the exercise price at the grant date of the
award.

We
estimate the fair value of stock options granted using the Monte-Carlo option-pricing
model. The option-pricing model requires a number of assumptions, of which the most
significant are, expected stock price volatility, and the expected option term. Expected
volatility was calculated based upon actual historical stock price movements over the most
recent periods ending on the grant date, equal to the contractual term of the option. We
have historically not paid dividends and has no foreseeable plans to issue
dividends. The risk-free interest rate is based on the yield from U.S. Treasury
zero-coupon bonds with an equivalent term.

Recently
Enacted Accounting Pronouncements

In
July 2006, the FASB issued FASB Interpretation 48, Accounting for Income Tax
Uncertainties (FIN 48). FIN 48 defines the threshold for recognizing the
benefits of tax return positions in the financial statements as
more-likely-than-not to be sustained by the taxing authority. The recently
issued literature also provides guidance on derecognition, measurement and classification
of income tax uncertainties, along with any related interest and penalties. FIN 48 also
includes guidance concerning accounting for income tax uncertainties in interim periods
and increases the level of disclosures associated with any recorded income tax
uncertainties. FIN 48 is effective for fiscal years beginning after December 15, 2006. The
differences between the amounts recognized in the statements of financial position prior
to the adoption of FIN 48 and the amounts reported after adoption will be accounted for as
a cumulative-effect adjustment recorded to the beginning balance of retained earnings.
Because the guidance was recently issued, we have not yet determined the impact, if any,
of adoption of the provisions of FIN 48 on its financial position, results of operations
and cash flows. We are currently evaluating the impact of FIN 48 on our consolidated
financial statements.

In
September 2006, FASB issued SFAS no. 157, Fair Value Measurements (SFAS
No. 157). SFAS No. 157 defines fair value, establishes a framework for measuring
fair value in generally accepted accounting principles and expands disclosures about fair
value measurements. SFAS No. 157 is effective for financial statements issued for fiscal
years beginning after November 15, 2007 and interim periods within those fiscal years. We
believe SFAS No. 157 will not have a material effect on our financial statements.

- 27 -

---

---



In
February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities (SFAS No. 159). SFAS No. 159 permits
companies to choose to measure certain financial instruments and certain other items at
fair value. SFAS No. 159 requires that unrealized gains and losses on items for which the
fair value option has been elected be reported in earnings. SFAS No. 159 is effective for
financial statements issued for fiscal years beginning after November 15, 2007 and interim
periods within those fiscal years, although earlier adoption is permitted. We are
currently evaluating the impact that SFAS No. 159 will have on its consolidated financial
statements.

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, 2006 Compared to Year Ended December 31, 2005

Revenues.
Total revenues for the year ended December 31, 2006 amounted to $20,224,000
compared to $ 16,820,000 for the year ended December 31, 2005, an increase
of 20%. Product sales increased by $2,256,000 or 23%, from $9,888,000 in 2005
to $12,144,000 in 2006, mainly because of an increase in our sales in Japan and
success in our AP workflow projects, mainly in Europe. Service revenues
increased by $1,148,000, or approximately 17%, from $6,932,000 in the year
ended December 31, 2005 to $8,080,000 in the year ended December 31, 2006. The
increase is mostly attributable to our increase in AP workflow services in
Europe, mainly in the SAP environment.

Cost
of Revenues. Cost of revenues increased by $885,000,
or 13%, from $6,763,000 in the year ended December 31, 2005 to $7,648,000 in
the year ended December 31, 2006. The increase is a result of growth in
expenses to third party service providers.

Research
and Development. During 2006, we continued to focus
efforts in enhancing our software recognition and core capabilities. Research
and development expenses in the year ended December 31, 2006 amounted to
$1,792,000 compared to $1,312,000 for the year ended December 31, 2005.

Selling,
General and Administrative Expenses. Selling, general
and administrative expenses in the year ended December 31, 2006 amounted to
$10,263,000 compared to $8,866,000 for the year ended December 31, 2005. This
increase of $1,397,000, or 16%, 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, 2006 amounted to $325,000 , compared to financing expense of
$146,000 for the year ended December 31, 2005. The move from financing expense
was primarily due to an increase of exchange currencies gain in 2006, which is
a product of the strengthening of the Euro and British Pound against the U.S.
Dollar. Net expenses from forward facilities transactions in 2006 was
$61,000.

Net
income (loss). As a result of the foregoing, our net
income for the year ended December 31, 2006 was $801,000, compared to a net
loss of $461,000 in year ended December 31, 2005.

- 28 -

---

---



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

Revenues.
Total revenues for the year ended December 31, 2005 amounted to $16,820,000
compared to $11,178,000 for the year ended December 31, 2004, an increase of
50%. Product sales increased by $2,924,000 or 42%, from $6,964,000 in 2004 to
$9,888,000 in 2005, mainly because of a large sale to a customer in Australia.
Service revenues increased by $2,718,000, or approximately 64%, from $4,214,000
in the year ended December 31, 2004 to $6,932,000 in the year ended December
31, 2005. This significant increase is attributable mainly to services performed
by TISJ, our subsidiary in Japan, which was established in 2004.

Cost
of Revenues. Cost of revenues increased by $3,291,000,
or 95%, from $3,472,000 in the year ended December 31, 2004 to $6,763,000 in
the year ended December 31, 2005. The increase is a result of growth in demand
for our products and services and for more comprehensive solutions, which
required us to allocate and invest more resources to meet such demand and meet
the software and other requirements of the more comprehensive solutions.

Research
and Development. During 2005, we continued to focus
efforts in enhancing our software recognition and core capabilities. Research
and development expenses in the year ended December 31, 2005 amounted to
$1,312,000 compared to $929,000 for the year ended December 31, 2004.

Selling,
General and Administrative Expenses. Selling, general
and administrative expenses in the year ended December 31, 2005 amounted to
$8,866,000 compared to $7,123,000 for the year ended December 31, 2004. This
increase of $1,743,000 or 24%, is mainly attributable to the expansion our
sales force and establishing roots for major sales centers in several locations
worldwide and our annual customers conference in the amount of $211,000 which took
place in February 2005, and had not been held in 2004.

Liquidated
Damages Related to September 2004 Private Placement.
In 2005, we paid liquidated damages in the amount of $164,000 as part of our
registration commitment to investors in the September 2004 private placement.
No such amounts were paid in 2004.

Financing
Income, net. Financing expense for the year ended
December 31, 2005 amounted to $146,000, compared to financing income of
$178,000 for the year ended December 31, 2004. The move to financing expense
was primarily due to a decrease of exchange gain in 2005, which is a product of
the weakening of the Euro and British Pound against the U.S. Dollar. During the
second quarter of 2005, we initiated some investments in forward investments
facilities (forwards) in order to reduce our balance and transactions exposure
against the Euro, GBP and JPY. The net savings from these
transactions in 2005 was $109,000.

Net
Loss. As a result of the foregoing, our net loss for
the year ended December 31, 2005 was $461,000, compared to a net loss of
$168,000 in year ended December 31, 2004.

Impact
of Currency Fluctuation and Inflation

We
maintain operations and generate revenues in a number of countries. The results
of operations and the financial position of our local operations are generally
reported in the relevant local currencies and then translated into U.S. dollars
at the applicable exchange rates for inclusion in our consolidated financial
statements, exposing us to currency translation risk. In addition, we are
exposed to currency transaction risk because some of our expenses are incurred
in a different currency from the currency in which our revenues are received.
Our most significant currency exposures are to the Euro, New Israeli Shekel, UK
Pound and Japanese yen. In periods when the U.S. dollar strengthens against
these other currencies, our reported results of operations may be adversely
affected.

- 29 -

---

---



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 1.21% and 2.4% in 2004
and 2005, 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 U.S. dollar. For
example, during the years 2004 and 2005, the devaluation of the NIS against the dollar,
which amounted to 1.62% and 6.8% accordingly, exceeded the inflation rate for the same
periods. On the other hand, the negative inflation rate in 2003 of 1.9% and 2006 of 0.1%
exceeded the devaluation of the dollar against the NIS, which amounted to 7.56% and 8.2%
respectively. The increase in the dollar cost of our operations in Israel relates
primarily to the costs of salaries in Israel, which constitute a significant portion of
our expenses and are paid in NIS. In addition, inflation in Israel will have a negative
effect on the profitability of 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 of our assets, 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 of our unlinked NIS assets and the dollar amounts of any unlinked NIS
liabilities.

From
time to time we purchase forward exchange contracts to reduce currency
transaction risk. However, these purchases will not eliminate translation risk
or all currency risk.

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, the most recent confrontation taking place in July-August 2006.
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. In addition, we cannot predict the
effect on Israel or the Middle East generally of the recent elections in the
Palestinian Authority in which Hamas, an Islamic movement responsible for many
attacks against Israelis, has formed the new government. 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 36 days 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.

- 30 -

---

---



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.

Liquidity
and Capital Resources

As
of December 31, 2006, our cash, cash equivalents, bank deposits and marketable
securities were $21,792,000, compared to $10,005,000 as of December 31, 2005.

Net
cash provided by operating activities for the year ended December 31, 2006 was
$439,000 as compared to $421,000 used in operating activities in the
corresponding period in 2005. This increase was attributable primarily to the
increase in our sales and the results of improvement in our collection efforts.
Our trade receivables increased to $7,642,000 at December 31, 2006 from
$6,802,000 at December 31, 2005. This increase reflects our increased sales in
2006. In addition, stronger collections in 2006 than in previous years reduced
our days of sales outstanding. 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. For the year ended December 31, 2006, the aggregate amount
of our capital expenditures was $252,000. These expenditures were principally
for the purchases of computer hardware and software and facilities
improvements. In December 2006 through the issuance of convertible debentures,
we raised net proceeds of $13,510,000. Subsequently on December 31, 2006, we
reduced our short term bank loan to $339,000.

As
of December 31, 2005, our cash, cash equivalents, bank deposits and marketable
securities were $10,005,000, compared to $10,415,000 as of December 31, 2004.

Net
cash used in operating activities for the year ended December 31, 2005 was
$421,000 as compared to $1,074,000 for the corresponding period in 2004. This
decrease was attributable primarily to the increase in our sales and the
results of improvement in our collection efforts. Our trade receivables
increased to $6,802,000 at December 31, 2005 from $5,541,000 at December 31,
2004. This increase reflected our increased sales in 2005.

For
the year ended December 31, 2006, the aggregate amount of our capital
expenditures was $252,000. These expenditures were principally for the
purchases of computer hardware and software and facilities improvements.

Convertible
debentures

On
December 27, 2006, we completed a public offering of approximately NIS 61.9
million (approximately $14.8 million) aggregate principal amount of convertible
debentures on the Tel Aviv Stock Exchange. The public offering was comprised of
112,500 convertible debentures of NIS 528 (approximately $124) par value each.
The convertible debentures are linked to the US Dollar and will bear interest
at the annual rate of six-month LIBOR minus 0.3%. The interest is payable
semi-annually commencing on June 30, 2007, and the principal is repayable in
four annual installments commencing on December 31, 2009. After taking into
account a concurrent private placement to the underwriter of NIS 500,000
aggregate principal amount of convertible debentures and an original issue
discount of 4% on all the convertible debentures, the gross proceeds to TIS
were NIS 59.87 million (approximately $14.8 million).

- 31 -

---

---



The
debentures may be converted at the election of the holder into our ordinary
shares at the conversion price of NIS 20.30 (approximately $4.81) per share. We
also have the right to force conversion on or after October 1, 2009 if our
share fair market value (as defined in the debenture documents) reaches NIS
25.50 (approximately $6.04) in the last 30 trading days in TASE on or after
October 1, 2009. This offering was made in Israel to residents of Israel only.
The convertible debentures offered were not and will not be registered under
the U.S. Securities Act of 1933, as amended.

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 were 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.

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.

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. Because of
this failure, the agreements with the investors required us to pay liquidated
damages in the amount of 1% of the amount invested and an additional 1% for
every month in which the failure was not cured, which obligation amounted to
$164,000. In addition, any future failure to maintain effectiveness of the
registration statement could subject us to additional liquidated damages under
the same formula, 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 Capital Market.

- 32 -

---

---



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
$2,300,000 and 75% of certain eligible trade receivables. As of December 31,
2006, we had approximately $339,000 outstanding credit in US dollars. The
revolving line of credit in NIS bears interest at a rate of Prime + 1% (as of
December 31, 2006, the prime rate was 6.5%) however no amount was outstanding
as of December 31, 2006. The line of credit in US dollars bears interest at a
rate of Libor + 2% (as of December 31, 2006, the Libor rate was 5.36%). 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.

Research and Development, Patents and
Licenses, etc.

The
main focus of our research and development in 2006 was the design and development of the new eFLOW
version, eFLOW4,
which will be released during the first quarter of 2007. The new abilities introduced
to eFLOW 4 were presented at our international conference in Berlin and we were
encouraged by the positive feedback we got from our customers and partners. The
main features we developed in 2006 are:

|   |                                                                                                                                                                                                                                                                                                                                                     
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|1. | Supporting Mailroom projects: eFLOW4 provides
  a better classifier with enhanced analysis tools which will result in better
  results with less implementation efforts. We have seen much interest from our
  customers, including at the conference we held in Berlin, for such solutions
  and we are intending to invest more in this direction.

(GRAPHIC)

|   |                                                                                                                                                                                                                                                                                                            
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|2. | Completion4: This new Data Entry module is
  now in the final stages of development and testing. Completion4 offers
  greater efficiency and productivity, new usability concepts, better
  performance and the new look of modern OS systems. In this screen shot you
  can see an example of Completion4:

- 33 -

---

---



(GRAPHIC)

|   |                                                                                    |                    
|-- | ---------------------------------------------------------------------------------- | -------------------
|3. | Supporting the latest development technology from
  Microsoft, Microsoft .Net 2.0.
|   |                                                                                   
|   | a.                                                                                 | Faster Code execute

| |  |          
| |  | ---------
| |  | (GRAPHIC)

| |    |                                                                                                                                                          
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------
| | b. | Group templates:
  a user can use a bank of templates (for example, German address), export it
  and use it later with other applications, as shown here:

| |  |          
| |  | ---------
| |  | (GRAPHIC)

- 34 -

---

---



|   |                                                                                                                                    
|-- | -----------------------------------------------------------------------------------------------------------------------------------
|4. | Two new additional recognition
  algorithms were added to be part of Freedom, Graphical
  Table Recognition and Automatic Learning.

(GRAPHIC)

|   |                                                                          
|-- | -------------------------------------------------------------------------
|5. | Generic connectivity to databases
  using eFLOW server side
  connection.

(GRAPHIC)

Improved
development process:

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|1. | Microsofts Team System 2005 is
  part of the R&D process.Together with Microsofts
  technical team and one of our partners we replaced the older version control
  system with Microsofts system.                                                                                                                                                                                                                                                       
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|2. | Agile development.We
  have used advanced design and development concepts, including detailed unit
  tests at the developer level.                                                                                                                                                                                                                                                                                                                         
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|3. | Automatic Tests.
  This is now a standard part of our quality assurance process. The use of
  automatic tools dramatically reduces the amount of time needed to test the
  released version, where most of the tests are being done automatically by the
  QA machine. This allows much faster iterations of Development-QA and an
  overall higher quality of the product, with fewer bugs released initially and
  quicker convergence to stable product.

- 35 -

---

---



Trends

We
expect that semi-structured technology will become a central part of the
document management market. We are addressing this trend by strengthening and
further developing our semi-structured technology, mainly in the Business
Process Outsourcing, or BPO, environment.

We
anticipate that growth will continue in the data capture market. We expect that
new recognition and classification technologies combined with more vertical
market integration will expend the main markets. However, we believe that there
will be a move toward integrated software solutions, such as Freedom, our eFLOWplug-in for semi-structured content,
instead of
individual data capture products and semi-structured technology. As of today,
there is a great demand for our Integra technology, especially in large
intensive government projects. We also anticipate that the need for
applications will increase substantially, mainly in the Accounts Payables
workflow area, . We expect outsourcing with respect to documents solutions to
increase due to its cost efficiency and improved quality and for the date
capture industry to continue to move toward consolidation. We are addressing
these trends by solidifying our relationships with our existing partners and
seeking to become the preferred data capture solution provider for many large
integrated system providers.

Tabular
disclosure of contractual obligations

The
following is a summary of our significant contractual obligations as of
December 31, 2006:

|                           |  |       |            |                      |  |           |  |           |           |                     |  |            |  |  |         | 
|-------------------------- |  | ----- | ---------- | -------------------- |  | --------- |  | --------- | --------- | ------------------- |  | ---------- |  |  | ------- | 
|Contractual Obligation     |  | Total |            | Less Than
  1
  Year |  | 1-3 Years |  | 3-5 Years |           | More than
  5 Years | 
|                           |  |       |            |                      |  |           |  |           |           |                     | 
|Operating Lease Obligation |  |       | 1,873,000  |                      |  | 734,000   |  |           | 671,000   |                     |  | 312,000    |  |  | 156,000 | 
|Convertible debenture      |  |       | 14,197,000 |                      |  | -         |  |           | 3,549,250 |                     |  | 10,647,750 |  |  | -       | 

We
also have a long-term liability on our balance sheet as of December 31, 2006 in
the amount of $1,016,000 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, 2006 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 10 to the
consolidated financial statements for the year ended December 31, 2006 as well
as the section entitled Compensation herein. We expect to finance these
contractual commitments from cash on hand and cash generated from operations.

With respect to
 our short term loan, please see the discussion under Line of Credit in
Liquidity and Capital Resources above.

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

- 36 -

---

---



Update

|                   |  |     |  |                                           
|------------------ |  | --- |  | ------------------------------------------
|Name               |  | Age |  | Title                                     
|                   |  |     |  |                                           
|                  
|Izhak Nakar        |  | 55  |  | Chairman of the Board                     
|                   |  |     |  |                                           
|Ido Schechter      |  | 46  |  | Chief Executive Officer and Director      
|                   |  |     |  |                                           
|Arie Rand          |  | 47  |  | Chief Financial Officer                   
|                   |  |     |  |                                           
|Gideon Shmuel      |  | 35  |  | Vice President of Sales                   
|                   |  |     |  |                                           
|Oded Leiba         |  | 36  |  | Vice President of Engineering             
|                   |  |     |  |                                           
|Ofir Shalev        |  | 35  |  | Vice President of Research and Development
|                   |  |     |  |                                           
|Victor Halpert     |  | 46  |  | Director                                  
|                   |  |     |  |                                           
|Sivan Sadan        |  | 33  |  | Director                                  
|                   |  |     |  |                                           
|Elie Housman       |  | 70  |  | Director                                  
|                   |  |     |  |                                           
|William M. Landuyt |  | 51  |  | Director                                  
|                   |  |     |  |                                           
|Yehezkel Yeshurun  |  | 58  |  | Director                                  

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.

Ido
Schechter has 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 eFLOW platform 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.

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.

- 37 -

---

---



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
Shalev has 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.

Sivan
Sadan has served in various positions at Tamir Fishman
entities from 1997 to 2005. Ms. Sadan acted as Managing Director and head of
Corporate Finance of Tamir Fishman and Co., and served as a Partner at Tamir
Fishman Ventures. Ms. Sadan is the founder and CEO of Or Capital Ltd. which was
established in 2006. Ms Sadan serves as a member of the Advisory Board of
Micronet Ltd. Ms. Sadan has a Bachelor degree with honors in Economics and
Management and a Master in Business Administration and Finance from Tel Aviv
University.

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 is a Senior Partner at Charterhouse Group, Inc., having joined the
New York City-based private equity firm in 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.

- 38 -

---

---



Yehezkel
Yeshurun has been a director of TIS 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 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, 2006, the compensation
paid, and value of benefits in kind granted, to Ido Schechter, our Chief
Executive Officer, was $306,000, which was composed of a base salary and bonus
of $237,000, and $69,000 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, on December 31, 2006, directors or members of
our administrative, supervisory or management bodies during that time was
$1,028,000. In addition, in 2006, members of that group, together with our
Chief Executive Officer, were granted an aggregate of options to purchase
286,600 ordinary shares under our Employee Share Option Plan 2003 with an
average exercise price of $3.78 per share. The compensation paid to all persons
other than Ido Schechter include (i) $84,000 reimbursement of directors
expenses, (ii) $195,000 which has been accrued to provide pension, retirement,
severance, vacation or similar benefits, and allowance for automobiles made available
to our officers, and does not include other expenses (including business
travel, and professional and business association dues and expenses) reimbursed
to officers and (iii) $102,000 for business development services rendered by
Mr. Nakar.

On
December 27, 2006, our shareholders approved the grant of an option to purchase 125,000
ordinary shares to several members of the board, at an exercise price of $ 3.84 and
vesting term of 2 years.

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 2006) and until their successors are duly elected and
qualified at the relevant annual meeting. The external directors may be elected
for additional three-year periods as more fully detailed under the title External Directors. At our shareholders
meeting held on December 27, 2006, the shareholders approved a payment to the
members of the Audit Committee, Compensation Committee and the board of
directors, in the amount per director of 15,750 NIS per annum. In addition each
of the above directors receives an amount of 3,000 NIS for each Board and/or
Audit committee or Compensation 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. Mr.
Yehezkel Yeshurun is entitled to compensation in the amount of 19,841 NIS per
year for his service as a member of the Board of Directors and 993 NIS for each
Board and/or committee meeting attended.

- 39 -

---

---



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, and as confirmed again in the General Shareholders Meeting held on
November 15, 2005, relating to our establishment of TISJ, 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, which was paid to Mr. Nakar in 2005 and 2006. In addition, Mr. Nakar was paid a
fee of $1,000, plus reimbursement of any expenses, for every business day invested by him
in consideration for his active involvement with any other TIS business throughout 2006.
During 2006, we recorded an expense of $102,000 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(a)(15) thereof. The board of directors
has determined that Sivan Sadan, William Landuyt, Elie Housman, Yehezkel
Yeshurun, and Victor Halpert are each independent directors for purposes of the
NASDAQ rules.

Israeli
law requires that a public company, such as TIS, have at least two external directors. As
of January 2006, the Israeli Companies Law -1999 requires as a general principle that at
least one statutory external director have financial and accounting expertise, and that
the other statutory external director have professional competence, as determined by
our board of directors; under the recently amended Companies Regulations (Allowances for
Companies with Securities Listed on an Exchange Outside Israel)  2000, TIS as a
company whose securities are listed both on the Tel Aviv Exchange and on NASDAQ as a
foreign exchange meeting Israeli statutory requirements, is exempt from having an external
director possessing financial and accounting expertise in the sense of the Israel
Companies Law  1999, provided that the company has a director possessing financial
and accounting expertise as an independent member of the audit committee under the foreign
law, so that all external directors may be directors possessing professional competence;
under the Companies Regulations (Qualifications of Director Having Financial and
Accounting Expertise and of Director Having Professional Competence)  2005, a
director having financial and accounting expertise is a person who, due to his or her
education, experience and talents is highly skilled in respect of, and understands,
business and accounting matters and financial reports, in a manner that enables him or her
to deeply understand the companys financial statements and to arouse discussion in
respect of the manner in which the financial data is presented. The board of directors has
determined that Victor Halpert is an audit committee financial expert pursuant to the
rules of the NASDAQ Stock Market. Under the regulations, a director having professional
competence is a person who has an academic degree in either economics, business
administration, accounting, law or public administration or an academic degree in an area
relevant to the companys business, or has at least five years experience in a senior
position in the business management of a corporation with a substantial scope of business,
in a senior position in the public service or in the field of the companys business.
The two external directors of the Company are Sivan Sadan and Victor Halpert.

Audit
Committee

The
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 Sivan
Sadan, serve on the audit committee of the board of directors, along with Elie
Housman. The board of directors has determined that Victor Halpert is an audit
committee financial expert pursuant to the rules of the NASDAQ Stock Market.

Compensation
Committee

In
August 2004, the board of directors authorized the establishment of a
Compensation Committee. The current members of the Committee are William M.
Landuyt, Yehezkel Yeshurun and Victor Halpert. 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.

- 40 -

---

---



Employees

As
of December 31, 2006, we employed the following employees:

|               |  |                   |  | 
|-------------- |  | ----------------- |  | 
|Company
  Name |  | No of
  Employees | 
|               |  |                   | 
|TIS Israel     |  | 52                |  | 
|TIS Germany    |  | 18                |  | 
|TIS Japan      |  | 19                |  | 
|TIS UK         |  | 15                |  | 
|TIS USA        |  | 4                 |  | 
|               |  |                   |  | 
|Total          |  | 108               |  | 

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.

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 principle 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 59,174 ordinary shares. These shares
represent 0.7% (0.4% 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% (1.9% 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 22.6% (13.3% on a fully diluted
basis) of our outstanding share capital.

Stock
Options

In
order to attract, retain and motivate employees (including officers) who perform
services for or on behalf of us, we maintain three Employee Share Option Plans,
one established in 1996 (ESOP 1996), the second in 2000 (ESOP 2000) and the
third in 2003 (ESOP 2003). Upon adoption of ESOP 2003, all shares previously
available for grant under ESOP 1996 and 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. We have filed registration statements on
Form S-8 covering our Employee Share Option Plans.

- 41 -

---

---



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 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 1996. 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. ESOP 1996 authorized 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, 2006, options to purchase 82,625 ordinary shares were outstanding
under the plan at exercise prices between $2.31 and $4.13 per share.

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.

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. Except as required by Section 102, the terms of ESOP 2000 are
substantially the same as those of ESOP 1996.

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, 2006,
options to purchase an aggregate of 118,500 shares were outstanding. All
options are exercisable and have exercise prices between $0.99 and $4.125 per
share.

- 42 -

---

---



Employee
Share Option Plan (2003)

An
additional share 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. The
terms of ESOP 2003 are substantially the same as those of ESOP 2000. 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 filed the necessary documents with
the Israeli tax authorities for the approval of the new option plan on June 4,
2003. Such approval provides the grantees the eligibility for certain benefits
under Section 102 of the Israeli Income Tax Ordinance (New Version) 1961 and
the rules promulgated thereunder as revised by the Israeli tax reform.

During
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. During 2006, the board of directors and the shareholders of the
Company approved the issuance of options to purchase an additional 700,000
ordinary shares pursuant to ESOP 2003.

On
December 27, 2006, the shareholders of the Company approved the grant of an
option to purchase 125,000 ordinary shares to several members of the board, at
an exercise price of $ 3.84 and vesting term of 2 years.

As of
December 31, 2006 options to purchase 643,317 ordinary shares
were available for future grant.

On
December 30, 2005, we decided to accelerate the vesting of 304,830 of our
unvested share options previously awarded to employees and officers (other than
executive officers) of the Company to purchase the Companys shares pursuant to
ESOP 1996, ESOP 2000 or ESOP 2003, such that, as of December 31, 2005, these
outstanding options to purchase any of the Companys ordinary shares were fully
vested.

As
a result of the acceleration, we recorded in 2005 additional compensation
expenses of $44,000, included in general and administrative expenses.

Our
decision to accelerate the vesting of those options and to grant fully vested
options, was based primarily on the issuance of SFAS No. 123(R), which requires
the Company to treat all unvested stock options as compensation expense,
effective January 1, 2006. We believe that the accelerated vesting of those
options will enable the Company to avoid recognizing stock-based compensation
expense associated with these options in future periods. Additional purposes
for the fully vested grant and for the acceleration were to make the options
more attractive to recipients and to avoid discrimination between groups of
option holders, respectively.

Non-Plan
Options

We
have reserved 115,000 ordinary shares for issuance upon the exercise of
outstanding non-plan share options all of which have been granted by the
Company to certain executive officers and key employees.

As
of December 31, 2006, no non-plan options are outstanding.

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

As
of December 31, 2006, Charter held 2,000,000 ordinary shares, or 22.6% (13.3%
on a fully diluted basis) of our outstanding share capital. At that time, Izhak
Nakar held in his name 59,174 ordinary shares, or 0.7% (0.4% 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% (1.9% 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 composed 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.

- 43 -

---

---



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 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 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
2006, we recorded on our books an amount of $102,000 for Mr. Nakars services.

Twenty-one
record holders of ordinary shares have declared postal addresses in the United
States. These twenty-one record holders hold, between them, 95.2% of our
outstanding share capital. These numbers are not representative of the number
of beneficial holders of our shares nor is it representative of where such
beneficial holders reside since many of these ordinary shares were held of
record by brokers or other nominees (including one U.S. nominee company, CEDE &
Co., which held approximately 68.5% of our outstanding ordinary shares as of
said date). There are no arrangements known to us that may at a subsequent date
result in a change in control of us.

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

|                             |  |      |            |      |  |            |   |  |            |  
|---------------------------- |  | ---- | ---------- | ---- |  | ---------- | - |  | ---------- | -
|                             |  | 2006 |            | 2005 |  | 2004       |  
|                             |  |      |            |      |  |            |  
|Export Revenues              |  |      |            |      |  |            |   |  |            |  
|Export Revenues              |  |      | 20,150,000 |      |  | 16,682,000 |   |  | 10,994,226 |  
|Total Revenues               |  |      | 20,224,000 |      |  | 16,820,000 |   |  | 11,178,448 |  
|Percentage of Total Revenues |  |      | 99         | %    |  | 99         | % |  | 98         | %
|                             |  |      |            |      |  |            |   |  |            |  
|Breakdown of Revenues        |  |      |            |      |  |            |   |  |            |  
|Product Revenues             |  |      | 60         | %    |  | 59         | % |  | 62         | %
|Service Revenues             |  |      | 40         | %    |  | 41         | % |  | 38         | %

- 44 -

---

---



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.

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

A. Offer and Listing Details.

Effective
November 1996, our ordinary shares have been quoted on the NASDAQ Capital
Market, under the symbol TISAF. Effective April 29, 1999, the symbol for the
ordinary shares was changed to TISA on the NASDAQ Capital Market.

The
following table sets forth, for the periods indicated, the high and low closing
prices of our ordinary shares, as reported on the NASDAQ Capital Market.

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       |  |    |  | NASDAQ
  Capital Market
|                  |  |    |  |                        
|December 31, 2006 |  | Hi |  | 4.44                   
|                  |  | Lo |  | 2.80                   
|                  |  |    |  |                        
|December 31, 2005 |  | Hi |  | 4.11                   
|                  |  | Lo |  | 2.13                   
|                  |  |    |  |                        
|December 31, 2004 |  | Hi |  | 5.00                   
|                  |  | Lo |  | 2.13                   
|                  |  |    |  |                        
|December 31, 2003 |  | Hi |  | 3.14                   
|                  |  | Lo |  | 0.42                   
|                  |  |    |  |                        
|December 31, 2002 |  | Hi |  | 3.92                   
|                  |  | Lo |  | 0.42                   

- 45 -

---

---



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

|                   |  |    |  |                        
|------------------ |  | -- |  | -----------------------
|Quarter Ending     |  |    |  | NASDAQ
  Capital Market
|                   |  |    |  |                        
|December 31, 2006  |  | Hi |  | 4.44                   
|                   |  | Lo |  | 3.07                   
|                   |  |    |  |                        
|September 30, 2006 |  | Hi |  | 3.50                   
|                   |  | Lo |  | 2.87                   
|                   |  |    |  |                        
|June 30, 2006      |  | Hi |  | 4.04                   
|                   |  | Lo |  | 3.07                   
|                   |  |    |  |                        
|March 31, 2006     |  | Hi |  | 4.00                   
|                   |  | Lo |  | 2.80                   
|                   |  |    |  |                        
|December 31, 2005  |  | Hi |  | 3.29                   
|                   |  | Lo |  | 2.31                   
|                   |  |    |  |                        
|September 30, 2005 |  | Hi |  | 3.59                   
|                   |  | Lo |  | 2.47                   
|                   |  |    |  |                        
|June 30, 2005      |  | Hi |  | 3.74                   
|                   |  | Lo |  | 2.67                   
|                   |  |    |  |                        
|March 31, 2005     |  | Hi |  | 4.11                   
|                   |  | Lo |  | 2.89                   

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       |  |    |  | NASDAQ
  Capital Market
|                   |  |    |  |                        
|February 28, 2007  |  | Hi |  | 4.00                   
|                   |  | Lo |  | 3.57                   
|                   |  |    |  |                        
|January 31, 2007   |  | Hi |  | 4.25                   
|                   |  | Lo |  | 3.50                   
|                   |  |    |  |                        
|December 31, 2006  |  | Hi |  | 3.99                   
|                   |  | Lo |  | 3.45                   
|                   |  |    |  |                        
|November 30, 2006  |  | Hi |  | 4.44                   
|                   |  | Lo |  | 3.07                   
|                   |  |    |  |                        
|October 31, 2006   |  | Hi |  | 3.68                   
|                   |  | Lo |  | 3.20                   
|                   |  |    |  |                        
|September 30, 2006 |  | Hi |  | 3.50                   
|                   |  | Lo |  | 2.97                   

Our
ordinary shares have been dual-listed for trading on the Tel Aviv Stock
Exchange since December 3, 2006. Since the date of listing, there has been only
limited and sporadic trading activity.

- 46 -

---

---



Markets

Effective
November 1996, our ordinary shares were quoted on the Nasdaq Capital 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 Capital Market. The ordinary shares are not
publicly traded outside the United States.

In
March of 2005, our board of directors determined that we derived no material
benefit from continued listing on the Boston Stock Exchange, as there had been
no trading activity in our ordinary shares on that exchange since November
1999, and authorized and directed management to commence voluntary delisting
procedures. The Securities and Exchange Commission subsequently approved our
application to delist, and our voluntary delisting became effective in March
2005.

Our
ordinary shares were dual-listed on the Tel Aviv Stock Exchange on December 3,
2006, in addition to being listed on the NASDAQ Stock Market. Effective January
1, 2007, the Tel Aviv Stock Exchange included our shares in the Tel Aviv
Tel-Tech index, which tracks the performance of the top Israeli technology
companies by market cap.

On
December 27, 2006, we completed a public offering of approximately NIS 61.9
million (approximately $14.7 million) aggregate principal amount of convertible
debentures on the Tel Aviv Stock Exchange. The public offering was composed of
112,500 convertible debentures of NIS 528 (approximately $124) par value each.
The convertible debentures are linked to the US Dollar and will bear interest
at the annual rate of six-month LIBOR minus 0.3%. The interest is payable
semi-annually commencing on June 30, 2007, and the principal is repayable in
four annual installments commencing on December 31, 2009. After taking into
account a concurrent private placement to the underwriter of NIS 500,000
aggregate principal amount of convertible debentures and an original issue
discount of 4% on all the convertible debentures, the gross proceeds to TIS
were NIS 59.87 million (approximately $14.1 million).

The
debentures may be converted at the election of the holder into our ordinary
shares at the conversion price of NIS 20.30 (approximately $4.81). We also have
the right to force conversion on or after October 1, 2009 if our share fair
market value (as defined in the debenture documents) reaches NIS 25.50
(approximately $6.04). This offering was made in Israel to residents of Israel
only. The convertible debentures offered were not and will not be registered
under the U.S. Securities Act of 1933, as amended.

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

- 47 -

---

---



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.

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

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 Companies
Regulations (Allowances for Companies with Securities Listed on an Exchange
Outside Israel)  2000. 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.                                            

- 48 -

---

---



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
(extendable for an additional three years term) and, with regard to companies
whose securities are listed on recognized foreign exchanges, such as TIS, may
be extended for additional three-year terms, subject to the approval of the
Audit Committee and the Board, presented to the general meeting, that such
directors expertise and special contribution to the operation of the Board
warrant that his appointment for an additional period is in the best interests
of the company, as provided in Companies Regulations (Allowances for Companies
with Securities Listed on an Exchange Outside Israel)  2000. The approval of
the general meeting shall requires that the majority of votes include one-third
of the non-controlling shareholders present at the meeting, or alternatively,
that the total of opposing votes does not exceed 1% of the voting rights (and
in the event that all Board members are of one gender, one of the external
directors should be of the other), in accordance with the provisions of the
Companies Law. 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.

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 from acting as an alternate director for more than one incumbent
director.

The
term of appointment of an alternate 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 an alternate director, except if the
director is unable to attend a meeting of the board of directors.

Internal Auditor and Certified Public
Accountant

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), nor an affiliate, nor 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.

- 49 -

---

---



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 27, 2006, 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

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 according
to an indemnification letter. At a shareholders meeting held on November 15,
2005, following statutory amendment of 2005, the shareholders approved the
indemnification letter currently in place with regard to the Companys
directors and officers in the form attached hereto.

Under
the Israeli Companies Law, a company may indemnify an office holder against any
monetary liability incurred in his or her capacity as an office holder whether
imposed on him or her or incurred by him or her in favor of another person
pursuant to a judgment, a settlement or an arbitrators award approved by
court. A company also can indemnify an office holder against reasonable
litigation expenses including attorneys fees, incurred, whether or not paid by
him or her in his or her capacity as an office holder, in proceedings
instituted against him or her by the company, on its behalf or by a
third-party, in connection with criminal proceedings in which the office holder
was acquitted, or as a result of a conviction for a crime that does not require
proof of criminal intent, or in which an indictment was not brought against the
office holder.

In
addition, a company may indemnify an office holder against reasonable legal
fees, including attorneys fees, incurred, whether or not paid by him, by him
or her in consequence of an investigation or proceeding instituted against him
or her by an authority that is authorized to conduct such investigation or
proceeding, and that was resolved without an indictment against him or her and
without imposing on him or her financial obligation as an alternative of a
criminal proceeding, or that was resolved without filing an indictment against
him or her but with the imposition on him or her of a financial obligation as
an alternative to a criminal proceeding in respect of an offense that does not
require the proof of criminal intent.

A
company may indemnify an office holder in respect of these liabilities either
in advance of an event or following an event. If a company undertakes to
indemnify an office holder in advance of an event, the indemnification, other
than litigation expenses, must be limited to foreseeable events in light of the
companys actual activities when the company undertook such indemnification,
and reasonable amounts or standards, as determined by the board of directors.

A
company may obtain insurance for an office holder against liabilities incurred
in his or her capacity as an office holder. These liabilities include a breach
of duty of care to the company or a third-party, including a breach arising out
of negligent conduct of the office holder, a breach of duty of loyalty and any
monetary liability imposed on the office holder in favor of a third-party. A
company may also exculpate an office holder from a breach of duty of care in
advance of that breach. Our articles of association provide for exculpation
both in advance or retroactively, to the extent permitted under Israeli law. A
company may not exculpate an office holder from a breach of duty of loyalty
towards the company or from a breach of duty of care concerning dividend
distribution or a purchase of the companys shares by the company or other
entities controlled by the company.

Under
the Israeli Companies Law, a company may indemnify or insure an office holder
against a breach of duty of loyalty only to the extent that the office holder
acted in good faith and had reasonable grounds to assume that the action would
not prejudice the company. In addition, a company may not indemnify, insure or
exculpate an office holder against a breach of duty of care if committed
intentionally or recklessly (excluding mere negligence), or committed with the
intent to derive an unlawful personal gain, or against a fine or forfeit levied
against the office holder in connection with a criminal offense.

- 50 -

---

---



Currently,
we hold an insurance policy for our office holders that provides coverage
limited to $15,000,000 in aggregate for the policy period ending on December
31, 2007.

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.

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.

According
to our Articles, any resolution on the change of the Companys share capital by
way of the creation of new shares, or cancellation of unissued registered
shares, with preferred or qualified rights is deemed a change of our Articles
of Association and as such requires the vote of a majority of 75% of the
shareholders participating in the general meeting. If at any time our share
capital is divided into different classes of shares, we may change the rights
of shareholders by way of a resolution of the general meeting, subject to the
consent of the shareholders of the class whose rights are being impaired by the
proposed change.

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.

- 51 -

---

---



The
determining date as to share ownership for purposes of attending and voting at
a general meeting is statutorily shall be as set forth in the decision to
convene a general meeting but not earlier than 21 day before the scheduled
general meeting date and not later than 4 days prior to such scheduled meeting
date; Notwithstanding the foregoing, Israeli companies such as ours whose
shares have been listed for trade both on the Tel Aviv Exchange and recognized
foreign stock exchange, which issue proxy statements to their shareholders in
conformity with the law of the country where such foreign exchange is located,
are entitled to vary such determining date to not earlier than 21 day before
the scheduled general meeting date and not later than 4 days prior to such
scheduled meeting date, and are entitled to certain allowances as to issuing
proxy statements to shareholders outside Israel, in accordance with the
Companies Regulations (Allowances for Companies with Securities Listed on an
Exchange Outside Israel) - 2000.

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. An
Israeli company whose securities are listed on the Tel Aviv Exchange and on a
recognized foreign exchange, such as our, enjoys certain allowances with regard
to a special purchase offer having consideration to the requirements of the law
of the country where such foreign exchange is located.

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.

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.

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:

- 52 -

---

---



| |   |                                                                               
| | - | ------------------------------------------------------------------------------
| |  | 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.

In
a recent amendment to the Companies Law, it has been specified that in the
event that a controlling shareholder breaches his duty of fairness then such
breach shall be considered as a breach of contract, mutatis mutandis, while
taking into account the special position of such controlling shareholder within
the company.

Material
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.

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
Israeli statutory corporate tax rate on taxable business income until the
fiscal year of 2003 was 36%. On June 29, 2004, and on August 10, 2005 the
Israeli Parliament passed the Amendment to the Income Tax Ordinance (No. 140
and No. 147 Temporary Provision), which progressively reduces the tax rates
applicable to companies from 35% in 2004 to a rate of 29% 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.

- 53 -

---

---



As
of December 31, 2006, we had operating loss carryforwards for
tax purposes in the amount of $3,971,000. The amount of our carryforward
operating losses will be offset against taxable future income for an indefinite
period.

As
of December 31, 2006 the foreign subsidiaries had operating
loss carryforwards for tax purposes in the amount of $ 4,449,000. A portion of
such losses expires over a period from 2007 through 2019.

Law for the Encouragement of Capital
Investments, 1959

General

The
Law for the Encouragement of Capital Investments, 1959, or 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 tax benefits 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,
2005, we are 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                   |  |                  |    |  

- 54 -

---

---



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 to ten-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. This limitation does not apply to the
exemption period.

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
April 1, 2005, an amendment to the Investment Law came into effect (the
Amendment) significantly changed the provisions of the Investment Law. The
Amendment limits the scope of enterprises which may be approved by the
Investment Center by setting criteria for the approval of a facility as an
Approved Enterprise, such as provisions generally requiring that at least 25%
of the Approved Enterprises income be derived from export. Additionally, the
Amendment enacted major changes in the manner in which tax benefits are awarded
under the Investment Law so that companies no longer require Investment Center
approval in order to qualify for tax benefits.

However,
the Investment Law provides that terms and benefits included in any certificate
of approval already granted will remain subject to the provisions of the law as
they were on the date of such approval. Therefore, our existing Approved
Enterprise will generally not be subject to the provisions of the Amendment. As
a result of the amendment, tax-exempt income generated under the provisions of
the new law will subject the Company to taxes upon distribution or liquidation
and the Company may be required to record deferred tax liability with respect
to such tax-exempt income. As of December 31, 2005, the Company did not
generate income under the provision of the new law.

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.

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.

- 55 -

---

---



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 dollars.

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.

Prior
to the tax reform (came into effect in January 1, 2003), 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 Capital 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.

Israeli
law generally imposes a capital gains tax on the sale of capital assets located
in Israel, including shares in Israeli resident companies, unless a specific
exemption is available or unless a treaty between Israel and the country of the
non-resident provides otherwise. An individual is subject to a 20% tax rate on
real capital gains derived from the sale of shares, as long as the individual
has not demanded a deduction of interest and linkage differences in connection
with the purchase and holding of the securities; and as long as the individual
is not a substantial shareholder of the company issuing the shares, which is
generally a shareholder with 10% or more of the right to profits, the right to
nominate a director and voting rights. A substantial shareholder (or a
shareholder who has demanded a deduction of interest and linkage differences)
will be subject to tax at a rate of 25% on real capital gains derived from the
sale of shares issued by the company. The determination of whether the
individual is a substantial shareholder will be made on the date that the
securities are sold. In addition, the individual will be deemed to be a
substantial shareholder if at any time during the twelve months preceding this
date he or she had been a substantial shareholder. The foregoing tax rates,
however, will not apply to dealers in securities.

- 56 -

---

---



Corporations
are subject to corporate tax rates in respect of capital gains from the sale of
shares in Israeli publicly traded companies. As described above in General
Corporate Tax Structure, recent changes in the law reduced the corporate tax
rate from 31% in 2006 to 29% in 2007, 27% in 2008, 26% in 2009 and 25% in 2010.
Between 2006 and 2009, however, corporations whose taxable income was not
determined immediately before the 2006 Tax Reform was published, pursuant to
part B of the Israeli Income Tax Law (Inflationary Adjustments), 1985, or
pursuant to the Income Tax Regulations (Rules on Bookkeeping by Foreign
Invested Companies and Certain Partnership and Determination of their
Chargeable Income), 1984, or the Dollar Regulations, will generally be taxed at
a rate of 25% on their capital gains from the sale of their shares.

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. Other tax
treaties provide different withholding tax rates.

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;                                                      
| |   |                                                                                                                                                                                                                                   
| |  | 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.

- 57 -

---

---



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-market 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.

- 58 -

---

---



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 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):

- 59 -

---

---



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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.

The
Company believes that it was not a PFIC in 2006. 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.

- 60 -

---

---



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.

Documents on Display

We are
subject to the informational requirements of the Securities Exchange Act of 1934, as
amended, applicable to foreign private issuers and fulfill the obligations with respect to such requirements by
filing
reports with the Securities and Exchange Commission. You may read and copy any
document we file with the Securities and Exchange Commission without charge at
the Securities and Exchange Commissions public reference room at 100 F Street,
N.E., Washington, D.C. 20549. Certain of our SEC filings are also available to
the public at the SECs website at http://www.sec.gov. Copies of such
material may be obtained by mail from the Public Reference Branch of the
Securities and Exchange Commission at such address, at prescribed rates. Please
call the Securities and Exchange Commission at 1-800-SEC-0330 for further
information on the public reference room. In addition, all corporate documents
are available for review at our headquarters, 2 Habarzel Street, Ramat Hahayal,
Tel Aviv 69710, Israel.

As a foreign
private issuer, we are exempt from the rules under the Exchange Act prescribing
the furnishing and content of proxy statements, and our officers,
directors and principal shareholders are exempt from the reporting and
short-swing profit recovery provisions
contained in Section 16 of the
Exchange Act. In addition, we are not required under the Exchange Act to file
periodic reports and financial statements with the Securities and Exchange
Commission as frequently or as promptly as United States companies whose
securities are registered under the Exchange Act. However, we generally
publicly announce our quarterly and year-end results periodically, and file
certain periodic information with the Securities and Exchange Commission under
cover of Form 6-K.

- 61 -

---

---



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

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

We
maintain operations and generate revenues in a number of countries. The results
of operations and the financial position of our local operations are generally
reported in the relevant local currencies and then translated into U.S. dollars
at the applicable exchange rates for inclusion in our consolidated financial
statements, exposing us to currency translation risk. In addition, we are exposed
to currency transaction risk because some of our expenses are incurred in a
different currency from the currency in which our revenues are received. Our
most significant currency exposures are to the Euro, New Israeli Shekel, UK
Pound and Japanese Yen. In periods when the U.S. dollar strengthens against
these other currencies, our reported results of operations may be adversely
affected. Although from time to time we purchase forward exchange contracts to
reduce currency transaction risk, these purchases will not eliminate
translation risk or all currency risk.

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

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, 2006. 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, (i) is
recorded, processed, summarized and reported within the time periods specified
in SEC rules and forms, and (ii) is accumulated and communicated to our
management, including our Chief Executive Officer and Chief Financial Officer,
as appropriate to allow timely decisions regarding required disclosure.

There
has been no change in our internal control over financial reporting that
occurred during the fiscal year ended December 31, 2006, that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting.

- 62 -

---

---



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

The
Board of Directors has determined that Victor Halpert, a member of our audit
committee, is an audit committee financial expert and is independent pursuant
to the rules of the NASDAQ Stock Market. See Mr. Halperts biography in Item 6.

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

We
have in place a Code of Business Conduct and Ethics that applies to all
directors, officers and employees. This code, as applied to TIS principal
financial officers (i.e. our principal executive officer, principal financial
officer, principal accounting officer or controller or persons performing
similar functions), is our code of ethics within the meaning of Section 406
of the Sarbanes-Oxley Act of 2002 and the rules promulgated thereunder. This
code is also our code of conduct within the meaning of Nasdaq Rule 4350(n).
The full text of the Code of Business Conduct and Ethics is available at our
Internet website at http://www.topimagesystems.com.

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

Audit Fees

During
2003, the Board of Directors appointed Kost Forer Gabbay and Kasierer, an
independent registered accounting firm (a member of Ernst & Young Global)
(EY) to audit our financial statements for the fiscal year ended December 31,
2003 succeeding Somekh Chaikin (a member firm of KPMG International) (KPMG).

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, 2006 and 2005 were $136,000 and $109,000
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, 2006, and 2005 were $0 and $47,000
respectively.

Tax Fees

For
the fiscal years ended December 31, 2006 and 2005 the aggregate fees billed for
tax compliance, tax advice and tax planning by EY were $24,000 and $13,000
each.

Non-Audit services

For
the fiscal years ended December 31, 2006 and 2005 the aggregate fees billed by
EY for other non-audit professional services, other than those services listed
above, were $12,000 and $18,000, respectively. Such services were comprised of
accounting and other consultation.

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.

- 63 -

---

---



In
certain instances, the Securities and Exchange Commission does not require
pre-approval.

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

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-35.

|         |         
|-------- | --------
|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 December 31, 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
  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).
|       |  |                                                                                                                                                                                                                                                                                   
|4.1    |  | 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).                                                                                           
|       |  |                                                                                                                                                                                                                                                                                   
|4.2    |  | 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    |  | Employee
  Agreement between the Company and Ido Schechter (incorporated by reference to
  exhibit 10.4(f) to the Companys Registration Statement on Form
  F-1 (registration number 333-05718)).                                                                                
|       |  |                                                                                                                                                                                                                                                                                   
|4.4    |  | 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)).                                                                   

- 64 -

---

---



|        |  |                                                                                                                                                                                                                                                                                           
|------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Number  |  | Description                                                                                                                                                                                                                                                                               
|        |  |                                                                                                                                                                                                                                                                                           
|4.5     |  | 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)).                                                                  
|        |  |                                                                                                                                                                                                                                                                                           
|4.6     |  | 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).                                            
|        |  |                                                                                                                                                                                                                                                                                           
|4.7     |  | 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).
|        |  |                                                                                                                                                                                                                                                                                           
|4.8     |  | 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).                                                          
|        |  |                                                                                                                                                                                                                                                                                           
|4.9     |  | 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).                                                                                               
|        |  |                                                                                                                                                                                                                                                                                           
|4.10    |  | Business
  Transfer Agreement between the Company and Toyo Ink Mfg. Co., Ltd., dated as
  of August, 2004.                                                                                                                                                                                
|        |  |                                                                                                                                                                                                                                                                                           
|4.11    |  | English summary of the terms and
  conditions of Convertible Debentures Issued December 27, 2006.                                                                                                                                                                                         
|        |  |                                                                                                                                                                                                                                                                                           
|8       |  | List of
  Subsidiaries.                                                                                                                                                                                                                                                                   
|        |  |                                                                                                                                                                                                                                                                                           
|10. *** |  | Letter of
  Indemnification of Directors and Officers                                                                                                                                                                                                                                     
|        |  |                                                                                                                                                                                                                                                                                           
|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
  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).                                                                                                                                     

- 65 -

---

---



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:                      | /s/ Ido
  Schechter             
| |                          |                                 
| |                          | Name: Ido
  Schechter           
| |                          | Title: Chief
  Executive Officer

Date:April 2,
2007

---

---

# TOP IMAGE SYSTEMS LTD.
AND ITS SUBSIDIARIES

# CONSOLIDATED FINANCIAL STATEMENTS

# AS OF DECEMBER 31, 2006

# IN U.S. DOLLARS

# INDEX

- 67 -

---

---



TOP IMAGE SYSTEMS LTD. AND ITS SUBSIDIARIES

CONSOLIDATED FINANCIAL STATEMENTS

AS OF DECEMBER 31, 2006

U.S. DOLLARS IN THOUSANDS

INDEX

|                                                          |                  
|--------------------------------------------------------- | -----------------
|                                                          | Page             
|                                                          |                  
|                                                          |                  
|Report of Independent Registered Public
  Accounting Firm | F    2          
|                                                          |                  
|Consolidated Balance Sheets                               | F    3    F  4
|                                                          |                  
|Consolidated Statements of Operations                     | F  5            
|                                                          |                  
|Statements of Changes in Shareholders
  Equity           | F  6            
|                                                          |                  
|Consolidated Statements of Cash Flows                     | F  7    F  8  
|                                                          |                  
|Notes to Consolidated Financial Statements                | F  9    F  35 
|                                                          |                  



---

---

---



(ERNST & YOUNG LOGO)

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, 2005 and
2006, and the related consolidated statements of operations, changes in
shareholders equity and cash flows for each of the three years in the period
ended December 31, 2006. These financial statements are the responsibility of
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 audits included consideration of internal control over financial reporting
as a basis for designing audit procedures that are appropriate in the circumstances,
but not for the purpose of expressing an opinion on the effectiveness of the
Companys internal control over financial reporting. Accordingly, we express no
such opinion. An audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management,
and evaluating the overall financial statement presentation. We believe that
our audits 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, 2005 and 2006, and the related consolidated results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2006, in conformity with U.S. generally accepted accounting
principles.

As
discussed in Note 2n to the consolidated financial statements, in 2006, the
Company adopted Statement Financial Accounting Standard Board No. 123(R),
Share Based Payment.

|                 |                                 
|---------------- | --------------------------------
|Tel-Aviv, Israel | KOST FORER GABBAY & KASIERER    
|March 30,
  2007 | A Member of Ernst & Young Global

F  2

---

---



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

|                                                                                                                              |  |              |        |      |   |        | 
|----------------------------------------------------------------------------------------------------------------------------- |  | ------------ | ------ | ---- | - | ------ | 
|                                                                                                                              |  | December 31, |       
|                                                                                                                              |  |              |       
|                                                                                                                              |  | 2005         |        | 2006 |  
|                                                                                                                              |  |              |        |      |  
|ASSETS                                                                                                                        |  |              |        |      |   |        | 
|                                                                                                                              |  |              |        |      |   |        | 
|CURRENT
  ASSETS:                                                                                                             |  |              |        |      |   |        | 
|Cash and cash equivalents                                                                                                     |  | $            | 8,200  |      | $ | 6,195  | 
|Short term deposits                                                                                                           |  |              | -      |      |   | 3,000  | 
|Marketable securities (Note 3)                                                                                                |  |              | 1,805  |      |   | 12,597 | 
|Trade receivables (net of allowance for
  doubtful accounts of $ 412 and $ 436 at December 31, 2005 and 2006,
  respectively) |  |              | 6,802  |      |   | 7,642  | 
|Other accounts receivable and prepaid
  expenses (Note 4)                                                                     |  |              | 622    |      |   | 1,120  | 
|                                                                                                                              |  |              |        |      |   |        | 
|                                                                                                                             
|Total
  current assets                                                                                                        |  |              | 17,429 |      |   | 30,554 | 
|                                                                                                                              |  |              |        |      |   |        | 
|                                                                                                                              |  |              |        |      |   |        | 
|LONG-TERM
  ASSETS:                                                                                                           |  |              |        |      |   |        | 
|Severance pay fund                                                                                                            |  |              | 654    |      |   | 717    | 
|Long-term deposits (Note 10b(2))                                                                                              |  |              | 135    |      |   | 136    | 
|Property and equipment, net (Note 5)                                                                                          |  |              | 577    |      |   | 588    | 
|Other intangible assets and deferred
  issuance costs, net (Note 6)                                                           |  |              | 1,100  |      |   | 1,835  | 
|Goodwill                                                                                                                      |  |              | 465    |      |   | 465    | 
|                                                                                                                              |  |              |        |      |   |        | 
|                                                                                                                             
|Total long-term
  assets                                                                                                      |  |              | 2,931  |      |   | 3,741  | 
|                                                                                                                              |  |              |        |      |   |        | 
|                                                                                                                             
|Total
  assets                                                                                                                |  | $            | 20,360 |      | $ | 34,295 | 
|                                                                                                                              |  |              |        |      |   |        | 

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

F  3

---

---



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

|                                                                                                                                                                     |  |              |         |      |   |         |  
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | ------- | ---- | - | ------- | -
|                                                                                                                                                                     |  | December 31, |        
|                                                                                                                                                                     |  |              |        
|                                                                                                                                                                     |  | 2005         |         | 2006 |  
|                                                                                                                                                                     |  |              |         |      |  
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                                                 |  |              |         |      |   |         |  
|                                                                                                                                                                     |  |              |         |      |   |         |  
|CURRENT
  LIABILITIES:                                                                                                                                               |  |              |         |      |   |         |  
|Short-term bank loans (Note 7)                                                                                                                                       |  | $            | 2,179   |      | $ | 339     |  
|Trade payables                                                                                                                                                       |  |              | 900     |      |   | 397     |  
|Accrued expenses and other accounts payable
  (Note 8)                                                                                                               |  |              | 2,213   |      |   | 2,966   |  
|                                                                                                                                                                     |  |              |         |      |   |         |  
|                                                                                                                                                                    
|Total
  current liabilities                                                                                                                                          |  |              | 5,292   |      |   | 3,702   |  
|                                                                                                                                                                     |  |              |         |      |   |         |  
|LONG-TERM
  LIABILITIES                                                                                                                                              |  |              |         |      |   |         |  
|                                                                                                                                                                     |  |              |         |      |   |         |  
|Convertible debentures (Note 9)                                                                                                                                      |  |              | -       |      |   | 14,197  |  
|Accrued severance pay                                                                                                                                                |  |              | 850     |      |   | 1,016   |  
|                                                                                                                                                                     |  |              |         |      |   |         |  
|                                                                                                                                                                    
|Total
  long-term liabilities                                                                                                                                        |  |              | 850     |      |   | 15,213  |  
|                                                                                                                                                                     |  |              |         |      |   |         |  
|COMMITMENTS,
  CONTINGENCIES AND CHARGES (Note 10)                                                                                                                   |  |              |         |      |   |         |  
|                                                                                                                                                                     |  |              |         |      |   |         |  
|SHAREHOLDERS
  EQUITY (Note 12):                                                                                                                                    |  |              |         |      |   |         |  
|Share capital:                                                                                                                                                       |  |              |         |      |   |         |  
|Ordinary shares of NIS 0.04 par value -                                                                                                                              |  |              |         |      |   |         |  
|Authorized: 125,000,000 shares at December
  31, 2005 and 2006; Issued and outstanding: 8,777,366 and 8,845,241 shares at
  December 31, 2005 and 2006, respectively |  |              | 97      |      |   | 98      |  
|Additional paid-in capital                                                                                                                                           |  |              | 29,561  |      |   | 29,921  |  
|Accumulated deficit                                                                                                                                                  |  |              | (15,440 | )    |   | (14,639 | )
|                                                                                                                                                                     |  |              |         |      |   |         |  
|                                                                                                                                                                    
|Total
  shareholders equity                                                                                                                                         |  |              | 14,218  |      |   | 15,380  |  
|                                                                                                                                                                     |  |              |         |      |   |         |  
|                                                                                                                                                                    
|Total liabilities
  and shareholders equity                                                                                                                         |  | $            | 20,360  |      | $ | 34,295  |  
|                                                                                                                                                                     |  |              |         |      |   |         |  

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

F  4

---

---



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

|                                                                                          |  |                           |            |      |   |            |   |   |           | 
|----------------------------------------------------------------------------------------- |  | ------------------------- | ---------- | ---- | - | ---------- | - | - | --------- | 
|                                                                                          |  | Year ended
  December 31, |           
|                                                                                          |  |                           |           
|                                                                                          |  | 2004                      |            | 2005 |   | 2006       |  
|                                                                                          |  |                           |            |      |   |            |  
|Revenues
  (Note 13):                                                                     |  |                           |            |      |   |            |   |   |           | 
|Products                                                                                  |  | $                         | 6,964      |      | $ | 9,888      |   | $ | 12,144    | 
|Services                                                                                  |  |                           | 4,214      |      |   | 6,932      |   |   | 8,080     | 
|                                                                                          |  |                           |            |      |   |            |   |   |           | 
|                                                                                         
|Total
  revenues                                                                          |  |                           | 11,178     |      |   | 16,820     |   |   | 20,224    | 
|                                                                                          |  |                           |            |      |   |            |   |   |           | 
|Cost of revenues:                                                                         |  |                           |            |      |   |            |   |   |           | 
|Products                                                                                  |  |                           | *) 492     |      |   | *)
  2,225 |   |   | 2,391     | 
|Services                                                                                  |  |                           | *)
  2,980 |      |   | *)
  4,538 |   |   | 5,257     | 
|                                                                                          |  |                           |            |      |   |            |   |   |           | 
|                                                                                         
|Total
  cost of revenues                                                                  |  |                           | 3,472      |      |   | 6,763      |   |   | 7,648     | 
|                                                                                          |  |                           |            |      |   |            |   |   |           | 
|                                                                                         
|Gross profit                                                                              |  |                           | 7,706      |      |   | 10,057     |   |   | 12,576    | 
|                                                                                          |  |                           |            |      |   |            |   |   |           | 
|Operating costs and expenses:                                                             |  |                           |            |      |   |            |   |   |           | 
|Research and development                                                                  |  |                           | 929        |      |   | 1,312      |   |   | 1,792     | 
|Selling and marketing                                                                     |  |                           | 4,547      |      |   | 5,396      |   |   | 6,695     | 
|General and administrative                                                                |  |                           | 2,576      |      |   | 3,470      |   |   | 3,568     | 
|Liquidated damages related to
  September 2004 investment                                 |  |                           | -          |      |   | 164        |   |   | -         | 
|                                                                                          |  |                           |            |      |   |            |   |   |           | 
|                                                                                         
|Total
  operating costs and expenses                                                      |  |                           | 8,052      |      |   | 10,342     |   |   | 12,055    | 
|                                                                                          |  |                           |            |      |   |            |   |   |           | 
|                                                                                         
|Operating income (loss)                                                                   |  |                           | (346       | )    |   | (285       | ) |   | 521       | 
|Financial income (expenses), net (Note 15)                                                |  |                           | 178        |      |   | (146       | ) |   | 325       | 
|                                                                                          |  |                           |            |      |   |            |   |   |           | 
|                                                                                         
|Income (loss) before taxes on income                                                      |  |                           | (168       | )    |   | (431       | ) |   | 846       | 
|                                                                                          |  |                           |            |      |   |            |   |   |           | 
|Taxes on income                                                                           |  |                           | -          |      |   | 30         |   |   | 45        | 
|                                                                                          |  |                           |            |      |   |            |   |   |           | 
|                                                                                         
|Net income (loss)                                                                         |  | $                         | (168       | )    | $ | (461       | ) | $ | 801       | 
|                                                                                          |  |                           |            |      |   |            |   |   |           | 
|                                                                                         
|Basic and diluted net earnings
  (loss) per share (Note 14)                               |  | $                         | (0.02      | )    | $ | (0.05      | ) | $ | 0.09      | 
|                                                                                          |  |                           |            |      |   |            |   |   |           | 
|                                                                                         
|Weighted average number of
  shares used in computation of net earnings (loss) per share: |  |                           |            |      |   |            |   |   |           | 
|                                                                                         
|Basic                                                                                     |  |                           | 6,905,559  |      |   | 8,764,222  |   |   | 8,819,857 | 
|                                                                                          |  |                           |            |      |   |            |   |   |           | 
|                                                                                         
|Diluted                                                                                   |  |                           | 6,905,559  |      |   | 8,764,222  |   |   | 9,032,354 | 
|                                                                                          |  |                           |            |      |   |            |   |   |           | 

|   |              
|-- | -------------
|*) | Reclassified.

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

F  5

---

---



|                                             
|---------------------------------------------
|TOP IMAGE SYSTEMS LTD. AND ITS SUBSIDIARIES  
|                                             
|STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY
|                                             
|U.S. dollars in thousands                    

|                                                                       |  |                 |      |                                |   |                                                     |   |                       |    |                               |   |         |   |   |      |   |   |        |  
|---------------------------------------------------------------------- |  | --------------- | ---- | ------------------------------ | - | --------------------------------------------------- | - | --------------------- | -- | ----------------------------- | - | ------- | - | - | ---- | - | - | ------ | -
|                                                                       |  | Share
  capital |      | Additional
  paid-in
  capital |   | Accumulated
  other
  comprehensive
  income (loss) |   | Accumulated
  deficit |    | Comprehensive
  income (loss) |   | Total   |  
|                                                                       |  |                 |      |                                |   |                                                     |   |                       |    |                               |   |         |  
|                                                                      
|Balance at January 1, 2004                                             |  |                 | 73   |                                |   | 22,380                                              |   |                       | (3 | )                             |   | (14,811 | ) |   |      |   |   | 7,639  |  
|Net unrealized gains on available-for-sale
securities                  |  |                 | -    |                                |   | -                                                   |   |                       | 1  |                               |   | -       |   | $ | 1    |   |   | 1      |  
|Net loss                                                               |  |                 | -    |                                |   | -                                                   |   |                       | -  |                               |   | (168    | ) |   | (168 | ) |   | (168   | )
|                                                                       |  |                 |      |                                |   |                                                     |   |                       |    |                               |   |         |   |   |      |   |   |        |  
|Comprehensive loss                                                     |  |                 |      |                                |   |                                                     |   |                       |    |                               |   |         |   | $ | (167 | ) |   |        |  
|                                                                       |  |                 |      |                                |   |                                                     |   |                       |    |                               |   |         |   |   |      |   |   |        |  
|Issuance of shares and warrants, net                                   |  |                 | 23   |                                |   | 6,960                                               |   |                       | -  |                               |   | -       |   |   |      |   |   | 6,983  |  
|Exercise of stock options                                              |  |                 | 1    |                                |   | 239                                                 |   |                       | -  |                               |   | -       |   |   |      |   |   | 240    |  
|                                                                       |  |                 |      |                                |   |                                                     |   |                       |    |                               |   |         |   |   |      |   |   |        |  
|                                                                       |  |                 |      |                                |   |                                                     |   |                       |    |                               |   |         |   |   |      |   |   |        |  
|Balance at December 31, 2004                                           |  |                 | 97   |                                |   | 29,579                                              |   |                       | (2 | )                             |   | (14,979 | ) |   |      |   |   | 14,695 |  
|Net unrealized gains on available-for-sale
securities                  |  |                 | -    |                                |   | -                                                   |   |                       | 2  |                               |   | -       |   | $ | 2    |   |   | 2      |  
|Net loss                                                               |  |                 | -    |                                |   | -                                                   |   |                       | -  |                               |   | (461    | ) |   | (461 | ) |   | (461   | )
|                                                                       |  |                 |      |                                |   |                                                     |   |                       |    |                               |   |         |   |   |      |   |   |        |  
|Comprehensive loss                                                     |  |                 |      |                                |   |                                                     |   |                       |    |                               |   |         |   | $ | (459 | ) |   |        |  
|                                                                       |  |                 |      |                                |   |                                                     |   |                       |    |                               |   |         |   |   |      |   |   |        |  
|Issuance expenses                                                      |  |                 | -    |                                |   | (77                                                 | ) |                       | -  |                               |   | -       |   |   |      |   |   | (77    | )
|Exercise of stock options                                              |  |                 | *) - |                                |   | 15                                                  |   |                       | -  |                               |   | -       |   |   |      |   |   | 15     |  
|Employee stock-based
  compensation related to acceleration of vesting |  |                 | -    |                                |   | 44                                                  |   |                       | -  |                               |   | -       |   |   |      |   |   | 44     |  
|                                                                       |  |                 |      |                                |   |                                                     |   |                       |    |                               |   |         |   |   |      |   |   |        |  
|                                                                       |  |                 |      |                                |   |                                                     |   |                       |    |                               |   |         |   |   |      |   |   |        |  
|Balance at December 31, 2005                                           |  |                 | 97   |                                |   | 29,561                                              |   |                       | -  |                               |   | (15,440 | ) |   |      |   |   | 14,218 |  
|                                                                       |  |                 |      |                                |   |                                                     |   |                       |    |                               |   |         |   |   |      |   |   |        |  
|Net income                                                             |  |                 | -    |                                |   | -                                                   |   |                       | -  |                               |   | 801     |   | $ | 801  |   |   | 801    |  
|                                                                       |  |                 |      |                                |   |                                                     |   |                       |    |                               |   |         |   |   |      |   |   |        |  
|                                                                       |  |                 |      |                                |   |                                                     |   |                       |    |                               |   |         |   |   |      |   |   |        |  
|Comprehensive income                                                   |  |                 |      |                                |   |                                                     |   |                       |    |                               |   |         |   | $ | 801  |   |   |        |  
|                                                                       |  |                 |      |                                |   |                                                     |   |                       |    |                               |   |         |   |   |      |   |   |        |  
|                                                                       |  |                 |      |                                |   |                                                     |   |                       |    |                               |   |         |   |   |      |   |   |        |  
|Exercise of stock options                                              |  |                 | 1    |                                |   | 117                                                 |   |                       | -  |                               |   | -       |   |   |      |   |   | 118    |  
|                                                                       |  |                 |      |                                |   |                                                     |   |                       |    |                               |   |         |   |   |      |   |   |        |  
|Employee stock based compensation                                      |  |                 | -    |                                |   | 243                                                 |   |                       | -  |                               |   | -       |   |   |      |   |   | 243    |  
|                                                                       |  |                 |      |                                |   |                                                     |   |                       |    |                               |   |         |   |   |      |   |   |        |  
|                                                                       |  |                 |      |                                |   |                                                     |   |                       |    |                               |   |         |   |   |      |   |   |        |  
|Balance at December 31, 2006                                           |  | $               | 98   |                                | $ | 29,921                                              |   | $                     | -  |                               | $ | (14,639 | ) |   |      |   | $ | 15,380 |  
|                                                                       |  |                 |      |                                |   |                                                     |   |                       |    |                               |   |         |   |   |      |   |   |        |  

*)          Represents
an amount lower than $ 1.

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

F  6

---

---



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

|                                                                                                     |  |                           |        |      |   |        |   |   |         |  
|---------------------------------------------------------------------------------------------------- |  | ------------------------- | ------ | ---- | - | ------ | - | - | ------- | -
|                                                                                                     |  | Year ended
  December 31, |       
|                                                                                                     |  |                           |       
|                                                                                                     |  | 2004                      |        | 2005 |   | 2006   |  
|                                                                                                     |  |                           |        |      |   |        |  
|                                                                                                     |  |                           |        |      |   |        |  
|Cash flows from operating
activities:                                                                |  |                           |        |      |   |        |   |   |         |  
|Net income (loss)                                                                                    |  | $                         | (168   | )    | $ | (461   | ) | $ | 801     |  
|Adjustments to reconcile net income (loss)
  to net cash provided by (used in) operating activities: |  |                           |        |      |   |        |   |   |         |  
|Non-cash stock-based compensation
expenses                                                           |  |                           | -      |      |   | 44     |   |   | 243     |  
|Interest on short-term bank loans                                                                    |  |                           | -      |      |   | 3      |   |   | -       |  
|Depreciation and amortization                                                                        |  |                           | 270    |      |   | 524    |   |   | 541     |  
|Amortization of deferred issuance costs                                                              |  |                           | -      |      |   | -      |   |   | 1       |  
|Accrued severance pay, net                                                                           |  |                           | (4     | )    |   | 10     |   |   | 103     |  
|Gain from marketable securities, net                                                                 |  |                           | (1     | )    |   | (3     | ) |   | (8      | )
|Interest and amortization of discount on convertible
  debentures                                    |  |                           | -      |      |   | -      |   |   | 8       |  
|Increase in trade receivables, net                                                                   |  |                           | (935   | )    |   | (1,261 | ) |   | (840    | )
|Increase in other accounts receivable and
  prepaid expenses                                         |  |                           | (153   | )    |   | (56    | ) |   | (498    | )
|Increase (decrease) in trade payables                                                                |  |                           | 99     |      |   | 495    |   |   | (515    | )
|Increase (decrease) in accrued expenses and
  other accounts payable                                 |  |                           | (182   | )    |   | 284    |   |   | 603     |  
|                                                                                                     |  |                           |        |      |   |        |   |   |         |  
|                                                                                                     |  |                           |        |      |   |        |   |   |         |  
|Net cash provided by (used in) operating
  activities                                                |  |                           | (1,074 | )    |   | (421   | ) |   | 439     |  
|                                                                                                     |  |                           |        |      |   |        |   |   |         |  
|                                                                                                     |  |                           |        |      |   |        |   |   |         |  
|Cash flows from investing
activities:                                                                |  |                           |        |      |   |        |   |   |         |  
|Acquisition of business activity (a)                                                                 |  |                           | (1,763 | )    |   | -      |   |   | -       |  
|Payment of accrued expenses on account of
  acquisition                                              |  |                           | -      |      |   | (73    | ) |   | (114    | )
|Purchase of property and equipment                                                                   |  |                           | (416   | )    |   | (164   | ) |   | (252    | )
|Proceeds from sale of marketable
securities                                                          |  |                           | 138    |      |   | 279    |   |   | -       |  
|Increase in short term deposits                                                                      |  |                           | -      |      |   | -      |   |   | (3,000  | )
|Purchase of marketable securities                                                                    |  |                           | (138   | )    |   | (1,800 | ) |   | (10,784 | )
|Decrease (increase) in long-term deposits                                                            |  |                           | (61    | )    |   | 12     |   |   | (1      | )
|                                                                                                     |  |                           |        |      |   |        |   |   |         |  
|                                                                                                     |  |                           |        |      |   |        |   |   |         |  
|Net cash used in investing activities                                                                |  |                           | (2,240 | )    |   | (1,746 | ) |   | (14,151 | )
|                                                                                                     |  |                           |        |      |   |        |   |   |         |  
|                                                                                                     |  |                           |        |      |   |        |   |   |         |  
|Cash flows from financing
activities:                                                                |  |                           |        |      |   |        |   |   |         |  
|                                                                                                     |  |                           |        |      |   |        |   |   |         |  
|Proceeds from exercise of stock options                                                              |  |                           | 240    |      |   | 15     |   |   | 118     |  
|Increase (decrease) in short-term bank
  loans, net                                                  |  |                           | 115    |      |   | 469    |   |   | (1,840  | )
|Proceeds from issuance of shares, net                                                                |  |                           | 7,240  |      |   | -      |   |   | -       |  
|Proceeds from issuance of convertible
  debenture, net                                               |  |                           | -      |      |   | -      |   |   | 13,510  |  
|Payment of accrued issuance expenses                                                                 |  |                           | -      |      |   | (253   | ) |   | (81     | )
|                                                                                                     |  |                           |        |      |   |        |   |   |         |  
|                                                                                                     |  |                           |        |      |   |        |   |   |         |  
|Net cash provided by financing activities                                                            |  |                           | 7,595  |      |   | 231    |   |   | 11,707  |  
|                                                                                                     |  |                           |        |      |   |        |   |   |         |  
|                                                                                                     |  |                           |        |      |   |        |   |   |         |  
|Increase (decrease) in cash and cash
  equivalents                                                   |  |                           | 4,281  |      |   | (1,936 | ) |   | (2,005  | )
|Cash and cash equivalents at the beginning
  of the year                                             |  |                           | 5,855  |      |   | 10,136 |   |   | 8,200   |  
|                                                                                                     |  |                           |        |      |   |        |   |   |         |  
|                                                                                                     |  |                           |        |      |   |        |   |   |         |  
|Cash and cash equivalents at the end of the
  year                                                   |  | $                         | 10,136 |      | $ | 8,200  |   | $ | 6,195   |  
|                                                                                                     |  |                           |        |      |   |        |   |   |         |  

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

F  7

---

---



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

|                                                                                     |  |                           |       |      |   |      |  |   |     | 
|------------------------------------------------------------------------------------ |  | ------------------------- | ----- | ---- | - | ---- |  | - | --- | 
|                                                                                     |  | Year ended
  December 31, |      
|                                                                                     |  |                           |      
|                                                                                     |  | 2004                      |       | 2005 |   | 2006 | 
|                                                                                     |  |                           |       |      |   |      | 
|                                                                                    
|Supplemental disclosure of cash flows
  activities:                                  |  |                           |       |      |   |      |  |   |     | 
|                                                                                     |  |                           |       |      |   |      |  |   |     | 
|Cash paid during the year for:                                                       |  |                           |       |      |   |      |  |   |     | 
|                                                                                     |  |                           |       |      |   |      |  |   |     | 
|Tax                                                                                  |  | $                         | -     |      | $ | -    |  | $ | 40  | 
|                                                                                     |  |                           |       |      |   |      |  |   |     | 
|Interest                                                                             |  | $                         | 72    |      | $ | 97   |  | $ | 121 | 
|                                                                                     |  |                           |       |      |   |      |  |   |     | 
|                                                                                     |  |                           |       |      |   |      |  |   |     | 
|Non-cash activities:                                                                 |  |                           |       |      |   |      |  |   |     | 
|                                                                                     |  |                           |       |      |   |      |  |   |     | 
|Accrued issuance expenses                                                            |  | $                         | 257   |      | $ | -    |  | $ | -   | 
|                                                                                     |  |                           |       |      |   |      |  |   |     | 
|                                                                                     |  |                           |       |      |   |      |  |   |     | 
|Accrued expenses on account of
acquisition                                           |  | $                         | 202   |      | $ | -    |  | $ | -   | 
|                                                                                     |  |                           |       |      |   |      |  |   |     | 
|                                                                                     |  |                           |       |      |   |      |  |   |     | 
|Accrued issuance expenses of convertible
  debenture                                 |  | $                         | -     |      | $ | -    |  | $ | 357 | 
|                                                                                     |  |                           |       |      |   |      |  |   |     | 
|                                                                                     |  |                           |       |      |   |      |  |   |     | 
|(a)      Acquisition
  of business activity:                                         |  |                           |       |      |   |      |  |   |     | 
|                                                                                     |  |                           |       |      |   |      |  |   |     | 
|Net fair value of assets acquired and
  liabilities assumed at the acquisition date: |  |                           |       |      |   |      |  |   |     | 
|                                                                                     |  |                           |       |      |   |      |  |   |     | 
|Identifiable intangible assets                                                       |  | $                         | 1,500 |      |   |      |  |   |     | 
|Goodwill                                                                             |  |                           | 465   |      |   |      |  |   |     | 
|                                                                                     |  |                           |       |      |   |      |  |   |     | 
|                                                                                     |  |                           |       |      |   |      |  |   |     | 
|                                                                                     |  |                           | 1,965 |      |   |      |  |   |     | 
|Accrued expenses on account of
acquisition                                           |  |                           | (202  | )    |   |      |  |   |     | 
|                                                                                     |  |                           |       |      |   |      |  |   |     | 
|                                                                                     |  |                           |       |      |   |      |  |   |     | 
|                                                                                     |  | $                         | 1,763 |      |   |      |  |   |     | 
|                                                                                     |  |                           |       |      |   |      |  |   |     | 

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

F  8

---

---



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

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

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a. | Business and
  organization:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    | Top Image
  Systems Ltd. (TIS or the Company) is engaged in the development and marketing
  of a variety of information recognition systems and technologies and
  automated document capture solutions for the efficient flow of information
  within and between organizations. The Companys software minimizes the need
  for manual data entry by automatically capturing, reading, understanding,
  identifying, processing, classifying and routing the information contained in
  documents, increasing data capture accuracy and the rate of information
  processing. The Companys shares are traded on the National Association of
  Securities Dealers Quotation (NASDAQ) in the United States and on the
  Tel-Aviv Stock Exchange (TASE).                                                                                                                                                                            
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    | As for
  information regarding the principal customers of the Company, see Note 13b.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | b. | The
  Companys marketing and sales activities are conducted through its wholly
  owned subsidiaries in the U.S., U.K, Germany and Japan.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | c. | 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
  (including $ 465 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
  the 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. As of December 31, 2006, the
  Company has no obligation to pay any royalties.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    | 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 purchase consideration:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  

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

F  9

---

---



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

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

| |                                                                                                                                                               
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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   |                                  |  | 5 | 
| | Customer
  relations |  |        | 750   |                                  |  | 5 | 
| |                      |  |        |       |                                  |  |   | 
| |                      |  |        |       |                                  |  |   | 
| |                      |  | $      | 1,500 |                                  |  |   | 
| |                      |  |        |       |                                  |  |   | 

|             |                                                                                                                                                                                                  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|------------ | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|             |                                                                                                                                                                                                  | See Note 6
  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 $ 531 and
  $ 136, respectively.                                                                                                                                                                                                                                                                                                                                      
|             |                                                                                                                                                                                                  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|NOTE 2:     | SIGNIFICANT ACCOUNTING POLICIES                                                                                                                                                                 
|             |                                                                                                                                                                                                 
|             | The
  consolidated financial statements have been prepared in accordance with
  accounting principles generally accepted in the U.S. (U.S. GAAP), applied
  on a consistent basis, as follows:
|             |                                                                                                                                                                                                 
|             | a.                                                                                                                                                                                               | Use of
  estimates:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|             |                                                                                                                                                                                                  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|             |                                                                                                                                                                                                  | The
  preparation of financial statements in conformity with generally accepted
  accounting principles requires management to make estimates and assumptions
  that affect the amounts reported in the financial statements and accompanying
  notes. Actual results could differ from those estimates.                                                                                                                                                                                                                                      
|             |                                                                                                                                                                                                  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|             | b.                                                                                                                                                                                               | Principles
  of consolidation:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|             |                                                                                                                                                                                                  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|             |                                                                                                                                                                                                  | The
  consolidated financial statements include the accounts of the Company and its
  wholly owned subsidiaries. Intercompany balances and transactions including
  profit from intercompany sales not yet realized outside the Group, have been
  eliminated upon consolidation.                                                                                                                                                                                                                                                             
|             |                                                                                                                                                                                                  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|             | c.                                                                                                                                                                                               | Financial
  statements in United States dollars:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|             |                                                                                                                                                                                                  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|             |                                                                                                                                                                                                  | A majority
  of the revenues of the Company and certain of its subsidiaries are generated
  in U.S. dollars (dollar). In addition, a substantial portion of the
  Companys costs is incurred in dollars. The majority of the Companys financing
  is in dollars. The Companys management believes that the dollar is the
  currency of the primary economic environment in which the Company and its
  subsidiaries operate. Thus, the functional and reporting currency of the
  Company and certain of its subsidiaries are the dollar.

F  10

---

---



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

|             |                                        
|------------ | ---------------------------------------
|NOTE 2:     | SIGNIFICANT ACCOUNTING POLICIES (CONT.)

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    | Accordingly,
  monetary accounts maintained in currencies other than the dollar are
  remeasured into dollars in accordance with SFAS No. 52, Foreign Currency
  Translation (SFAS No. 52). All transaction gains and losses of the
  remeasurement of monetary balance sheet items are reflected in the statements
  of operations as financial income or expenses, as appropriate.                                                                                     
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | d. | Cash
  equivalents:                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    | Cash
  equivalents are short-term highly liquid investments that are readily
  convertible to cash with maturities of three months or less, at the date
  acquired.                                                                                                                                                                                                                                                                                                          
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | e. | Short-term
  deposits:                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    | Short-term
  deposits include deposits with original maturities of more than three months
  and less than one year which presented at cost, including accrued interest.
  The deposits are in U.S. dollars and bear interest at an annual rate of 5.32%
  for the year ended December 31, 2006.                                                                                                                                                                              
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | f. | Marketable
  securities:                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    | Marketable
  securities consist of auction rate securities and commercial papers.                                                                                                                                                                                                                                                                                                                                                                                            
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    | The Company
  accounts for investments in marketable securities in accordance with SFAS No.
  115, Accounting for Certain Investments in Debt and Equity Securities (SFAS
  No. 115). Management determines the appropriate classification of its
  investments in marketable debt securities at the time of purchase and
  reevaluates such determinations at each balance sheet date. Debt securities
  are classified as available-for-sale and reported at fair value.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    | Unrealized
  gains and losses are excluded from earnings and are reported as a component
  of accumulated other comprehensive income (loss) in shareholders equity.                                                                                                                                                                                                                                                                                                         
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    | Auction rate
  securities and commercial papers are reported at fair value, which
  approximates cost due to the interest rate reset feature of these securities.
  As such, no unrealized gains or losses related to these securities were
  recognized during the years ended December 31, 2006 and 2005.                                                                                                                                                                  
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | g. | Long-term
  deposits:                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    | Consist
  mainly of long-term prepaid expenses for motor vehicle and rent leasing.                                                                                                                                                                                                                                                                                                                                                                                           

F  11

---

---



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

|             |                                        
|------------ | ---------------------------------------
|NOTE 2:     | SIGNIFICANT ACCOUNTING POLICIES (CONT.)

| |    |                                                                                                                                                                                                                    
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | h. | Property and
  equipment, net:                                                                                                                                                                                     
| |    |                                                                                                                                                                                                                    
| |    | Property and
  equipment are stated at cost, net of accumulated depreciation. Depreciation
  is computed by the straight-line method over the estimated useful lives of
  the assets at the following annual rates:

| |                                      |  |                                   
| | ------------------------------------ |  | ----------------------------------
| |                                      |  | Years                             
| |                                      |  |                                   
| | Computers
  and peripheral equipment |  | 3                                 
| | Office
  furniture and equipment     |  | 7 - 15                            
| | Leasehold
  improvements             |  | Over the shorter of the lease term
| |                                      |  | or useful economic life           

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | i. | Impairment
  of long-lived assets:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |    | The
  Companys long-lived assets are reviewed for impairment in accordance with
  SFAS 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. As of
  December 31, 2005 and 2006, no impairment indicators have been identified.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | j. | Goodwill:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |    | Goodwill
  represents the excess of the costs over the net assets of businesses
  acquired. Under SFAS No. 142, Goodwill and Other Intangible Assets (SFAS
  No. 142), goodwill is not amortized as of January 1, 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |    | SFAS No. 142
  requires goodwill to be tested for impairment at least annually or between
  annual tests in certain circumstances, and written down when impaired.
  Goodwill attributable to one reporting unit is tested for impairment by
  comparing the fair value of the reporting unit with its carrying value. Fair
  value is determined using discounted cash flows. Significant estimates used
  in the methodologies include estimates of future cash flows, future short-term
  and long-term growth rates and weighted average cost of capital for each of
  the reportable units. As of December 31, 2005 and 2006, no impairment
  indicators have been identified.                                                                                                     

F  12

---

---



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

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

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | k. | Other
  intangible assets:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    | Intangible
  assets are comprised of acquired technology customer relations, and deferred
  issuance cost. The acquired technology and customer relations are amortized
  over their useful life using a method of amortization that reflects the
  pattern in which the economic benefits of the intangible assets are consumed
  or otherwise used up. Acquired technology and customer relations are
  amortized on a straight line basis over a period of five years.                                                                                                                                                                                                                                                                                                                                                                       
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | l. | Convertible
  debentures:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    | Convertible
  debentures are accounted for in accordance with the provisions of EITF Issue
  No. 05-2, The Meaning of Conventional Convertible Debt Instruments, APB 14,
  Accounting for Convertible Debt and Debt issued with Stock Purchase
  Warrants, and related pronouncements.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    | Under these
  pronouncements, the Company recorded the convertible debentures as long-term
  liabilities, and did not bifurcate the conversion option.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    | The discount
  on the convertible debentures will be amortized to interest expenses from the
  commitment date to the stated maturity date using the interest method.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    | Cost
  incurred in respect of issuance expenses of debentures is deferred and
  amortized as a component of interest expense over the contractual life of the
  debenture using the effective interests method.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | m. | Revenue
  recognition:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    | The  Company  derives  its  revenues  mainly  from
                     sales of products and services.  Product  revenues  include  mainly sales of software
                     and, to a lesser  extent,  the  related  hardware.  Revenues  from  services  include
                     maintenance and technical support, consulting and training                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    | The Company accounts for
  software sales in accordance with Statement of Position No. 97-2,
  Software Revenue Recognition (SOP No. 97-2), as amended by Statement of
  Position 98-9, Modifications of SOP 97-2, Software Revenue Recognition with
  Respect to Certain Transactions. SOP No. 97-2 generally requires revenues
  earned from software arrangements involving multiple elements to be allocated
  to each element based on the relative fair values of the elements determined
  by the vendors specific objective evidence (VSOE) of fair value. Revenues
  are recognized under the residual method when VSOE of fair value exists for
  all undelivered elements and VSOE of fair value does not exist for all of the
  delivered elements, and when all SOP No. 97-2 criteria for revenue
  recognition are met.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    | Revenue from
  license fees is recognized when persuasive evidence of an agreement exists,
  delivery of the product has occurred, the fee is fixed or determinable, and
  collectibility is probable.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    | Maintenance
  and support revenue is deferred and recognized on a straight-line basis over
  the term of the maintenance and support agreement. The VSOE of fair value of
  the undelivered elements (maintenance, support and services) included in
  multiple element arrangements is determined based on the price charged for
  the undelivered element when sold separately or renewed.                                                                                                                                                                                                                                                                                                                                                                                                                                                    

F  13

---

---



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

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

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    | Hardware  sales are  recognized  when the  product
                     is  delivered  to  the  customer.  Because  the  software  is  not  essential  to the
                     functionality   of  the  unrelated   equipment,   the  equipment  is  not  considered
                     software-related  and, therefore,  is excluded from the scope of SOP 97-2,  therefore
                     it is  recognized  according to SAB 104 when  persuasive  evidence of an  arrangement
                     exist, delivery has occurred,  the vendors fee is fixed or determinable,  no further
                     obligation exists and collectibility is probable..                                                                                                                                                                                                                                                                                                                                                                                             
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    | Arrangements
  that include consulting/professional services are evaluated to determine
  whether those services are essential to the functionality of other elements
  of the arrangement. When consulting services are not considered essential,
  the revenue allocable to the consulting services is recognized as the
  services are performed.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    | If services
  are considered essential to the functionality of other elements of the
  arrangement, revenues from software licenses that require significant
  customization, integration and installation are recognized using contract
  accounting based on Statement of Position No.81-1, on the percentage of
  completion method, in accordance with the Input Method, 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. The
  percentage of completion is determined based on the ratio of actual cost to
  total estimated cost. As for contracts in which a loss is anticipated, a
  provision is recorded for the full amount of the expected loss, in the period
  in which such losses are first determined. As of December 31, 2006, no such
  estimated losses were identified.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    | Deferred
  revenues represent mainly unearned amounts received under technical support
  and maintenance arrangements that are paid by customers and not yet
  recognized as revenues.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | n. | Accounting
  for stock-based compensation:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    | On
  January 1, 2006, the Company adopted Statement of Financial Accounting
  Standards No. 123 (revised 2004), Share-Based Payment (SFAS 123(R))
  which requires the measurement and recognition of compensation expense based
  on estimated fair values for all share-based payment awards made to employees
  and directors. SFAS 123(R) supersedes Accounting Principles Board Opinion
  No. 25, Accounting for Stock Issued to Employees (APB 25), for
  periods beginning in fiscal 2006. In March 2005, the Securities and Exchange
  Commission issued Staff Accounting Bulletin No. 107 (SAB 107) relating
  to SFAS 123(R). The Company has applied the provisions of SAB 107 in its
  adoption of SFAS 123(R).                                                                                                                                                                                                                                                                                                                                         
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    | SFAS 123(R)
  requires companies to estimate the fair value of equity-based payment awards
  on the date of grant using an option-pricing model. The value of the portion
  of the award that is ultimately expected to vest is recognized as an expense
  over the requisite service periods in the Companys consolidated income
  statement. Prior to the adoption of SFAS 123(R), the Company accounted for equity-based
  awards to employees and directors using the intrinsic value method in
  accordance with APB 25 as allowed under Statement of Financial Accounting
  Standards No. 123, Accounting for Stock-Based Compensation (SFAS
  123).                                                                                                                                                                                                                                                                                                                                                                                                               

F  14

---

---



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

|             |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|------------ | --------------------------------------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2:     | SIGNIFICANT ACCOUNTING POLICIES (CONT.)
|             |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|             |                                         | The   Company   adopted   SFAS  123(R)  using  the
                     modified  prospective  transition  method,  which  requires  the  application  of the
                     accounting  standard  starting from  January 1,  2006, the first day of the Company's
                     fiscal year 2006. Under that transition  method,  compensation cost recognized in the
                     year  ended  December  31,  2006,  includes:  compensation  cost for all  share-based
                     payments  granted  subsequent to January 1, 2006,  based on the grant-date fair value
                     estimated in accordance  with the provisions of Statement  123(R).  Results for prior
                     periods have not been restated.                                                                                                                      
|             |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|             |                                         | The Company
  recognizes compensation expenses for the value of its awards, which have
  graded vesting based on the straight line method over the requisite service
  period of each of the awards, net of estimated forfeitures. Estimated
  forfeitures are based on actual historical pre-vesting forfeitures.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|             |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|             |                                         | As a result
  of adopting SFAS 123(R) on January 1, 2006, the Companys income before
  income taxes and net income for the year ended December 31, 2006, is $ 145
  lower than if it had continued to account for stock-based compensation under
  APB 25. Basic and diluted net loss per share for the year ended December 31,
  2006, are $ 0.02 lower,
  than if the Company had continued to account for share-based compensation
  under APB 25.                                                                                                                                                                                                                                                                                                                                                                                                                                         
|             |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|             |                                         | Prior to
  January 1, 2006, the Company applied the intrinsic value method of accounting
  for stock options as prescribed by APB 25, whereby compensation expense is
  equal to the excess, if any, of the quoted market price of the stock over the
  exercise price at the grant date of the award.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|             |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|             |                                         | The  Company  estimates  the  fair  value of stock
                     options  granted  using the  Monte-Carlo  option-pricing  model.  The  option-pricing
                     model requires a number of assumptions,  of which the most significant are,  expected
                     stock price  volatility,  and the contractual  option term.  Expected  volatility was
                     calculated  based upon actual  historical  stock price movements over the most recent
                     periods ending on the grant date,  equal to the contractual  term of the option.  The
                     Company has  historically  not paid dividends and has no  foreseeable  plans to issue
                     dividends.  The  risk-free  interest  rate is based on the yield  from U.S.  Treasury
                     zero-coupon bonds with an equivalent term.
|             |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|             |                                         | The   fair  value  for  of  the  Company's   stock
                     options  granted to employees  and  directors  was  estimated at using the  following
                     assumptions:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                

| |                                |  |                                  |            | 
| | ------------------------------ |  | -------------------------------- | ---------- | 
| |                                |  | Year ended
  December 31,
  2006 |           
| |                                |  |                                  |           
| |                                |  | %                                |           
| |                                |  |                                  |           
| |                                |  |                                  |            | 
| | Dividend
  yield               |  |                                  | 0%         | 
| | Expected
  volatility          |  |                                  | 33% - 85%  | 
| | Risk-free
  interest rate      |  |                                  | 4.75%      | 
| | Contractual
  term of up to    |  |                                  | 10
  years | 
| | Forfeiture
  rate              |  |                                  | 13.4%      | 
| | Suboptimal
  exercise multiple |  |                                  | 2.06       | 

F  15

---

---



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

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

| |                                                                                                                                                                                                                                                                                                                                                                          |  |                         |      |      |   |       |  
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ----------------------- | ---- | ---- | - | ----- | -
| |                                                                                                                                                                                                                                                                                                                                                                          |  | Year ended December 31, |     
| |                                                                                                                                                                                                                                                                                                                                                                          |  |                         |     
| |                                                                                                                                                                                                                                                                                                                                                                          |  | 2004                    |      | 2005 |  
| |                                                                                                                                                                                                                                                                                                                                                                          |  |                         |      |      |  
| |                                                                                                                                                                                                                                                                                                                                                                          |  |                         |      |      |   |       |  
| | Net
  loss - as reported                                                                                                                                                                                                                                                                                                                                                 |  | $                       | 168  |      | $ | 461   |  
| | Deduct: stock-based compensation expense
  recognized under APB 25                                                                                                                                                                                                                                                                                                       |  |                         | -    |      |   | (44   | )
| | Add: stock-based compensation expense
  determined under fair value method for all awards                                                                                                                                                                                                                                                                                |  |                         | 178  |      |   | 815   |  
| |                                                                                                                                                                                                                                                                                                                                                                          |  |                         |      |      |   |       |  
| |                                                                                                                                                                                                                                                                                                                                                                          |  |                         |      |      |   |       |  
| | Pro
  forma net loss:                                                                                                                                                                                                                                                                                                                                                    |  | $                       | 346  |      | $ | 1,232 |  
| |                                                                                                                                                                                                                                                                                                                                                                          |  |                         |      |      |   |       |  
| |                                                                                                                                                                                                                                                                                                                                                                          |  |                         |      |      |   |       |  
| | Net
  loss per share:                                                                                                                                                                                                                                                                                                                                                    |  |                         |      |      |   |       |  
| |                                                                                                                                                                                                                                                                                                                                                                          |  |                         |      |      |   |       |  
| | Basic and diluted net loss per share, as
  reported                                                                                                                                                                                                                                                                                                                      |  | $                       | 0.02 |      | $ | 0.05  |  
| |                                                                                                                                                                                                                                                                                                                                                                          |  |                         |      |      |   |       |  
| |                                                                                                                                                                                                                                                                                                                                                                          |  |                         |      |      |   |       |  
| | Pro forma basic and diluted net loss per
  share                                                                                                                                                                                                                                                                                                                         |  | $                       | 0.05 |      | $ | 0.14  |  
| |                                                                                                                                                                                                                                                                                                                                                                          |  |                         |      |      |   |       |  
| | For purpose
  of pro-forma disclosures, stock-based compensation is estimated using a
  Black-Scholes option pricing model and amortized over the vesting period
  using the accelerated attribution method.
  The fair value for of the Companys stock options granted to employees and
  directors was estimated at using the following weighted-average assumptions:

| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |                           |  |           |  |  |              | 
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ------------------------- |  | --------- |  |  | ------------ | 
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                          | Year ended
  December 31, | 
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |                           | 
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                          | 2004                      |  | 2005      | 
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |                           |  |           | 
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                          | %                         | 
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |                           | 
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |                           |  |           |  |  |              | 
| | Dividend
  yield                                                                                                                                                                                                                                                                                                                                                                                                                                                         |                           |  | 0%        |  |  | 0%           | 
| | Expected
  volatility                                                                                                                                                                                                                                                                                                                                                                                                                                                    |                           |  | 84%       |  |  | 107%         | 
| | Risk-free
  interest rate                                                                                                                                                                                                                                                                                                                                                                                                                                                |                           |  | 3.14%     |  |  | 4.25%        | 
| | Expected
  life of up to                                                                                                                                                                                                                                                                                                                                                                                                                                                 |                           |  | 4
  years |  |  | 3.36
  years | 
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |                           |  |           |  |  |              | 
| | Pro-forma
  compensation expense under SFAS 123, among other computational differences,
  does not consider potential pre-vesting forfeitures. Because of these
  differences, the pro-forma stock based compensation expense presented above
  for the prior years ended December 31 2004 and 2005 under SFAS 123 and the
  stock based compensation expense recognized during the current year ended
  December 31 2006 under SFAS 123(R) are not directly comparable.

F  16

---

---



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

|             |                                         |                                                                                                                                                                            
|------------ | --------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2:     | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|             |                                         |                                                                                                                                                                            
|             |                                         | During the
  year ended December 31 2006, the Company recognized stock-based
  compensation expense related to employee stock options in the amount of $ 243,
  as follows:

| |                                        |  |                                   |     | 
| | -------------------------------------- |  | --------------------------------- | --- | 
| |                                        |  | Year ended
  December 31, 
  2006 |    
| |                                        |  |                                   |    
|
| | Cost of revenue                        |  | $                                 | 30  | 
| | Research and development               |  |                                   | 30  | 
| | Selling and marketing                  |  |                                   | 44  | 
| | General and administrative             |  |                                   | 139 | 
| |                                        |  |                                   |     | 
| |                                        |  |                                   |     | 
| | Total Stock-based compensation expense |  | $                                 | 243 | 
| |                                        |  |                                   |     | 

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | o. | Research and
  development costs:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    | Research and
  development costs, are charged to the statement of operations as incurred.
  Statement of Financial Accounting Standard No. 86, Accounting for the Costs
  of Computer Software to be Sold, Leased or Otherwise Marketed (SFAS No.
  86), requires capitalization of certain software development costs
  subsequent to the establishment of technological feasibility.                                                                                                                                    
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    | Based   on  the  Company's   product   development
                     process,  technological  feasibility  is  established  upon  completion  of a working
                     model.  Costs incurred by the Company between completion of the working model and the
                     point at which the  products are ready for general  release have been  insignificant.
                     Therefore, all research and development costs have been expensed.                                                    
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | p. | Royalty-bearing
  grants:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    | Royalty-bearing
  grants from the Government of Israel for funding approved research and
  development projects are recognized at the time the Company is entitled to
  such grants, on the basis of the costs incurred and included as a reduction
  in research and development costs. No research and development grants were
  received during the years 2002 through 2006. Total royalties paid amounted to
  $ 15, $ 1 and $ 0 in 2004, 2005 and 2006, respectively and were recorded as part
  of the cost of revenues.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | q. | Basic and
  diluted net earnings (loss) per share:                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    | Basic net
  earnings (loss) per share is computed based on the weighted average number of
  Ordinary shares outstanding during each year. Diluted net earnings (loss) per
  share is computed based on the weighted average number of Ordinary shares
  outstanding during each year, plus the dilutive potential of Ordinary shares
  considered outstanding during the year, in accordance with SFAS No. 128,
  Earnings Per Share (SFAS No. 128).                                                                      

F  17

---

---



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

|             |                                        
|------------ | ---------------------------------------
|NOTE 2:     | SIGNIFICANT ACCOUNTING POLICIES (CONT.)

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    | Part of the
  outstanding stock options and warrants has been excluded from the calculation
  of the diluted net earnings (loss) per share because such securities are
  anti-dilutive for 2004, 2005 and 2006. The weighted average number of shares
  related to the outstanding options and warrants excluded from the
  calculations of diluted net earnings (loss) per share was 1,781,563,
  1,819,003 and 1,408,999 for the years ended December 31, 2004, 2005 and 2006,
  respectively.                                                                                                                                                                                               
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | r. | Income
  taxes:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    | The Company
  and its subsidiaries account for income taxes in accordance with SFAS
  No. 109, Accounting for Income Taxes (SFAS No. 109). This Statement
  prescribes the use of the liability method whereby deferred tax assets and
  liability account balances are determined based on differences between
  financial reporting and tax bases of assets and liabilities and are measured
  using the enacted tax rates and laws that will be in effect when the
  differences are expected to reverse. The Company and its subsidiaries provide
  a valuation allowance, if necessary, to reduce deferred tax assets to their
  estimated realizable value.                          
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | s. | Concentrations
  of credit risk:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    | Financial
  instruments which potentially subject the Company and its subsidiaries to
  concentration of credit risk consist principally of cash and cash
  equivalents, marketable securities and trade receivables.                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    | The
  Companys cash and cash equivalents are invested primarily in deposits with
  major banks worldwide, however, such cash and cash equivalents in the United
  States may be in excess of insured limits and are not insured in other jurisdictions.
  Management believes that the financial institutions that hold the Companys
  investments are financially sound, and accordingly, minimal credit risk
  exists with respect to these investments.                                                                                                                                                                                                                                   
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    | The
  Companys marketable securities include investments in auction rate
  securities guaranteed by U.S. government. Management believes that those
  corporations and governments are financially sound and that the portfolios
  are well-diversified, and accordingly, minimal credit risk exists with
  respect to these marketable securities.                                                                                                                                                                                                                                                                                                                                           
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    | Trade   receivables   of  the   Company   and  its
                     subsidiaries  are derived  from sales to  customers  located  primarily  in the U.S.,
                     Europe,  Japan and Israel.  The Company  performs  ongoing credit  evaluations of its
                     customers.  An allowance for doubtful  accounts is  determined  with respect to those
                     amounts that the Company has determined to be doubtful of  collection.  For the years
                     ended December 31, 2006,  2005 and 2004, the Company  recorded  expenses for doubtful
                     accounts in the amounts of $ 436, $ 408 and $ 577, respectively.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | t. | Derivative
  instruments:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    | Financial
  Accounting Standards Board Statement No. 133, Accounting for Derivative Instruments
  and Hedging Activities (SFAS No. 133), requires companies to recognize all
  of its derivative instruments as either assets or liabilities in the
  statement of financial position at fair value. The accounting for changes in
  the fair value (i.e., gains or losses) of a derivative instrument depends on
  whether it has been designated and qualifies as part of a hedging
  relationship and further, on the type of hedging relationship.                                                                                                                                       

F  18

---

---



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

|             |                                        
|------------ | ---------------------------------------
|NOTE 2:     | SIGNIFICANT ACCOUNTING POLICIES (CONT.)

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    | All  of the Company's derivative  instruments were
                     not  designated  as hedging  instruments  as such the gain or loss is  recognized  in
                     other income/expense in current earnings during the period of change.                                                                                                                                                                                                                                                                                                                      
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | u. | Severance
  pay:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    | The
  Companys liability for severance pay is calculated pursuant to Israels
  Severance Pay Law, based on the most recent salary of the employees
  multiplied by the number of years of employment, as of the balance sheet
  date. Employees are entitled to one months salary for each year of
  employment or a portion thereof. The Companys liability for all of its
  employees in Israel is fully provided by monthly deposits with insurance
  policies and by an accrual. The value of these policies is recorded as an
  asset in the Companys balance sheet.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    | The
  deposited funds include profits accumulated up to the balance sheet date. The
  deposited funds may be withdrawn only upon the fulfillment of the obligation
  pursuant to Israels Severance Pay Law or labor agreements. The value of the
  deposited funds is based on the cash surrendered value of these policies, and
  includes immaterial profits.                                                                                                                                                                                                              
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    | Severance
  expenses for the years ended December 31, 2004, 2005 and 2006 amounted to
  approximately $ 94, $ 102 and $ 107, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | v. | Fair value
  of financial instruments:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    | The
  following methods and assumptions were used by the Company and its
  subsidiaries in estimating their fair value disclosures for financial instruments:                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    | The carrying
  amounts of cash and cash equivalents, trade receivables and other accounts
  receivable, short-term bank credit, trade payables and other accounts payable
  approximate their fair value due to the short-term maturity of these instruments.                                                                                                                                                                                                                                                                                                                 
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    | The fair
  values for marketable securities are based on quoted market prices and do not
  differ from carrying amounts (see also Note 3).                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    | The carrying
  amount of the Companys long-term borrowing approximates its fair value. The
  fair value was estimated using discounted cash flow analyses, based on the
  Companys incremental borrowing rates for similar type of borrowing
  arrangements.                                                                                                                                                                                                                                                                                                                
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | w. | Advertising
  expenses:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    | Advertising expenses are charged to selling
  and marketing expenses, as incurred. Advertising expenses for
  the years ended December 31, 2004, 2005 and 2006 were $ 175, $ 91 and $ 189,
  respectively.                                                                                                                                                                                                                                                                                                                                                                    

F  19

---

---



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

|             |                                        
|------------ | ---------------------------------------
|NOTE 2:     | SIGNIFICANT ACCOUNTING POLICIES (CONT.)

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | x. | Reclassification:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    | Certain
  comparative data in these financial statements have been reclassified to
  confirm with current years presentation.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | y. | Impact of
  recently issued Accounting Standards:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    | In July
  2006, the FASB issued FASB Interpretation 48, Accounting for Income
  Tax Uncertainties (FIN 48). FIN 48 defines the threshold for recognizing
  the benefits of tax return positions in the financial statements as
  more-likely-than-not to be sustained by the taxing authority. The recently
  issued literature also provides guidance on derecognition, measurement and
  classification of income tax uncertainties, along with any related interest
  and penalties. FIN 48 also includes guidance concerning accounting for income
  tax uncertainties in interim periods and increases the level of disclosures
  associated with any recorded income tax uncertainties. FIN 48 is effective
  for fiscal years beginning after December 15, 2006. The differences between
  the amounts recognized in the statements of financial position prior to the
  adoption of FIN 48 and the amounts reported after adoption will be accounted
  for as a cumulative-effect adjustment recorded to the beginning balance of
  retained earnings. The Company is currently evaluating the impact of FIN 48
  on its consolidated financial statements.                                                                                                                                                                                                                                                                                                 
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    | In  September  2006,  FASB  issued  SFAS no.  157,
                     "Fair  Value  Measurements"  ("SFAS No.  157").  SFAS No.  157  defines  fair  value,
                     establishes  a framework for measuring  fair value in generally  accepted  accounting
                     principles and expands  disclosures  about fair value  measurements.  SFAS No. 157 is
                     effective for financial  statements  issued for fiscal years beginning after November
                     15, 2007 and interim  periods  within those fiscal years.  The  Company's  management
                     believes SFAS No. 157 will not have a material effect on its financial statements.
In February
  2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
  Assets and Financial Liabilities (SFAS No. 159). SFAS No. 159
  permits companies to choose to measure certain financial instruments and
  certain other items at fair value. SFAS No. 159 requires that unrealized
  gains and losses on items for which the fair value option has been elected be
  reported in earnings. SFAS No. 159 is effective for financial statements
  issued for fiscal years beginning after November 15, 2007 and interim
  periods within those fiscal years, although earlier adoption is permitted.
  The Company is currently evaluating the impact that SFAS No. 159 will have
  on its consolidated financial statements.

|             |                                                                                                                                                                                                                                                                                                                                                          
|------------ | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 3:     | MARKETABLE SECURITIES                                                                                                                                                                                                                                                                                                                                    
|             |                                                                                                                                                                                                                                                                                                                                                          
|             | As  of December  31,  2006 the Company  invests in
              marketable  securities,  with  maturity  no longer  then 28 days,  which are  classified  as
              available-for-sale.  The securities  were recorded as of December 31, 2006 in amortized cost
              that equal to the market value. No unrealized gains were recorded.
|             |                                                                                                                                                                                                                                                                                                                                                          
|NOTE 4:     | OTHER ACCOUNTS RECEIVABLE AND PREPAID EXPENSES                                                                                                                                                                                                                                                                                                           

| |                             |  |                |     |      |   |       | 
| | --------------------------- |  | -------------- | --- | ---- | - | ----- | 
| |                             |  | December
  31, |    
| |                             |  |                |    
| |                             |  | 2005           |     | 2006 |  
| |                             |  |                |     |      |  
| |                             |  |                |     |      |   |       | 
| | Government authorities      |  | $              | 316 |      | $ | 306   | 
| | Prepaid expenses and others |  |                | 250 |      |   | 716   | 
| | Employees                   |  |                | 56  |      |   | 98    | 
| |                             |  |                |     |      |   |       | 
| |                             |  |                |     |      |   |       | 
| |                             |  | $              | 622 |      | $ | 1,120 | 
| |                             |  |                |     |      |   |       | 

F  20

---

---



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

|             |                       
|------------ | ----------------------
|NOTE 5:     | PROPERTY AND EQUIPMENT

| |                                      |  |                |       |      |   |       | 
| | ------------------------------------ |  | -------------- | ----- | ---- | - | ----- | 
| |                                      |  | December
  31, |      
| |                                      |  |                |      
| |                                      |  | 2005           |       | 2006 |  
| |                                      |  |                |       |      |  
| |                                      |  |                |       |      |   |       | 
| | Cost:                                |  |                |       |      |   |       | 
| | Computers and
  peripheral equipment |  | $              | 1,674 |      | $ | 1,895 | 
| | Furniture and
  office equipment     |  |                | 465   |      |   | 488   | 
| | Leasehold
  improvements             |  |                | 139   |      |   | 147   | 
| |                                      |  |                |       |      |   |       | 
| |                                      |  |                |       |      |   |       | 
| |                                      |  |                | 2,278 |      |   | 2,530 | 
| |                                      |  |                |       |      |   |       | 
| | Accumulated depreciation:            |  |                |       |      |   |       | 
| | Computers and
  peripheral equipment |  |                | 1,383 |      |   | 1,554 | 
| | Furniture and
  office equipment     |  |                | 229   |      |   | 291   | 
| | Leasehold
  improvement              |  |                | 89    |      |   | 97    | 
| |                                      |  |                |       |      |   |       | 
| |                                      |  |                |       |      |   |       | 
| |                                      |  |                | 1,701 |      |   | 1,942 | 
| |                                      |  |                |       |      |   |       | 
| |                                      |  |                |       |      |   |       | 
| | Depreciated cost                     |  | $              | 577   |      | $ | 588   | 
| |                                      |  |                |       |      |   |       | 

| |                                                                                                                                   
| | ----------------------------------------------------------------------------------------------------------------------------------
| | Depreciation
  expense amounted to $ 189 and $ 205 and $ 241 for the years ended
  December 31, 2004, 2005 and 2006, respectively.
| |                                                                                                                                   
| | As to
  charges, see Note 9c(1).                                                                                                  

|             |                                                    
|------------ | ---------------------------------------------------
|NOTE 6:     | OTHER INTANGIBLE ASSETS AND DEFERRED ISSUANCE COSTS

| |                                                                                                                                                              |                                  
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------ | ---------------------------------
| | Other
  intangible assets arose from the acquisition of the business from Toyo in
  August 2004 (see Note 1b), and of convertible debentures issuance costs.
| |                                                                                                                                                             
| | a.                                                                                                                                                           | Identifiable
  intangible assets:

| |                              |  |                |       |      |   |       | 
| | ---------------------------- |  | -------------- | ----- | ---- | - | ----- | 
| |                              |  | December
  31, |      
| |                              |  |                |      
| |                              |  | 2005           |       | 2006 |  
| |                              |  |                |       |      |  
| |                              |  |                |       |      |  
| | Original amount:             |  |                |       |      |   |       | 
| | Customer
  relations         |  | $              | 750   |      | $ | 750   | 
| | Acquired
  technology        |  |                | 750   |      |   | 750   | 
| |                              |  |                |       |      |   |       | 
| |                              |  |                |       |      |   |       | 
| |                              |  |                | 1,500 |      |   | 1,500 | 
| |                              |  |                |       |      |   |       | 
| | Accumulated amortization:    |  |                |       |      |   |       | 
| | Customer
  relations         |  |                | 200   |      |   | 350   | 
| | Acquired
  technology        |  |                | 200   |      |   | 350   | 
| |                              |  |                |       |      |   |       | 
| |                              |  |                |       |      |   |       | 
| |                              |  |                | 400   |      |   | 700   | 
| |                              |  |                |       |      |   |       | 
| |                              |  |                |       |      |   |       | 
| | Amortized cost               |  |                | 1,100 |      |   | 800   | 
| |                              |  |                |       |      |   |       | 
| |                              |  |                |       |      |   |       | 
| | Deferred issuance costs, net |  |                | -     |      |   | 1,035 | 
| |                              |  |                |       |      |   |       | 
| |                              |  |                |       |      |   |       | 
| |                              |  | $              | 1,100 |      | $ | 1,835 | 
| |                              |  |                |       |      |   |       | 

F  21

---

---



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

|             |                                                             |                                                                                                                                                                                                                                                                                                                                                                                                
|------------ | ----------------------------------------------------------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 6:     | OTHER INTANGIBLE ASSETS AND DEFERRED ISSUANCE COSTS (Cont.)
|             |                                                            
|             | b.                                                          | Amortization
  expenses amounted to $ 81, $ 319 and $ 301 for the years ended December 31,
  2004, 2005 and 2006, respectively. Issuance costs allocated to the
  convertible debenture, in the amount of $ 1,036, were recorded as deferred
  charges and were amortized to interest expenses from the commitment date to
  the stated redemption date using the interest method (see Note 9).
|             |                                                             |                                                                                                                                                                                                                                                                                                                                                                                                
|             |                                                             | As of
  December 31, 2006, the amortization of the deferred issuance cost amounted to
  $ 1.                                                                                                                                                                                                                                                                                                   
|             |                                                             |                                                                                                                                                                                                                                                                                                                                                                                                
|             | c.                                                          | Estimated
  amortization expenses of intangible assets for the year ended:                                                                                                                                                                                                                                                                                                                     

| |              |  |   |                             |  | 
| | ------------ |  | - | --------------------------- |  | 
| | December 31, |  |   | Other
  intangible
  assets | 
| |              |  |   |                             | 
| |              |  |   |                             | 
| | 2007         |  | $ | 300                         | 
| | 2008         |  |   | 300                         | 
| | 2009         |  |   | 200                         | 

|             |                       |             
|------------ | --------------------- | ------------
|NOTE 7:     | SHORTTERM BANK LOANS
|             |                      
|             | a.                    | Composition:

| |                           |  |               |  |              |  |      |       |      |       |     |   |     | 
| | ------------------------- |  | ------------- |  | ------------ |  | ---- | ----- | ---- | ----- | --- | - | --- | 
| |                           |  | Interest rate |  | December 31, | 
| |                           |  |               |  |              | 
| |                           |  | 2005          |  | 2006         |  | 2005 |       | 2006 |      
| |                           |  |               |  |              |  |      |       |      |      
| |                           |  | %             |  |              |  |      |       |      |      
| |                           |  |               |  |              |  |      |       |      |      
| | Short-term
  bank loans:  |  |               |  |              |  |      |       |      |       |     |   |     | 
| | In NIS                    |  | 5.8           |  | -            |  | $    | 740   |      | $     | -   |  
| |                           |  |               |  |              |  |      |       |      |       |     |   |     | 
| |                           |  |               |  |              |  |      |       |      |       |     |   |     | 
| | Short-term
  bank credit: |  |               |  |              |  |      |       |      |       |     |   |     | 
| | In NIS (1)                |  | Prime +
  1%  |  | -            |  |      | 85    |      |       | -   |  
| | In U.S. dollars (2)       |  | Libor +
  2%  |  | Libor +
  2% |  |      | 1,354 |      |       | 339 |  
| |                           |  |               |  |              |  |      |       |      |       |     |   |     | 
| |                           |  |               |  |              |  |      |       |      |       |     |   |     | 
| |                           |  |               |  |              |  |      |       |      | 1,439 |     |   | 339 | 
| |                           |  |               |  |              |  |      |       |      |       |     |   |     | 
| |                           |  |               |  |              |  |      |       |      |       |     |   |     | 
| |                           |  |               |  |              |  |      |       | $    | 2,179 |     | $ | 339 | 
| |                           |  |               |  |              |  |      |       |      |       |     |   |     | 

| |    |                                                                                                                                                                                                        |                                                                                      
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | -------------------------------------------------------------------------------------
| |    | (1)                                                                                                                                                                                                    | As of
  December 31, 2005, the prime rate is 5.5%.                                   
| |    |                                                                                                                                                                                                        |                                                                                      
| |    | (2)                                                                                                                                                                                                    | As of
  December 31, 2005 and 2006, the Libor rate is 4.375% and 5.36%, respectively.
| |    |                                                                                                                                                                                                        |                                                                                      
| |    | The Company
  has a revolving line of credit with banks for total borrowings of up to
  $ 2,300, based on 75% of its trade receivables. The line of credit is secured
  by a charge (see Note 10c(2)).
| |    |                                                                                                                                                                                                       
| | b. | Interest
  expenses amounted to $ 72, $ 100 and $ 121 for the years ended 2004, 2005 and
  2006, respectively.                                                                                        

F  22

---

---



|                                                          
|----------------------------------------------------------
|TOP IMAGE SYSTEMS LTD. AND ITS SUBSIDIARIES               
|                                                          
|NOTES TO FINANCIAL STATEMENTS                             
|                                                          
|U.S. dollars in thousands, except share and per share data

|             |                                            
|------------ | -------------------------------------------
|NOTE 8:     | ACCRUED EXPENSES AND OTHER ACCOUNTS PAYABLE

| |                                    |  |                |       |      |   |       | 
| | ---------------------------------- |  | -------------- | ----- | ---- | - | ----- | 
| |                                    |  | December
  31, |      
| |                                    |  |                |      
| |                                    |  | 2005           |       | 2006 |  
| |                                    |  |                |       |      |  
| |                                    |  |                |       |      |   |       | 
| | Employees and payroll accruals     |  | $              | 172   |      | $ | 176   | 
| | Government authorities             |  |                | 575   |      |   | 778   | 
| | Provision for accrued vacation pay |  |                | 254   |      |   | 331   | 
| | Deferred revenues                  |  |                | 440   |      |   | 704   | 
| | Accrued expenses and other         |  |                | 772   |      |   | 977   | 
| |                                    |  |                |       |      |   |       | 
| |                                    |  |                |       |      |   |       | 
| |                                    |  | $              | 2,213 |      | $ | 2,966 | 
| |                                    |  |                |       |      |   |       | 

|            |                       
|----------- | ----------------------
|NOTE 9:    | CONVERTIBLE DEBENTURES

|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |                                                                                                                                                                                                                                                                                                                                                          
|------------ | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|             | In December
  2006, the Company issued an aggregate amount of $14,780 Convertible
  debentures in a discount of 4% by way of public offering in the Tel Aviv
  Stock Exchange. The Convertible debenture terms include an offering of
  112,500 units of 528 New Israeli Shekel par value each, linked to the dollar
  and carry an annual interest rate of 6 months Libor minus 0.3%. The
  debentures principal will be repaid in 4 annual installments commencing on
  December 31, 2009 and the interest is payable semi-annually commencing on
  June 30, 2007.
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|             | The
  debentures may be converted into Ordinary shares of the Company in a ratio of
  20.3 New Israeli Shekel par values for each Ordinary share (subject to
  adjustments). The Company has the right to force the conversion on the debentures
  holders, when and if its share fair market value shall reach 25.5 New Israeli
  Shekels in the last 30 trading days in TASE on or after October 1, 2009.                                                                                                                                                          
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|NOTE 10:    | COMMITMENTS, CONTINGENCIES AND CHARGES                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|             | a.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | Legal
  proceedings:                                                                                                                                                                                                                                                                                                                                     
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |                                                                                                                                                                                                                                                                                                                                                          
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | Lawsuits have been lodged against the Company in the ordinary course of business in insignificant
amounts. The Company intends to defend itself vigorously against those lawsuits.
Management cannot predict the outcome of the lawsuits nor can they make any estimate of
the amount of damages; therefore, no provision has been made for the lawsuits.

F  23

---

---



|                                                          
|----------------------------------------------------------
|TOP IMAGE SYSTEMS LTD. AND ITS SUBSIDIARIES               
|                                                          
|NOTES TO FINANCIAL STATEMENTS                             
|                                                          
|U.S. dollars in thousands, except share and per share data

|             |                                                |              |                                                                                                                                                                                                                                                                                                                                                                             
|------------ | ---------------------------------------------- | ------------ | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 10:    | COMMITMENTS, CONTINGENCIES AND CHARGES (Cont.)
|             |                                               
|             | b.                                             | Commitments:
|             |                                                |             
|             |                                                | 1.           | With respect
  to the participation of the Israeli Government in software research and
  development costs, the Company is committed to pay to the Government
  royalties at the rate of 2%-3.5% of revenues from sale of its FormOut! Software, up to a maximum of
  150% of the amount of participation received, linked to the dollar, plus
  interest at the LIBOR rate.
|             |                                                |              |                                                                                                                                                                                                                                                                                                                                                                             
|             |                                                |              | The
  Companys total outstanding obligation in respect of royalty-bearing
  government participation received or accrued, net of royalties paid or
  accrued, amounted to $ 69 as of December 31, 2006.                                                                                                                                                                    
|             |                                                |              |                                                                                                                                                                                                                                                                                                                                                                             
|             |                                                |              | Royalties
  payable to the Office of the Chief Scientist of Israels Ministry of Industry
  and Trade (the OCS) are classified as part of cost of revenues.                                                                                                                                                                                                               
|             |                                                |              |                                                                                                                                                                                                                                                                                                                                                                             
|             |                                                | 2.           | The Company
  has entered into operating lease agreements 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, 2006, commitments are as follows:                                                

| |       |  |   |     | 
| | ----- |  | - | --- | 
| | 2007  |  | $ | 218 | 
| | 2008  |  |   | 151 | 
| | 2009  |  |   | 46  | 
| |       |  |   |     | 
| |       |  |   |     | 
| | Total |  | $ | 415 | 
| |       |  |   |     | 

| |  |    |                                                                                                                                                                                                                           
| |  | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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,
  2006, commitments for such leases are as follows:

| |       |  |   |       | 
| | ----- |  | - | ----- | 
| | 2007  |  | $ | 516   | 
| | 2008  |  |   | 318   | 
| | 2009  |  |   | 156   | 
| | 2010  |  |   | 156   | 
| | 2011  |  |   | 156   | 
| | 2012  |  |   | 156   | 
| |       |  |   |       | 
| |       |  |   |       | 
| | Total |  | $ | 1,458 | 
| |       |  |   |       | 

| |  |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |  | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  |    | Part of the
  lease agreements is secured by a bank guarantee in the amount of $ 56.                                                                                                                                                                                                                                                                                                                                                                                       
| |  |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |  | 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 and
  2.75% of related sales. The amount is due in four quarterly payments for each
  year. During the years 2005 and 2006, the Company paid annual fees of $ 300,
  which were recorded as part of cost of revenues.

F  24

---

---



|                                                          
|----------------------------------------------------------
|TOP IMAGE SYSTEMS LTD. AND ITS SUBSIDIARIES               
|                                                          
|NOTES TO FINANCIAL STATEMENTS                             
|                                                          
|U.S. dollars in thousands, except share and per share data

|             |                                        |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|------------ | -------------------------------------- | ----------------------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 10:    | COMMITMENTS, CONTINGENCIES AND CHARGES
|             |                                        |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|             | 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 charge is unlimited in amount and it may not be further
  pledged or transferred without the 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 rights in favor of this bank.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|             |                                        |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|NOTE 11:    | TAXES ON INCOME                       
|             |                                        |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|             | a.                                     | Israeli
  income taxes:
|             |                                        |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|             |                                        | 1.                      | The Law for
  the Encouragement of Capital Investments, 1959 (the Law):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|             |                                        |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|             |                                        |                         | According to
  the Law, the companies are entitled to various tax benefits by virtue of the
  approved enterprise status granted to part of their enterprises, as defined
  by this Law.                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|             |                                        |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|             |                                        |                         | In March
  2005, the Israeli Parliament passed the Arrangements Law for fiscal year
  2005, which includes a broad and comprehensive amendment to the provisions of
  the above Law (Amendment No. 60 to the Law).                                                                                                                                                                                                                                                                                                                                                                                                                                             
|             |                                        |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|             |                                        |                         | The
  Companys production facilities in Israel have been granted Approved
  Enterprise status under the above Law. The Company has a program with three
  expansions, according to the Alternative Benefits Track. The main benefit
  arising from such status is the reduction in tax rates on income derived from
  Approved Enterprises. Consequently, the Company is entitled to a two-year
  tax exemption and five to eight years of tax at a reduced rate of 10%-25%,
  based on the percentage of foreign investment in the Company. Since the Company
  has had no taxable income, the benefits have not yet commenced for any of the
  programs.
|             |                                        |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|             |                                        |                         | The  period of tax  benefits,  for each program as
                            detailed  above,  is subject to limit of 12 years from the  completion  of the
                            investment  or  commencement  of  production,  or 14 years from receipt of the
                            approval,  whichever is earlier.  Please note that the years'  limitation does
                            not apply to the exemption period.                                                                                                                                                                                                               
|             |                                        |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|             |                                        |                         | The  Company  received  approvals  for  the  first
                            program  and tree of its  expansions  during the years  1990,  1991,  1999 and
                            2000,  of which the first two  programs  have already  expired.  The period of
                            benefits for the second and third expansion has not yet commenced.                                                                                                                                                                                                                                                                                          

F  25

---

---



|                                                          
|----------------------------------------------------------
|TOP IMAGE SYSTEMS LTD. AND ITS SUBSIDIARIES               
|                                                          
|NOTES TO FINANCIAL STATEMENTS                             
|                                                          
|U.S. dollars in thousands, except share and per share data

|             |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|------------ | ----------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 11:    | TAXES ON INCOME (Cont.)
|             |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|             |                         | The
  entitlement to the above benefits is conditional upon the Companys
  fulfilling the conditions stipulated by the above Law, regulations published
  thereunder and the letters of approval for the specific investments in
  approved enterprises. In the event of failure to comply with these
  conditions, the benefits may be canceled and the Company may be required to refund
  the amount of the benefits, in whole or in part, including interest. As of
  December 31, 2006, management believes that the Company is meeting all of the
  aforementioned conditions.                                                                                                                                                    
|             |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|             |                         | If these
  retained tax-exempt profits attributable to the Approved Enterprise are
  distributed in a manner other than in the complete liquidation of the Company
  they would be taxed at the corporate tax rate applicable to such profits as
  if the Company had not elected the alternative benefits track, currently
  between 10%-20% for an Approved Enterprise. As of December 31, 2006, the
  accumulated deficit of the Company does not include tax-exempt profits earned
  by the Companys Approved Enterprise.                                                                                                                                                                                                       
|             |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|             |                         | Income from
  sources other than the Approved Enterprise during the benefit period will
  be subject to tax at the regular corporate tax rate.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|             |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|             |                         | On April 1,
  2005, an amendment to the Investment Law came into effect (the Amendment)
  and has significantly changed the provisions of the Investment Law. The
  Amendment limits the scope of enterprises which may be approved by the
  Investment Center by setting criteria for the approval of a facility as a
  Privileged Enterprise, such as provisions generally requiring that at least
  25% of the Privileged Enterprises income will be derived from export.
  Additionally, the Amendment enacted major changes in the manner in which tax
  benefits are awarded under the Investment Law so that companies no longer
  require Investment Center approval in order to qualify for tax benefits.                  
|             |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|             |                         | However, the
  Investment Law provides that terms and benefits included in any certificate
  of approval already granted will remain subject to the provisions of the law
  as they were on the date of such approval. Therefore, the Companys existing
  Approved Enterprise will generally not be subject to the provisions of the
  Amendment. As a result of the amendment, tax-exempt income generated under
  the provisions of the new law, will subject the Company to taxes upon
  distribution or liquidation and the Company may be required to record
  deferred tax liability with respect to such tax-exempt income. As of December
  31, 2006, the Company did not generate income under the provisions of the
  Amendment.
|             |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|             |                         | The dividend
  distributed by an Approved Enterprise and Privileged Enterprise will be
  subject to withholding tax of 15%.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            

F  26

---

---



|                                                          
|----------------------------------------------------------
|TOP IMAGE SYSTEMS LTD. AND ITS SUBSIDIARIES               
|                                                          
|NOTES TO FINANCIAL STATEMENTS                             
|                                                          
|U.S. dollars in thousands, except share and per share data

|             |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|------------ | ----------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 11:    | TAXES ON INCOME (Cont.)
|             |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|             |                         | 2.                                                                                                                                                                                                                                                                                                                                                                                                                                                           | Measurement
  of taxable income:                                                                                                                                                                                                                                                                                                                                                                                                                          
|             |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|             |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                              | 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. Accordingly, commencing taxable year 2003, results for tax purposes are
  measured in terms of earnings in dollar.
|             |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|             |                         | 3.                                                                                                                                                                                                                                                                                                                                                                                                                                                           | Tax benefits
  under the Law for the Encouragement of Industry (Taxes), 1969:                                                                                                                                                                                                                                                                                                                                                                             
|             |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|             |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                              | The Company
  is an industrial company, as defined by this law and, as such, is entitled
  to certain tax benefits, mainly accelerated depreciation of machinery and
  equipment, as prescribed by regulations published under the Inflationary
  Adjustments Law, the right to claim public issuance expenses and amortization
  of patents and other intangible property rights as a deduction for tax
  purposes.                                    
|             |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|             |                         | 4.                                                                                                                                                                                                                                                                                                                                                                                                                                                           | Corporate
  tax rates:                                                                                                                                                                                                                                                                                                                                                                                                                                    
|             |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|             |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                              | Taxable
  income of Israeli companies is subject to tax at the rate as follows: 2004 -
  35%, 2005 - 34%, 2006 - 31%, 2007 - 29%, 2008 - 27%, 2009 - 26%, 2010 and
  thereafter - 25%.                                                                                                                                                                                                                                                                    
|             |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|             |                         | 5.                                                                                                                                                                                                                                                                                                                                                                                                                                                           | The Company
  has received final tax assessments through the year 1999.                                                                                                                                                                                                                                                                                                                                                                                   
|             |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|             | b.                      | The main
  reconciling item between the statutory tax rate of the Company and the
  effective tax rate is the recognition of valuation allowances in respect of
  deferred taxes relating to accumulated net operating losses carried forward
  among the various subsidiaries worldwide due to the uncertainty of the
  realization of such deferred taxes, the effect of the Approved Enterprise
  and undeductible expenses related to option expenses.
|             |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|             |                         | The tax
  expenses in 2005 and 2006 in the amount of $ 30 and $ 45, respectively in the
  financial statements are a result of taxes paid on income of certain
  subsidiary, due to the transfer pricing arrangement between the companies.                                                                                                                                                                                                                 
|             |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|             | c.                      | Carryforward
  losses:                                                                                                                                                                                                                                                                                                                                                                                                                                      
|             |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|             |                         | As of
  December 31, 2006, the Company had operating losses carryforward for tax
  purposes in the amount of $ 3,971. The amount of the Companys carryforward
  operating losses will be offset against taxable future income for an
  indefinite period.                                                                                                                                                                                                  
|             |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|             |                         | As of
  December 31, 2006, the subsidiaries had operating losses carryforward for tax
  purposes in the amount of $ 4,449. A portion of such losses expires over a
  period from 2007 through 2019.                                                                                                                                                                                                                                                         

F  27

---

---



|                                                          
|----------------------------------------------------------
|TOP IMAGE SYSTEMS LTD. AND ITS SUBSIDIARIES               
|                                                          
|NOTES TO FINANCIAL STATEMENTS                             
|                                                          
|U.S. dollars in thousands, except share and per share data

|             |                         |                                        
|------------ | ----------------------- | ---------------------------------------
|NOTE 11:    | TAXES ON INCOME (Cont.)
|             |                         |                                        
|             | d.                      | Income
  (loss) before taxes on income:

|         |  |                         |      |      |   |        |   |   |     | 
|-------- |  | ----------------------- | ---- | ---- | - | ------ | - | - | --- | 
|         |  | Year ended December 31, |     
|         |  |                         |     
|         |  | 2004                    |      | 2005 |   | 2006   |  
|         |  |                         |      |      |   |        |  
|         |  |                         |      |      |   |        |   |   |     | 
|Domestic |  | $                       | (68  | )    | $ | (1,253 | ) | $ | 526 | 
|Foreign  |  |                         | (100 | )    |   | 822    |   |   | 320 | 
|         |  |                         |      |      |   |        |   |   |     | 
|         |  |                         |      |      |   |        |   |   |     | 
|         |  | $                       | (168 | )    | $ | (431   | ) | $ | 846 | 
|         |  |                         |      |      |   |        |   |   |     | 

| |    |                  
| | -- | -----------------
| | e. | Deferred
  taxes:

|                                                     |  |              |        |      |   |        |  
|---------------------------------------------------- |  | ------------ | ------ | ---- | - | ------ | -
|                                                     |  | December 31, |       
|                                                     |  |              |       
|                                                     |  | 2005         |        | 2006 |  
|                                                     |  |              |        |      |  
|                                                     |  |              |        |      |   |        |  
|Carryforward
  losses                                |  | $            | 2,538  |      | $ | 2,158  |  
|Accrued
  severance pay                              |  |              | 59     |      |   | 81     |  
|Accrued
  vacation pay                               |  |              | 81     |      |   | 96     |  
|Allowance
  for doubtful accounts                    |  |              | 131    |      |   | 121    |  
|                                                     |  |              |        |      |   |        |  
|                                                     |  |              |        |      |   |        |  
|Net deferred
  tax assets before valuation allowance |  |              | 2,809  |      |   | 2,456  |  
|Valuation
  allowance                                |  |              | (2,809 | )    |   | (2,456 | )
|                                                     |  |              |        |      |   |        |  
|                                                     |  |              |        |      |   |        |  
|Net deferred
  tax assets                            |  | $            | -      |      | $ | -      |  
|                                                     |  |              |        |      |   |        |  

|             |                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|------------ | -------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|             |                      | 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, in the foreseeable future.                                               
|             |                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|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 $ 8,000. The Company filed a registration statement
  which had become effective by the Securities and Exchange Commission 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.                                                                                                                                                                                                                                                                                                              
|             |                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|             |                      | 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.

F  28

---

---



|                                                          
|----------------------------------------------------------
|TOP IMAGE SYSTEMS LTD. AND ITS SUBSIDIARIES               
|                                                          
|NOTES TO FINANCIAL STATEMENTS                             
|                                                          
|U.S. dollars in thousands, except share and per share data

|             |                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|------------ | ---------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 12:    | SHAREHOLDERS EQUITY (Cont.)
|             |                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|             |                              | As of December 31, 2006 no
  warrants were exercised.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|             |                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|             |                              | 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 $ 164
  (including interest). In addition, any future failure to maintain
  effectiveness of the registration statement could subject the Company to
  additional liquidated damages.
|             |                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|             | b.                           | Employee
  stock options:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|             |                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|             |                              | 1.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             | Employee
  Stock Option Plan (1996):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|             |                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|             |                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                | In September 1996, the
  Board of Directors of the Company adopted, and the shareholders approved, the
  Employee Stock Option Plan (1996) (the ESOP 96). The ESOP 96 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.
|             |                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|             |                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                | As of December 31, 2006,
  options to purchase 82,625 Ordinary shares are outstanding under the plan at
  exercise prices between $ 2.31 and $ 4.13 per share. The outstanding options
  under the Plan become exercisable in four equal parts upon each of the first
  four anniversaries of the option grant dates.                                                                                                                                                                                                     
|             |                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|             |                              | 2.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             | 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 the ESOP 2000. As of December 31,
  2006, 118,500 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.                                                                                                                                                                                                                                                  
|             |                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|             |                              | 3.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             | Employee
  Stock Option Plan (2003):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|             |                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|             |                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                | The Employee
  Stock Option Plan (2003) (the ESOP 2003) is designed to benefit from, and
  is made pursuant to, the provisions of Section 102 of the Israeli Income Tax
  Ordinance.                                                                                                                                                                                                                                                                                                                                    

F  29

---

---



|                                                          
|----------------------------------------------------------
|TOP IMAGE SYSTEMS LTD. AND ITS SUBSIDIARIES               
|                                                          
|NOTES TO FINANCIAL STATEMENTS                             
|                                                          
|U.S. dollars in thousands, except share and per share data

|             |                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |                                                                                                                                                                                                                                                                                                                                                                                 
|------------ | ---------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 12:    | SHAREHOLDERS EQUITY (Cont.)
|             |                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |                                                                                                                                                                                                                                                                                                                                                                                 
|             |                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     | 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 an increase of 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.                                                                                                                                                  
|             |                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |                                                                                                                                                                                                                                                                                                                                                                                 
|             |                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     | In  May 2004 and in  December  2006,  the Board of
                            Directors and the  shareholders  of the Company  approved the additional  pool
                            of options to purchase an  additional  650,000  and 700,000  Ordinary  shares,
                            respectively, pursuant to the ESOP 2003.                                   
|             |                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |                                                                                                                                                                                                                                                                                                                                                                                 
|             |                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     | As of
  December 31, 2006, 969,600 options are outstanding. All the options have an
  exercise price between $ 1.31 and $ 3.84 per share.                                                                                                                                                                                                                                       
|             |                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |                                                                                                                                                                                                                                                                                                                                                                                 
|             |                              | 4.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  | As of
  December 31, 2006, an aggregate amount of 643,317 options is still available
  for future grant under all of the above mentioned plans.                                                                                                                                                                                                                                 
|             |                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |                                                                                                                                                                                                                                                                                                                                                                                 
|             | c.                           | On December
  30, 2005, the Company decided to accelerate the vesting of 304,830 of its
  unvested stock options previously awarded to employees and officers of the
  Company, to purchase the Companys shares pursuant to one of the Companys
  Stock Option Plans, such that, as of December 31, 2005, these outstanding
  options to purchase any of the Companys Ordinary shares, were fully vested.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|             |                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |                                                                                                                                                                                                                                                                                                                                                                                 
|             |                              | As a result
  of the acceleration, in accordance with FIN 44, the Company recorded
  additional compensation expenses of $ 44, included in general and
  administrative expenses.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|             |                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |                                                                                                                                                                                                                                                                                                                                                                                 
|             |                              | The  Company's  decision to accelerate the vesting
                     of those  options and to grant fully  vested  options  was based  primarily  upon the
                     issuance of SFAS No.  123R,  which will  require  the  Company to treat all  unvested
                     stock  options as  compensation  expense,  effective  January 1,  2006.  The  Company
                     believes  that the  accelerated  vesting of those  options will enable the Company to
                     avoid recognizing  stock-based  compensation expense associated with these options in
                     future  periods.  Additional  purposes  for  the  fully  vested  grant  and  for  the
                     acceleration  were to make the options more  attractive  to  recipients  and to avoid
                     discrimination between groups of option holders, respectively.
|             |                              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |                                                                                                                                                                                                                                                                                                                                                                                 
|             |                              | The impact
  of vesting accelerating on pro forma stock-based compensation required to be
  disclosed in the financial statement footnotes under the provisions of SFAS
  No. 123, was to increase such disclosed compensation cost for the year ended
  December 31, 2005 by approximately $ 568 (see Note 2n).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   

F  30

---

---



|                                                          
|----------------------------------------------------------
|TOP IMAGE SYSTEMS LTD. AND ITS SUBSIDIARIES               
|                                                          
|NOTES TO FINANCIAL STATEMENTS                             
|                                                          
|U.S. dollars in thousands, except share and per share data

|             |                              |                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                              
|------------ | ---------------------------- | ------------------------------------------------------------------------------------------------------------------------------ | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 12:    | SHAREHOLDERS EQUITY (Cont.)
|             |                             
|             | d.                           | Options to
  directors:                                                                                                       
|             |                              |                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                              
|             |                              | 1.                                                                                                                             | 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. In August
  2005, all the options were exercised.
|             |                              |                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                              
|             |                              | 2.                                                                                                                             | On December
  27, 2006, the shareholders of the Company approved the grant of an option to
  purchase 125,000 ordinary shares to several members of the board, at an
  exercise price of $ 3.84 and vesting term of 2 years.                                                                                                                                                 
|             |                              |                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                              
|             |                              | 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                    |   | 2005                                  |      | 2006                |        
|                                                                 |  |                         |   |                                       |      |                     |        
|                                                                 |  | Number of
  options     |   | Weighted
  average
  exercise
  price |      | Number of
  options |         | Weighted
  average
  exercise
  price |   | Number of
  options |  | Weighted
  average
  exercise
  price |   | Aggregate
  intrinsic
  value (in
  thousands) |     
|                                                                 |  |                         |   |                                       |      |                     |         |                                       |   |                     |  |                                       |   |                                                |     
|Outstanding at the beginning of the year                         |  | 417,875                 |   | $                                     | 2.46 |                     | 499,375 |                                       | $ | 2.60                |  | 822,000                               |   | $                                              | 2.65 |  |   |       | 
|Granted                                                          |  | 153,000                 |   | $                                     | 3.08 |                     | 350,000 |                                       | $ | 2.72                |  | 433,600                               |   | $                                              | 3.12 |  |   |       | 
|Exercised                                                        |  | (23,875                 | ) | $                                     | 2.93 |                     | (3,375  | )                                     | $ | 1.66                |  | (67,875                               | ) | $                                              | 1.73 |  |   |       | 
|Forfeited                                                        |  | (47,625                 | ) | $                                     | 2.75 |                     | (24,000 | )                                     | $ | 2.38                |  | (17,000                               | ) | $                                              | 4.86 |  |   |       | 
|                                                                 |  |                         |   |                                       |      |                     |         |                                       |   |                     |  |                                       |   |                                                |      |  |   |       | 
|Outstanding at the end of the year                               |  | 499,375                 |   | $                                     | 2.60 |                     | 822,000 |                                       | $ | 2.65                |  | 1,170,725                             |   | $                                              | 2.85 |  |   |       | 
|                                                                 |  |                         |   |                                       |      |                     |         |                                       |   |                     |  |                                       |   |                                                |      |  |   |       | 
|                                                                 |  |                         |   |                                       |      |                     |         |                                       |   |                     |  |                                       |   |                                                |      |  |   |       | 
|Exercisable at the end of the year                               |  | 260,375                 |   | $                                     | 2.71 |                     | 620,500 |                                       | $ | 2.77                |  | 861,908                               |   | $                                              | 2.71 |  | $ | 1,130 | 
|                                                                 |  |                         |   |                                       |      |                     |         |                                       |   |                     |  |                                       |   |                                                |      |  |   |       | 
|                                                                 |  |                         |   |                                       |      |                     |         |                                       |   |                     |  |                                       |   |                                                |      |  |   |       | 
|Weighted average fair value of options
  granted during the year |  |                         |   | $                                     | 1.93 |                     |         |                                       | $ | 1.84                |  |                                       |   | $                                              | 1.84 |  | $ | 951   | 
|                                                                 |  |                         |   |                                       |      |                     |         |                                       |   |                     |  |                                       |   |                                                |      |  |   |       | 

| |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   | 
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | 
| |  | The  aggregate  intrinsic value in the table above
                     represents the total intrinsic value (the  difference  between the Company's  closing
                     stock  price on the last  trading  day of the fourth  quarter of fiscal  2006 and the
                     exercise  price,  multiplied by the number of  in-the-money  options) that would have
                     been received by the option  holders had all option holders  exercised  their options
                     on  December 31,  2006.  This amount  changes  based on the fair market  value of the
                     Company's  stock.  Total  intrinsic  value of  options  exercised  for the year ended
                     December 31,  2006 was  approximately  $ 116.  As of  December  31,  2006,  there was
                     approximately $ 489 of total  unrecognized  compensation  costs related to non-vested
                     share-based  compensation  arrangements  granted  under the  Company's  stock  option
                     plans.
| |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   | 
| |  | That cost is
  expected to be recognized over a weighted-average period of 1.2 years. Total
  grant-date fair value of vested options for the year ended December 31, 2006
  was approximately $ 243.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            

F  31

---

---



|                                                          
|----------------------------------------------------------
|TOP IMAGE SYSTEMS LTD. AND ITS SUBSIDIARIES               
|                                                          
|NOTES TO FINANCIAL STATEMENTS                             
|                                                          
|U.S. dollars in thousands, except share and per share data

|             |                              |                                                                                                                    | 
|------------ | ---------------------------- | ------------------------------------------------------------------------------------------------------------------ | 
|NOTE 12:    | SHAREHOLDERS EQUITY (Cont.)
|             |                              |                                                                                                                    | 
|             |                              | The options
  outstanding as of December 31, 2006, have been separated into ranges of exercise
  price as follows:

|                            |  |                                                     |  |                                                             |  |                                       |      |                                                     |         |                                                                  |   |      | 
|--------------------------- |  | --------------------------------------------------- |  | ----------------------------------------------------------- |  | ------------------------------------- | ---- | --------------------------------------------------- | ------- | ---------------------------------------------------------------- | - | ---- | 
|Range of
  exercise
  price |  | Options
  Outstanding
  as of
  December 31,
  2006 |  | Weighted
  average
  remaining
  contractual
  life (years) |  | Weighted
  average
  exercise
  price |      | Options
  exercisable
  as of
  December 31,
  2006 |         | Weighted
  average
  exercise
  price of
  options
  exercisable |  
|                            |  |                                                     |  |                                                             |  |                                       |      |                                                     |         |                                                                  |  
|                            |  |                                                     |  |                                                             |  |                                       |      |                                                     |         |                                                                  |   |      | 
|$0.99 - $1.46               |  | 93,500                                              |  | 5.61                                                        |  | $                                     | 1.33 |                                                     | 93,500  |                                                                  | $ | 1.33 | 
|$2.08 - $2.92               |  | 807,225                                             |  | 8.25                                                        |  | $                                     | 2.75 |                                                     | 623,408 |                                                                  | $ | 2.73 | 
|$3.27 - $4.13               |  | 270,000                                             |  | 5.11                                                        |  | $                                     | 3.68 |                                                     | 145,000 |                                                                  | $ | 3.54 | 
|                            |  |                                                     |  |                                                             |  |                                       |      |                                                     |         |                                                                  |   |      | 
|                            |  |                                                     |  |                                                             |  |                                       |      |                                                     |         |                                                                  |   |      | 
|                            |  | 1,170,725                                           |  | 7.32                                                        |  | $                                     | 2.85 |                                                     | 861,908 |                                                                  | $ | 2.71 | 
|                            |  |                                                     |  |                                                             |  |                                       |      |                                                     |         |                                                                  |   |      | 

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                  | 
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | 
| | e. | Share
  purchase agreement:                                                                                                                                                                                                                                                                                                                                                                                                     
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                  | 
| |    | In
  consideration of the purchase of 990,000 of E - Mobilis shares (subsidiary of
  the Company, which is inactive), 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. During
  2003, 15,000 options were exercised and the remaining 85,000 options were exercised
  during 2004.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | f. | 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.                                                                                                                                                                                                                                                                                                                                                   

F  32

---

---



|                                                          
|----------------------------------------------------------
|TOP IMAGE SYSTEMS LTD. AND ITS SUBSIDIARIES               
|                                                          
|NOTES TO FINANCIAL STATEMENTS                             
|                                                          
|U.S. dollars in thousands, except share and per share data

|             |                         
|------------ | ------------------------
|NOTE 13:    | GEOGRAPHICAL INFORMATION

| |    |                                                                                                                                                                                                                                                                                                                                  
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a. | Business
  segment, geographical areas and foreign operations:                                                                                                                                                                                                                                                                   
| |    |                                                                                                                                                                                                                                                                                                                                  
| |    | The Company
  manages its business on the basis of one reportable segment (see Note 1 for a
  brief description of the Companys business). The Companys business is
  divided into the geographic areas regions as described bellow. Total revenues are attributed to
  geographic areas based on the location of the customer.
| |    |                                                                                                                                                                                                                                                                                                                                  
| | b. | Geographic information:                                                                                                                                                                                                                                                                                                          

| |                                                                      |  |                         |        |      |   |        |   |   |        | 
| | -------------------------------------------------------------------- |  | ----------------------- | ------ | ---- | - | ------ | - | - | ------ | 
| |                                                                      |  | Year ended December 31, |       
| |                                                                      |  |                         |       
| |                                                                      |  | 2004                    |        | 2005 |   | 2006   |  
| |                                                                      |  |                         |        |      |   |        |  
| | Product sales:                                                       |  |                         |        |      |   |        |   |   |        | 
| | Israel                                                               |  | $                       | 142    |      | $ | 60     |   | $ | 69     | 
| | Far East (excluding Japan)                                           |  |                         | 598    |      |   | 2,020  |   |   | 1,844  | 
| | Europe                                                               |  |                         | 5,356  |      |   | 5,604  |   |   | 6,711  | 
| | North and south America                                              |  |                         | 607    |      |   | 944    |   |   | 1,191  | 
| | Africa                                                               |  |                         | 166    |      |   | 512    |   |   | 461    | 
| | Japan                                                                |  |                         | 95     |      |   | 748    |   |   | 1,868  | 
| |                                                                      |  |                         |        |      |   |        |   |   |        | 
| |                                                                      |  |                         |        |      |   |        |   |   |        | 
| |                                                                      |  |                         | 6,964  |      |   | 9,888  |   |   | 12,144 | 
| |                                                                      |  |                         |        |      |   |        |   |   |        | 
| | Service revenues:                                                    |  |                         |        |      |   |        |   |   |        | 
| | Israel                                                               |  |                         | 42     |      |   | 78     |   |   | 5      | 
| | Far East (excluding Japan)                                           |  |                         | 326    |      |   | 375    |   |   | 598    | 
| | Europe                                                               |  |                         | 2,610  |      |   | 3,396  |   |   | 4,675  | 
| | North and south America                                              |  |                         | 647    |      |   | 883    |   |   | 962    | 
| | Africa and Middle East
  (excluding Israel)                          |  |                         | 14     |      |   | 53     |   |   | 75     | 
| | Japan                                                                |  |                         | 575    |      |   | 2,147  |   |   | 1,765  | 
| |                                                                      |  |                         |        |      |   |        |   |   |        | 
| |                                                                      |  |                         |        |      |   |        |   |   |        | 
| |                                                                      |  |                         | 4,214  |      |   | 6,932  |   |   | 8,080  | 
| |                                                                      |  |                         |        |      |   |        |   |   |        | 
| |                                                                      |  |                         |        |      |   |        |   |   |        | 
| | Total revenues                                                       |  | $                       | 11,178 |      | $ | 16,820 |   | $ | 20,224 | 
| |                                                                      |  |                         |        |      |   |        |   |   |        | 
| |                                                                      |  |                         |        |      |   |        |   |   |        | 
| | Sales to single customers
  exceeding 10% of revenues:               |  |                         |        |      |   |        |   |   |        | 
| | Customer A                                                           |  |                         | 10     | %    |   | *)  -  |   |   | *)  -  | 
| |                                                                      |  |                         |        |      |   |        |   |   |        | 
| |                                                                      |  |                         |        |      |   |        |   |   |        | 
| | Customer B                                                           |  |                         | *)  -  |      |   | 10     | % |   | *)  -  | 
| |                                                                      |  |                         |        |      |   |        |   |   |        | 
|
| | *) Less than 10%                                                     |  |                         |        |      |   |        |   |   |        | 
|
| | The
  Companys substantial long-lived assets are located in Israel. |  |                         |        |      |   |       

F  33

---

---



|                                                          
|----------------------------------------------------------
|TOP IMAGE SYSTEMS LTD. AND ITS SUBSIDIARIES               
|                                                          
|NOTES TO FINANCIAL STATEMENTS                             
|                                                          
|U.S. dollars in thousands, except share and per share data

|             |                                                
|------------ | -----------------------------------------------
|NOTE 14:    | BASIC AND DILUTED NET EARNINGS (LOSS) PER SHARE

The following
table sets forth the computation of basic and diluted net earnings (loss) per
share:

| |                                                                                                   |  |                           |           |      |   |           |   |   |           | 
| | ------------------------------------------------------------------------------------------------- |  | ------------------------- | --------- | ---- | - | --------- | - | - | --------- | 
| |                                                                                                   |  | Year ended
  December 31, |          
| |                                                                                                   |  |                           |          
| |                                                                                                   |  | 2004                      |           | 2005 |   | 2006      |  
| |                                                                                                   |  |                           |           |      |   |           |  
| | Numerator for basic net earnings (loss)
  per share - net income (loss) available to shareholders |  | $                         | (168      | )    | $ | (461      | ) | $ | 801       | 
| |                                                                                                   |  |                           |           |      |   |           |   |   |           | 
| |                                                                                                   |  |                           |           |      |   |           |   |   |           | 
| | Interest expenses on convertible
  debentures                                                     |  |                           | -         |      |   | -         |   |   | 8         | 
| |                                                                                                   |  |                           |           |      |   |           |   |   |           | 
| |                                                                                                   |  |                           |           |      |   |           |   |   |           | 
| | Net income used for the computation of
  diluted net earnings (loss) per share                    |  | $                         | (168      | )    | $ | (461      | ) | $ | 809       | 
| |                                                                                                   |  |                           |           |      |   |           |   |   |           | 
| |                                                                                                   |  |                           |           |      |   |           |   |   |           | 
| | Weighted average Ordinary shares
  outstanding                                                    |  |                           | 6,905,559 |      |   | 8,764,222 |   |   | 8,819,857 | 
| |                                                                                                   |  |                           |           |      |   |           |   |   |           | 
| | Effect of dilutive securities:                                                                    |  |                           |           |      |   |           |   |   |           | 
| |                                                                                                   |  |                           |           |      |   |           |   |   |           | 
| | Employees stock options                                                                           |  |                           | *)  -     |      |   | *)  -     |   |   | 178,823   | 
| |                                                                                                   |  |                           |           |      |   |           |   |   |           | 
| | Convertible debentures                                                                            |  |                           | -         |      |   | -         |   |   | 33,674    | 
| |                                                                                                   |  |                           |           |      |   |           |   |   |           | 
| |                                                                                                   |  |                           |           |      |   |           |   |   |           | 
| |                                                                                                   |  |                           | -         |      |   | -         |   |   | 212,497   | 
| |                                                                                                   |  |                           |           |      |   |           |   |   |           | 
| |                                                                                                   |  |                           |           |      |   |           |   |   |           | 
| | Diluted weighted average Ordinary
  shares outstanding                                            |  |                           | 6,905,559 |      |   | 8,764,222 |   |   | 9,032,354 | 
| |                                                                                                   |  |                           |           |      |   |           |   |   |           | 
| |                                                                                                   |  |                           |           |      |   |           |   |   |           | 
| | Basic and diluted net earnings (loss)
  per share                                                 |  | $                         | (0.02     | )    | $ | (0.05     | ) | $ | 0.09      | 
| |                                                                                                   |  |                           |           |      |   |           |   |   |           | 

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

|             |                                 
|------------ | --------------------------------
|NOTE 15:    | FINANCIAL INCOME (EXPENSES), NET

| |                                            |  |                           |     |      |   |         |   |   |     | 
| | ------------------------------------------ |  | ------------------------- | --- | ---- | - | ------- | - | - | --- | 
| |                                            |  | Year ended
  December 31, |    
| |                                            |  |                           |    
| |                                            |  | 2004                      |     | 2005 |   | 2006    |  
| |                                            |  |                           |     |      |   |         |  
|
| | Interest income, net                       |  | $                         | 84  |      | $ | 140     |   | $ | 193 | 
| | Exchange rate gain (loss) and bank charges |  |                           | 93  |      |   | *) (326 | ) |   | 38  | 
| | Gain from marketable securities            |  |                           | 1   |      |   | 40      |   |   | 94  | 
| |                                            |  |                           |     |      |   |         |   |   |     | 
| |                                            |  |                           |     |      |   |         |   |   |     | 
| |                                            |  | $                         | 178 |      | $ | (146    | ) | $ | 325 | 
| |                                            |  |                           |     |      |   |         |   |   |     | 

| |    |                                                                                                                                                    
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------
| | *) | Includes
  income (expense) from forward transactions in the amount of $ 109 and $ (61)
  for the year end December 31, 2005 and 2006 respectively.

F  34

---

---



|                                                          
|----------------------------------------------------------
|TOP IMAGE SYSTEMS LTD. AND ITS SUBSIDIARIES               
|                                                          
|NOTES TO FINANCIAL STATEMENTS                             
|                                                          
|U.S. dollars in thousands, except share and per share data

|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|------------ | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 16:    | RELATED PARTY TRANSACTION                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|             | Based on a
  resolution of the shareholders of the Company, one of its directors was
  entitled to an amount of $ 254 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 in 2004) and amount of $114 and $ 102 for
  consulting fees related to other business development affairs in 2005 and
  2006 respectively. In addition, during 2005 and 2006, the director received
  $6 for his service as a Board member in each year.



---

F  35

---

---