---

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

# FORM 20-F

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

| | OR | 
| | -- | 

|x | ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
the fiscal year ended December 31, 2005 | 
|- | ---------------------------------------------------------------------------------------------------------------------------- | 

| | OR | 
| | -- | 

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

| | OR | 
| | -- | 

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

# Commission File Number
001-14552

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Top Image Systems Ltd.(Exact name of Registrant as specified in its charter)

Israel (Jurisdiction of incorporation or organization)

---

2 Habarzel Street,
Ramat Hahayel, Tel Aviv 69710, Israel(Address of principal executive offices)

---

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

|Title of each class | Name of each exchange onwhich registered
|------------------- | ----------------------------------------
|                    |                                         
|None                | None                                    

Securities registered or to be registered pursuant to Section 12(g) of the Act:Ordinary Shares, nominal value NIS 0.04 per share

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



---

---



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

________ 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



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# 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                                                | 9   
|         | ITEM 5.   | OPERATING AND FINANCIAL REVIEW AND PROSPECTS                                 | 21  
|         | ITEM 6.   | DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES                                   | 31  
|         | ITEM 7.   | MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS                            | 38  
|         | ITEM 8.   | FINANCIAL INFORMATION                                                        | 39  
|         | ITEM 9.   | LISTING                                                                      | 39  
|         | ITEM 10.  | ADDITIONAL INFORMATION                                                       | 41  
|         | ITEM 11.  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                   | 55  
|         | ITEM 12.  | DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES                       | 55  
|PART II  |           |                                                                              | 55  
|         | ITEM 13.  | DEFAULTS, DIVIDENDS, ARREARAGES AND DELINQUENCIES                            | 55  
|         | ITEM 14.  | MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS | 55  
|         | ITEM 15.  | CONTROLS AND PROCEDURES                                                      | 56  
|         | ITEM 16A. | AUDIT COMMITTEE FINANCIAL EXPERT                                             | 56  
|         | ITEM 16B. | CODE OF ETHICS                                                               | 56  
|         | ITEM 16C. | PRINCIPAL ACCOUNTANT FEE AND SERVICES                                        | 56  
|         | ITEM 16D. | EXEMPTIONS FROM THE LISTING STANDARDS OF AUDIT COMMITTEES                    | 57  
|         | ITEM 16E. | PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS       | 57  
|PART III |           |                                                                              | 57  
|         | ITEM 17.  | FINANCIAL STATEMENTS                                                         | 57  
|         | ITEM 18.  | FINANCIAL STATEMENTS                                                         | 57  
|         | ITEM 19.  | EXHIBITS                                                                     | 58  

-i-

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# Forward-Looking
Statements

Certain
matters discussed in this report on Form 20-F are forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995. 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 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,
|-------------------------------------- | -----------------------
|
|
|
|
|Statement of Operations Data:          |                        
|Revenues                               |                        
|Cost of revenues                       |                        
|Gross profit                           |                        
|Research and development, net          |                        
|Selling, administrative and general    |                        
|Financial expense (income), net        |                        
|Other (income) expense                 |                        
|Tax on income                          |                        
|Net loss                               |                        
|Net basic and dilutive loss per share  |                        
|Weighted average number of shares      |                        
|outstanding for basic and dilutive net |                        
|loss per share                         |                        



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|                               | As of December 31,
|------------------------------ | ------------------
|
|
|
|
|Summary of Balance Sheet Data: |                   
|Cash and cash equivalents      |                   
|Working capital                |                   
|Total Assets                   |                   
|Long Term debt                 |                   
|Total liabilities              |                   
|Shareholders' equity           |                   

# 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.
| | - | -----------------------

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.

- 2 -

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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 and 1998, and our losses may continue. For the year ended December 31, 2005, we had a
net loss of $461,000, and accumulated deficit of $15,440,000. 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
| | - | ----------------------------------------------------

| |  | 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.

- 3 -

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

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

Large customers
constitute a significant portion of our orders.

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% and 17% of our sales in 2004 and 2003,
respectively. 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). We believe that there are legal grounds for the patent to be revoked or
substantially limited and are vigorously pursuing such ends. In May 2004, we filed a
Notice of Opposition with the European Patent Office requesting that the patent be revoked
in its entirety. However, there is no assurance that our efforts will be successful.
Although we do not believe that any of our products would infringe upon this patent, there
is some risk that if the patent remains intact, ReadSoft may at some point in the future
allege that we infringe on the patent, requiring us to dedicate time and resources to
defend our intellectual property rights, which could impact our financial results. If
ReadSoft were to prevail in such a claim, there could be a material adverse effect on our
business, prospects and financial condition.

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.

- 4 -

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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.

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:

- 5 -

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| |  | 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. 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 condition,
including our ability to develop, manufacture and market our products.

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

Some
of our executive officers and employees in Israel are obligated to perform up to 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.

- 6 -

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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. 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.

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.

- 7 -

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

In
the past, we have received grants from the government of Israel through the Office of the
Chief Scientist of the Ministry of Industry and Trade, or the OCS, for the financing of a
portion of our research and development expenditures in Israel. The Israeli government has
reduced the benefits available under this program in recent years and may decide not to
continue the program in the future at its current level or to terminate it altogether. The
terms of the OCS grants limit our ability to develop products and transfer technologies
outside of Israel without the prior approval of the OCS, if such products or technologies
were developed using OCS grants. Such approval, if granted, will generally be subject to
additional financial obligations. In addition, if we fail to comply with any of the
conditions imposed by the OCS, including the payment of royalties with respect to grants
received, we may be required to refund any payments previously received from the OCS,
together with interest and penalties. See also 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. The benefits
available to an Approved Enterprise program are dependent upon the continuing fulfillment
of ongoing conditions stipulated under applicable law and in the certificate of approval.
If we fail to comply with these conditions, in whole or in part, benefits from tax
exemptions or reduced tax rates would likely be denied to our shareholders or us in the
future.

On
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, 2005, we did not generate
income subject to the provisions of the new law.

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.

- 8 -

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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. 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.

We do not intend to pay
dividends

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

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

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

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

# History and Development

We
were incorporated 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).

- 9 -

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General

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

Products

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

Based
on a single, integrated environment, the 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.

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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.

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 Smartinclude 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.

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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.

AFPSPro

AFPSPro
had been our flagship product until the introduction of the eFLOW Unified
ContentPlatform. 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, 2005, 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.
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,
|------------------------------ | -----------------------
|
|
|
|
|Europe                         |                        
|Far East (excluding Japan)     |                        
|South America                  |                        
|Africa                         |                        
|North America                  |                        
|Israel                         |                        
|Middle East (excluding Israel) |                        
|Japan                          |                        
|Other                          |                        
|                               |                        
|Total                          |                        
|                               |                        

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

|                               | Year Ended December 31,
|------------------------------ | -----------------------
|
|
|
|
|Europe                         |                        
|North America                  |                        
|Far East (excluding Japan)     |                        
|Africa                         |                        
|Japan                          |                        
|Israel                         |                        
|South America                  |                        
|Middle East (excluding Israel) |                        
|Other                          |                        
|                               |                        
|Total                          |                        
|                               |                        

Seasonality

Our
business significantly depends upon the requirements of large corporations and
governmental agencies. Because many of these entities operate according to annual budgets,
their tendency is to approve budgets in the beginning of the fiscal year and release the
budgets toward the end of the fiscal year. This mode of operation affects our results of
operations throughout the year. 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, or OEMs, generally have better access to
end-users in their respective markets than we do. By engaging value-added resellers,
distributors, systems integrators and potentially, OEMs, to include our products as part
of their products and service offerings, we can sell products to end-users without the
costs of directly marketing to end-users. However, working through channels instead of
engaging in direct sales to customers limits our share in each transactions
revenues.

It
is essential while working in remote territories to provide an efficient platform for
marketing 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.

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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
February 2006, we teamed up with Asiasoft, a regional business consultancy and technology
service powerhouse in Asia Pacific. 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 TIS solutions to this market.

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 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. 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. eFLOW
Ability offers a complete SAP-oriented business workflow and an accounts payable
document processing, approval, and validation solution. It provides an integrated module
interfacing with SAP systems for automated parking, approval and posting of invoices and
any other document within SAP systems.

In
September 2005, we signed a European-wide partnership agreement with Xerox, a global
leader in document management services. TIS and Xerox have been working successfully
together for the last 8 years on projects in France, Germany and Latin America and are now
to extend 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

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 3.0integrates with any enterprise information system,
including SAP, Oracle and others. See also Research and Development, Patents and
Licenses, etc. in Item 5 herein.

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

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

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

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

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

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

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

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

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

Licensed
Technology

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

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Intellectual
Property Rights

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

| |  | any
patents which we may obtain will be broad enough to protect our technology, will provide
us with competitive advantages or will escape challenge or invalidation by third parties;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the
patents of others will not have an adverse effect on our ability to do business; or
| | - | ---------------------------------------------------------------------------------------

| |  | others
will not independently develop similar products, duplicate our products or, if patents
are issued to us, design around these patents.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------

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

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

ReadSoft,
one of our competitors, filed a patent application entitled Method and arrangement
for Automatic Data Acquisition of Forms. The patent was granted on August 13, 2003
(EP 0976092). We believe that there are legal grounds for the patent to be revoked or
substantially limited and are vigorously pursuing such ends. In May 2004, we filed a
Notice of Opposition with the European Patent Office requesting that the patent be revoked
in its entirety. However, there is no assurance that our efforts will be successful.
Although we do not believe that any of our products would infringe upon this patent, there
is some risk that if the patent remains intact, ReadSoft may at some point in the future
allege that we infringe on the patent, requiring us to dedicate time and resources to
defend our intellectual property rights, which could impact our financial results. If
ReadSoft were to prevail in such a claim, there could be a material adverse effect on our
business, prospects and financial condition.

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

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

| |  | 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.

- 17 -

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

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

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

Customers

Our
customers consist of both governmental and other enterprises.

During
2005, we 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. We created and
installed systems for complicated semi-structured applications, including 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: Prodata, one of the
primary service bureaus in Germany; AZ Direct, a leading force in direct marketing in
Europe and a subsidiary of Arvato Direct Services, part of the media giant Bertelsmann AG;
Vengroff, Williams & Associates, Inc. (VWA), a global leader in the receivables
management industry; AIMS Logistics, one of the largest freight payment and transportation
service companies in the USA; HEFAME, a Spanish cooperative society that distributes
specialties and pharmaceutical accessories to pharmacies; a major global research-driven
pharmaceutical company that was aiming to standardize its invoice circulation, review and
approval, as well as create a uniform approach to face future business needs; Armstrong, a
US-based global leader in the design and manufacture of floors, ceiling and cabinets; and
the largest utility company in the Netherlands.

In
addition, the U.S. Social Security Administration (SSA) expanded its use of eFLOW
solution to streamline process of healthcare claims and monetary application forms; Ten
new customers and partners in Singapore have choseneFLOW to
streamline their accounts payable, accounts receivable, letters, forms and other
documents. Among these customers are Singapore Airline, Singapore tax department (IRAS)
and Singapore General Hospital. Fifteen existing customers in Japan decided to upgrade
their solution to eFLOW Version 3.0; and the Australian Department of Defence chose
to upgrade its system to eFLOW Version 3 and subsequently signed a five-year
strategic agreement with us to extend the system to provide the capability to use the
technology within other functions of the Department including its human resources,
personal files, and medical record applications as well as additional AP functions.

- 18 -

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Smart,
the automatic classification module introduced in eFLOW Version 3.0, is already
running productively in several projects. For example, it was chosen by SNT Deutschland AG
as a mailroom solution to classify and route the entire flow of incoming information. SNT
Deutschland AG is a customer relationship management, or CRM, service provider whose
customers include large insurance companies, various top brands in consumer products,
banks, IT and telecom companies.

Recall,
one of the worlds largest archive bureaus for physical documents, has chosen
Smart to sort and dispatch all incoming information in its Italian operations. In
Recall Italy, Smart now 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 Recalls back-end enterprise systems.

In
addition, we further strengthened our position in the automated data collection for
national population census projects when we were selected as the information collection
solution for the 2006 Irish Census. On this project, we cooperated with our long-time
partner, CACI.

Other
market solutions provided by us include integrated systems for complicated semi-structured
applications, including automating the capture and process of data from hundreds of
different customer coupons for Editions Atlas, a European leader in mail-order catalogues.
Discovery, the third largest insurance company in South Africa, selected eFLOW to
serve as the crucial input management point to an existing workflow system.

Warranty
and Service

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

We
may be exposed to potential product liability claims by our customers and users of our
products. Currently, we hold a worldwide product liability insurance policy that provides
coverage limited to $5,000,000 in aggregate for the policy period ending on September 30,
2006. Despite this coverage, a successful claim against us for product liability could
have a material adverse effect on our financial condition. While we have not experienced
material warranty liability in the past, we cannot assure you that future warranty expense
will not have an adverse effect on us.

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

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

# Governmental Regulation

The
government of Israel encourages research and development projects oriented towards
products for export through its Office of the Chief Scientist Office, or OCS, pursuant to
the Law for the Encouragement of Industrial Research and Development, 1984, commonly
referred to as the Research Law. In exchange for assistance provided by the
Israeli government in connection with research and development cost, we are committed to
pay to the Israeli government royalties at the rate of 2% to 3.5% of revenues from sale of
our FormOut! and eFLOW software, up to a maximum of 150% of the
amount of participation received, linked to the U.S. dollar plus interest at the LIBOR
rate. Our total outstanding obligation in respect of royalty-bearing government
participation received or accrued, net of royalties paid or accrued, amounted to $66,510
as of December 31, 2005.

- 19 -

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

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

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

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

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

# Organizational Structure

We
currently have four operating subsidiaries. In August 1991, we established TIS America,
Inc. to provide sales, marketing and technical support to our customers. TIS America is
incorporated under the laws of Delaware and is a wholly owned subsidiary of TIS. In
January 2000, we, together with others, established e-Mobilis. e-Mobilis was incorporated
in Israel, and we initially held 80.2% of its issued shares. During 2001, we acquired the
remaining 19.8% interest in e-Mobilis, and e-Mobilis operations were integrated into
ours. 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, TIS 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. Our
subsidiary in Germany leases approximately 241 square meters of office space in Cologne,
Germany for a monthly sum of $7,000 and our UK subsidiary leases approximately 35 square
meters of office space in Uxbridge for the amount of $5,500 per month. We also lease
approximately 250 square meters of office space in Tokyo, Japan for approximately $11,000
per month pursuant to a lease expiring in 2006. All other lease agreements other than for
our Israeli headquarters will either expire or will be terminated during 2006.

- 20 -

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

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

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

General

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

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

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

As
a result of our strategy of pursuing strategic alliances with value-added resellers,
distributors and system integrators, a substantial portion of our revenues is derived from
such alliances. During the years ended December 31, 2003, 2004, and 2005, revenues
deriving from value-added resellers, distributors and system integrators accounted for
approximately 51%, 28%, and 46%, respectively, of our revenues. The decline during 2004
was mainly because of our direct sales to a major customer in Europe.

Historically,
we have recognized a majority of our revenues from product sales. During the years ended
December 31, 2003, 2004, and 2005, product revenues accounted for approximately 75%, 62%
and 59%, respectively, of revenues, while service revenues accounted for approximately
25%, 38% and 41%, respectively, of revenues. During 2004, we stopped marketing our
AFPSPro product. In 2005, sales of eFLOW accounted for 95% of
our product sales and for approximately 60% of our revenue.

Seasonality

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.

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Geographical
Considerations

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

Total Revenues by Region
(U.S. dollars in thousands)

|                               | Year Ended December 31,
|------------------------------ | -----------------------
|
|
|
|
|Europe                         |                        
|                               |                        
|North America                  |                        
|                               |                        
|Far East (excluding Japan)     |                        
|                               |                        
|Africa                         |                        
|                               |                        
|Japan                          |                        
|                               |                        
|Israel                         |                        
|                               |                        
|South America                  |                        
|                               |                        
|Middle East (excluding Israel) |                        
|                               |                        
|Other                          |                        
|                               |                        
|Total                          |                        
|                               |                        

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

Critical
Accounting Policies and Estimates

Our consolidated
financial statements have been prepared in accordance with generally accepted accounting
principles in 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.

Revenue
Recognition

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

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

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We
allocate revenue from software arrangements involving multiple elements to each element
based on the relative fair values of the elements. The determination of fair value of each
element in multiple element arrangements is based on the price charged when a similar
element is sold separately and creates vendor specific objective evidence
(VSOE). 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.

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

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

Our
criteria for revenue recognition are as follows:

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

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

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

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

License
revenues from reseller arrangements are recognized upon delivery unless payment is
dependent on third-party collection by the reseller. During the years ended December 31,
2003, 2004 and 2005, we had no arrangements in which payment terms were dependent on
third-party collection by the reseller.

When
services are considered essential, revenue under the arrangement is recognized using
contract accounting according to SOP 81-1. When consulting services are not considered
essential, the revenue allocable to the consulting services is recognized as the services
are performed or when acceptance is received, if required by the agreement.

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

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

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, 2005
is determined as a specific amount for those accounts the collection of which is
uncertain. We regularly review the allowance by considering factors such as historical
experience, credit quality, age of the accounts receivable balances, and current economic
conditions that may affect a customers ability to pay. If a major customers
creditworthiness deteriorates, or if actual defaults are higher than our historical
experience, or if other circumstances arise, our estimates of the recoverability of
amounts due to us could be overstated, and additional allowances could be required, which
could have an adverse impact on our results of operations.

Goodwill
and other intangible assets

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

Government
Grants

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

Research
and Development Costs

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

Loss
Contingencies

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

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# Recently Enacted
Accounting Pronouncements

On
December 16, 2004, the Financial Accounting Standards Board (FASB) issued SFAS
No. 123(R), Share-Base Payment (SFAS 123(R)) which revises the
previously effective SFAS No. 123 and supersedes APB No. 25. SFAS 123(R) requires all
share-based payments to employees, including grants of employee stock options, to be
recognized in the financial statements based upon their fair values, beginning with the
first interim or annual period after December 15, 2005, with early adoption encouraged.

We
have the option to choose either the modified prospective or modified retrospective
method. We expect to adopt SFAS 123(R) in the first quarter of 2006, using the modified
prospective method of adoption which requires that compensation expense be recorded over
the expected remaining life of all unvested stock options and for any new grants thereof
at the beginning of the first quarter of adoption of SFAS 123(R).

Had
we adopted SFAS 123(R) in prior periods, the impact of that statement would have
approximated the impact of SFAS 123 as described in the disclosure of pro forma net loss
and net loss per share in Note 13 to the consolidated financial statements.

In
March 2005, the SEC released SEC Staff  Accounting  Bulletin No. 107,  "Share-Based  Payment" ("SAB
107").  SAB 107  provides  the SEC staff's  position  regarding  the  application  of SFAS 123(R) and  contains
interpretive  guidance  related to the interaction  between SFAS 123(R) and certain SEC rules and  regulations,
and also  provides the SEC staff's  views  regarding  the valuation of  share-based  payment  arrangements  for
public  companies.  SAB 107  highlights  the  importance of  disclosures  made relating to the  accounting  for
share-based payment transactions.

In
May 2005, the FASB issued Statement of Financial Accounting Standard No. 154 (SFAS
154), Accounting Changes and Error Corrections, a replacement of APB No.
20, Accounting Changes and SFAS No. 3, Reporting Accounting Changes in
Interim Financial Statements. SFAS 154 provides guidance on the accounting for and
reporting of accounting changes and error corrections. APB No. 20 previously required that
most voluntary changes in accounting principles be recognized by including in net income
for the period of the change the cumulative effect of changing to the new accounting
principle. SFAS 154 requires retroactive application to prior periods financial
statements of a voluntary change in accounting principles unless it is impracticable. SFAS
154 is effective for accounting changes and corrections of errors made in fiscal years
beginning after December 15, 2005.

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, 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.

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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, liquidation damages in the amount of $164,000 which we had to pay as
part of our registration commitment to the investors in the private placement of September
2004 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 $178,000 in year ended December 31, 2004.

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

Revenues.
          Total revenues for the year ended December 31, 2004 amounted to $11,178,000
          compared to $8,319,000 for the year ended December 31, 2003, an increase of
34%.           Product sales increased by $754,000 or 12%, from $6,211,000 in 2003 to
          $6,964,000 in 2004, mainly because, of an increase in product sales in Germany.
          Service revenues increased by $2,106,000 or approximately 100%, from $2,108,000
          in the year ended December 31, 2003 to $4,214,000 in the year ended December
31,           2004. This significant increase is attributable mainly to services
performed for           a major customer during 2004 and due to our continued focus on
providing           comprehensive support to our customers document management
environment.

Cost
of Revenues. Cost of revenues increased $1,132,000 or 48% from $2,340,000 in the year
ended December 31, 2003 to $3,472,000 in the year ended December 31, 2004. The increase is
a result of growth in demand for our products and services, which required us to allocate
and invest more resources to meet such demand.

Research
and Development. During 2004, we continued to focus efforts in enhancing our software
recognition and core capabilities. Research and development expenses in the year ended
December 31, 2004 amounted to $929,000 compared to $863,000 for the year ended December
31, 2003.

Selling,
General and Administrative Expenses. Selling, general and administrative expenses in
the year ended December 31, 2004 amounted to $7,123,000 compared to $5,819,000 for the
year ended December 31, 2003. This increase of $1,304,000 or 22% is mainly attributable to
the expansion our sales force and establishing roots for major sales centers in several
locations worldwide.

Financing
Income, net. Financing income for the year ended December 31, 2004 amounted to
$178,000 compared to financing income of $109,000 for year ended December 31, 2003. The
increase in financing income was primarily due to an increase of exchange gain in 2004,
which is a product of the strengthening of the Euro and British Pound against the U.S.
Dollar.

Net
Loss. As a result of the foregoing, our net loss for the year ended December 31, 2004
was $168,000 compared to a net loss of $594,000 in year ended December 31, 2003.

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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.

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 1.9%, 1.21% and 2.4%
in 2003, 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 for 2003 of 1.9% exceeded
the devaluation of the dollar against the NIS, which amounted to 7.56%. The increase in
the dollar cost of our operations in Israel relates primarily to the costs of salaries in
Israel, which constitute a 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 assets of the Company, which consist of receivables payable in NIS (unless such
receivables are linked to the dollar). Such a devaluation would also have the effect of
reducing the dollar amount of our liabilities which are payable in NIS (unless such
payables are linked to the dollar). Conversely, any increase in the value of the NIS in
relation to the dollar will have the effect of increasing the dollar value of any unlinked
NIS assets of the Company and the dollar amounts of any unlinked NIS liabilities of the
Company.

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. 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.

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

Trade
Relations

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

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

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.

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. We also anticipate that the need for applications will increase substantially.
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.

Liquidity
and Capital Resources

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 $424,000 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 reflects our increased sales in 2005.
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. Trade and other payables and accrued expenses increased by
$779,000 due to an increase in our operations and provisions with regard to software
components which were sold in the fourth quarter.

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For
the year ended December 31, 2005, the aggregate amount of our capital expenditures was
$164,000. These expenditures were principally for the purchases of computer hardware and
software and facilities improvements.

Cash
used in operating activities in 2004 was $1,074,000, compared to cash used in operating
activities in 2003 of $2,516,000. During 2004, our trade payables and other expenses
decreased by $83,000, and our accounts receivable increased by $935,000. The increase in
our accounts receivable reflects both increase in our sales and transactions, which were
made under the previous payment terms policy. The decrease in our accrued liabilities and
other payables is mainly attributable to payments for liquidated damages related to the
private placement. Cash used in investing activities in 2004 was $2,240,000, mainly
because of the establishment of TISJ, compared to cash provided from investing activities
in 2003 of $185,000. Cash provided by financing activities in 2004 was $7,595,000 as a
result of the private placement, compared to cash provided by financing activities in 2003
of $785,000.

Private
Placement

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

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

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.

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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, 2005, we had approximately
$2,179,000 outstanding after extension of additional credit from the bank. The revolving
line of credit in NIS bears interest at a rate of prime + 1% (as of December 31, 2005, the
prime rate was 7%). The line of credit in US dollars bears interest at a rate of Libor +
2% (as of December 31, 2005, the Libor rate was 4.375%). Any indebtedness under this
credit line is payable on demand and secured by a floating charge on our assets. Our
ability to issue securities is restricted. In the event that we default under the line of
credit, the bank could declare our indebtedness immediately due and payable and, if we are
unable to make the required payments, foreclose on our assets. Moreover, to the extent
that our assets continue to secure such indebtedness, such assets will not be available to
secure additional indebtedness unless approved by the Bank.

Contractual
Obligations and Commitments

The
following is a summary of our contractual obligations as of December 31, 2005:

|Contractual Obligation     | Total | Less Than 1Year | 2 Years | 3 Years and more
|-------------------------- | ----- | --------------- | ------- | ----------------
|
|
|
|
|Operating Lease Obligation |       |                 |         | 706,000         
|Purchase Obligation        |       |                 |         | 300,000         

We
also have a long-term liability on our balance sheet as of December 31, 2005 in the amount
of $196,000 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, 2005 principally include
obligations associated with our outstanding indebtedness, future minimum operating lease
obligations, a right to use a third party software (see below) and contractual and legal
obligations to employees and officers severance expense. Such obligations are
detailed in Notes 9 to the consolidated financial statements for the year ended December
31, 2005 as well as the section entitled Compensation herein. We expect to
finance these contractual commitments from cash on hand and cash generated from
operations.

We
entered into an engagement under which we have to the right to use third party software
during fiscal years 2005 and 2006. Pursuant to the agreement, we agreed to pay an annual
license fee equal to the greater of $ 300,000 and 2.75% of related sales. The amount is
due in four equal quarterly payments for each year.

# Research and
Development, Patents and Licenses, etc.

During
2005, our Research and Development efforts were focused mainly on enhancing our product
offerings and extending their capabilities. Such efforts included development of new
products for dealing with processing of unstructured information, such as Smart,
and refinements of our products, such as improvements in image enhancement, automatic
forms recognition, automatic forms removal, machine print and handwritten character
recognition, as well as special purpose algorithms.

Our
research and development efforts have led to the development of our current solutions
technology, eFLOW Unified Content PlatformTM. Our latest research and
development efforts have concentrated on the unstructured technology which is being used
in mailroom applications to process incoming information flowing into an organization. We
also focused on semi-structured forms processing, resulting in the development of our
Freedom product. These developments are enhancing, and we believe they will
continue to enhance, our ability to compete in complicated projects as a solution provider
for all kinds of forms and all types of information. Freedom and its different
applicationsfit well with our plans to keep pace with the trend towards the
ultimate integration of all forms and formats of information entering the organization.

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During
the first quarter of 2005, we released eFLOW Version 3.0, the latest version of our
leading software, eFLOW Unified Content Platform. 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 integrates with any enterprise information system, including SAP, Oracle and
others through certified connectors. The enhanced solution includes our new automated
classification solution, Smart,which adds the ability to automatically sort the
incoming information, classify all documents, recognize and extract the data from
documents, apply the organizations business rules, validate the data, and seamlessly
deliver this data to back-end enterprise systems. These capabilities are efficiently
achieved by using best of combination of fuzzy search and recognition engines, to provide
customers with the highest recognition results. Processing efficiency, accurate
information and improved throughput lead to significant savings and rapid ROI. The
entire development of eFLOW Version 3.0 is based on .NET, Microsofts latest
technology, as well as its roadmap for future developments. This choice is compatible with
TIS forward-looking strategy to maintain eFLOW on the cutting edge of new
technologies which is beneficial both for us and for the end-users of our eFLOW
product, who can customize eFLOW using .NET code such as C# or VB.NET. At the same
time, the new developments are compatible with all former eFLOW versions. eFLOW
Version 3.0 is a robust stable scalable platform which efficiently copes with
large-scale projects and balances loads of millions of documents per day. With the use of
a central controller, eFLOW Version 3.0 can administrate and monitor both local and
remote production sites in real-time and simultaneously manage more than one application.
Its highly sophisticated designer enables minimal code writing to adjust the solution to
customers unique needs. Various powerful recognition engines have been integrated
into the new version to allow mixed Full Page OCR & ICR which enables the
recognition of both handwriting and printed information on any type of document.
eFLOWs unique voting algorithm along with its component for approximate
search on very large databases, further increase recognition rates and speed up the
process. The foregoing statement does not constitute our commitment to deliver these
products. New versions will be released if and when available.

|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.

|Name               | Age | Title                                     
|------------------ | --- | ------------------------------------------
|
|
|
|
|Izhak Nakar        | 54  | Chairman of the Board                     
|Ido Schechter      | 45  | Chief Executive Officer and Director      
|Arie Rand          | 46  | Chief Financial Officer                   
|Gideon Shmuel      | 34  | Vice President of Sales                   
|Oded Leiba         | 35  | Vice President of Engineering             
|Ofir Shalev        | 34  | Vice President of Research and Development
|Victor Halpert     | 45  | Director                                  
|Zamir Bar Zion     | 48  | Director                                  
|Elie Housman       | 69  | Director                                  
|William M. Landuyt | 50  | Director                                  
|Yehezkel Yeshurun  | 57  | 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.

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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 ASP(2), 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.

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.

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

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.

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

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

# Compensation

For
the year ended December 31, 2005, the compensation paid, and value of benefits in kind
granted, to Ido Schechter, our Chief Executive Officer, was $257,000, which was comprised
of a base salary of $189,000, and $68,000 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, at December 31, 2005, directors or members of our
administrative, supervisory or management bodies during that time was $843,000. In
addition, in 2005, members of that group, together with our Chief Executive Officer, were
granted an aggregate of options to purchase 230,000 ordinary shares under our Employee
Share Option Plan 2003 with an average exercise price of $2.72 per share. The compensation
paid to all persons other than Ido Schechter include (i) reimbursement of directors
expenses, (ii) $134,000 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.

- 33 -

---

---



# Board Practices

Board
of Directors

All
directors (other than external directors) currently hold office until the next annual
meeting of shareholders and until their successors are duly elected and qualified.
External directors currently hold office for three years from their appointment (in
December 2003) and until their successors are duly elected and qualified at the relevant
annual meeting. The external directors may be elected for one additional three-year
period. At our shareholders meeting held on December 18, 2003, our shareholders approved a
monthly payment to Mr. Thomas C. Lavey in the amount of $2,000 as compensation for his
service as a director and Chairman of the Board, which was paid until Mr. Lavey resigned
in September 2005 (see below). The shareholders also approved a payment to Mr. Victor
Halpert and Mr. Zamir Bar-Zion for their service as external directors, members of Audit
Committee and the board of directors, and Mr. Elie Housman for his service as member of
the Audit Committee and board of directors, in the amount 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 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. At
our shareholders meeting held on November 15th, 2004, a monthly payment was approved to
Mr. Yehzekel Yeshurun for his service as a member of the Board of Directors in the amount
of 19,841 NIS per year and 993 NIS for each Board and/or committee meeting attended.

Mr.
          Thomas Lavey resigned from his position as director and Chairman of the Board
of           Directors in September of 2005 for personal reasons. The Board of Directors
          subsequently elected Mr. Nakar as a temporary Chairman.

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. In addition, should we require the active involvement of Mr. Nakar with any
other business of ours, then he shall be paid a fee of $1,000, plus reimbursement of any
expenses, for every business day invested by him with regard to same. During 2005, we
recorded an expense of $120,000 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(15) thereof. The board of directors has
determined that each of Zamir Bar Zion, William Landuyt, Elie Housman, Yehezkel Yeshurun,
Victor Halpert, and Thomas Lavey is an independent director for purposes of the NASDAQ
rules.

Israeli
law requires that a public company, such as TIS, have at least two independent directors.
As of January 2006, Israeli law requires 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 the companys board of directors.
Under recently enacted regulations, 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. 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.

- 34 -

---

---



Audit
Committee; Compensation Committee

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

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

In
August 2004, the board of directors authorized the establishment of a Compensation
Committee. The current members of the Committee are William M. Landuyt, Zamir Bar-Zion,
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.

# Employees

As
of December 31, 2005, we employed the following employees:

|Company Name | No of Employees
|------------ | ---------------
|
|
|
|
|TIS Israel   | 50             
|TIS Germany  | 20             
|TIS Japan    | 12             
|TIS UK       | 13             
|TIS USA      | 4              
|             |                
|Total        | 99             

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
principal for interpretation is that the provision which is more favorable to the employee
will prevail.

- 35 -

---

---



# 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% (0.5% on a fully diluted basis) of our outstanding share
capital.           In addition, Mr. Nakar and members of his immediate family own Nir 4
You           Technologies Ltd., an Israeli company that holds 280,000 ordinary shares
          amounting to 3.2% (2.5% on a fully diluted basis) of our outstanding share
          capital. None of the ordinary shares discussed in this section have different
          voting rights than those of other outstanding ordinary shares.

Charter
owns 2,000,000 ordinary shares representing 22.8% (17.8% 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.

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, 2005, options to
purchase 82,625 ordinary shares were outstanding under the plan at exercise prices between
$0.52 and $5.00 per share. All of the outstanding options under the plan become
exercisable in four equal parts upon each of the first four anniversaries of the option
grant dates. During 2005, 875 options had been exercised and 500 had been forfeited
through December 31, 2005.

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.

- 36 -

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---



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, 2005, options to
purchase an aggregate of 135,500 shares were outstanding. All of the granted options vest
over a three-year period and have exercise prices between $0.99 and $4.125 per share. The
number of shares covered by an option granted under ESOP 2000 is subject to adjustment for
stock splits, mergers, consolidations, reorganizations and recapitalizations. During 2005,
2,500 options were exercised and 5,500 had been forfeited through December 31, 2005.

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.

As
of December 31, 2005, options to purchase an aggregate of 586,000 shares were outstanding
at exercise prices between $1.31 and $3.27 per share. During 2005, no options were
exercised and 18,000 had been forfeited through December 31, 2005.

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.

As
of December 31, 2005, options to purchase 359,917 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 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.

- 37 -

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---



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, 2005, 17,875 non-plan options were outstanding and exercisable at prices
ranging between $2.77 and $5.00 per share.

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

As
of March 27, 2006, Charter held 2,000,000 ordinary shares, or 22.8% (17.8% on a fully diluted basis) of
our outstanding share capital.

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

Based
on a Schedule 13G filed on March 13, 2006, Smithfield Fiduciary LLC may be deemed the
beneficial owner of 158,227 ordinary shares and 79,114 warrants to purchase ordinary
shares owned by it, or 2.66% of our outstanding share capital as of March 27, 2006, and
each of Highbridge International LLC, Highbridge Master L.P., Highbridge Capital
Corporation, Highbridge Capital L.P., Highbridge GP, Ltd., Highbridge GP, LLC, Highbridge
Capital Management, LLC, Glenn Dubin and Harry Swieca may be deemed the beneficial owner
of the ordinary shares and warrants to purchase ordinary shares owned by Smithfield
Fiduciary LLC and the 489,827 ordinary shares owned by Highbridge International LLC, or
8.16% of our outstanding share capital as of March 27, 2006.  Smithfield Fiduciary LLC is
a wholly-owned subsidiary of Highbridge International LLC. Highbridge International LLC
is a subsidiary of Highbridge Master L.P. Highbridge Capital Corporation and Highbridge
Capital L.P. are limited partners of Highbridge Master L.P. Highbridge GP, Ltd. is the
General Partner of Highbridge Master L.P. Highbridge GP, LLC is the General Partner of
Highbridge Capital L.P. Highbridge Capital Management, LLC is the trading manager of
Smithfield Fiduciary LLC, Highbridge International LLC, Highbridge Capital Corporation,
Highbridge Capital L.P. and Highbridge Master L.P. Glenn Dubin is a Co-Chief Executive
Officer of Highbridge Capital Management, LLC. Henry Swieca is a Co-Chief Executive
Officer of Highbridge Capital Management, LLC. The Schedule 13G stated that each of
Highbridge Capital Management, LLC, Highbridge GP, Ltd., Highbridge GP, LLC, Glenn Dubin
and Henry Swieca disclaims beneficial ownership of ordinary shares owned by Smithfield
Fiduciary LLC.

In
connection with the investment by Charter, certain rights were granted to Izhak  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 2005, we recorded on our
books an amount of $120,000 for Mr. Nakars services. For additional information, see
Note 9 to the consolidated financial statements included herein.

In
January 2000, TIS, together with Izhak Nakar, our then CEO, and Yehezkel Yeshurun, our
former Chief Scientist and a former director, established e-Mobilis Ltd. as a subsidiary
of TIS. The shareholdings in e-Mobilis at that time were as follows: TIS held 80.2%, Mr.
Nakar held 9.9% and Mr. Yeshurun held 9.9%. In November 2001, we acquired from Mr. Nakar,
and Mr. Yeshurun, their interests in e-Mobilis. The acquisition was in consideration of
the issuance to each of them of immediately vested options to purchase 50,000 ordinary
shares at an exercise price of $2.00 per share. These options expire three years from the
date they were granted and were valued at $90,000 using the Black Scholes valuation model.
As of December 31, 2005, all these options were exercised.

17
record holders of ordinary shares have declared postal addresses in the United States.
These 17 record holders hold, between them, 93% of our outstanding share capital. There
are no arrangements known to us that may at a subsequent date result in a change in
control of us.

- 38 -

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

# Consolidated statements
and other financial information

Consolidated
Financial Statements

See
Item 18.

Other
Financial Information

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

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

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

# 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:

- 39 -

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---



|Year Ending       |    | NASDAQCapital Market
|----------------- | -- | --------------------
|
|
|
|
|December 31, 2005 | Hi | 4.11                
|                  | Lo | 2.13                
|                 
|December 31, 2004 | Hi | 5.00                
|                  | Lo | 2.13                
|                 
|December 31, 2003 | Hi | 3.140               
|                  | Lo | 0.420               
|                 
|December 31, 2002 | Hi | 3.92                
|                  | Lo | 0.42                
|                 
|December 31, 2001 | Hi | 4.90                
|                  | Lo | 2.05                

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     |    | NASDAQCapital Market
|------------------ | -- | --------------------
|
|
|
|
|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                
|                  
|December 31, 2004  | Hi | 3.35                
|                   | Lo | 2.72                
|                  
|September 30, 2004 | Hi | 3.23                
|                   | Lo | 2.54                
|                  
|June 30, 2004      | Hi | 3.88                
|                   | Lo | 3.14                
|                  
|March 31, 2004     | Hi | 4.44                
|                   | Lo | 2.36                

- 40 -

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

|Month Ending       |    | NASDAQCapital Market
|------------------ | -- | --------------------
|
|
|
|
|February 28, 2006  | Hi | 3.62                
|                   | Lo | 3.00                
|                   |    |                     
|January 31, 2006   | Hi | 3.44                
|                   | Lo | 2.80                
|                   |    |                     
|December 31, 2005  | Hi | 3.29                
|                   | Lo | 2.77                
|                   |    |                     
|November 30, 2005  | Hi | 2.96                
|                   | Lo | 2.50                
|                   |    |                     
|October 31, 2005   | Hi | 2.80                
|                   | Lo | 2.31                
|                   |    |                     
|September 30, 2005 | Hi | 3.00                
|                   | Lo | 2.47                

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.

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

# Memorandum and Articles
of Association

General

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

Directors
and other Office Holders

General

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

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

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

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

External
Directors

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

| |  | an
employment relationship;
| | - | ---------------------------

| |  | a
business or professional relationship maintained on a regular basis;
| | - | ----------------------------------------------------------------------

| |  | control;
and
| | - | ------------

| |  | service
as an office holder.
| | - | ----------------------------

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

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

| |  | the
majority of shares voted at the meeting, including at least one-third of the shares held
by non-controlling shareholders voted at the meeting, vote in favor of election of the
director; or
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the
total number of shares held by non-controlling shareholders voted against the election of
the directors does not exceed one percent of the aggregate voting rights in the company.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

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

Alternate
Directors

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

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

Internal
Auditor and Certified Public Accountant

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

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

Indemnification
of Directors and Officers

At
the shareholders meeting on December 18, 2003, the Company adopted new Articles of
Association which allow for insurance and indemnification for office holders for future
liabilities. At the same meeting, the shareholders approved indemnification of the
officers and directors of the Company, in the form described herein.

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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 for a
fine or forfeit levied against the office holder in connection with a criminal offense.

Currently,
we hold an insurance policy for our office holders that provides coverage limited to
$10,000,000 in aggregate for the policy period, ending on December 31, 2005, and was
renewed until December 31, 2006.

Rights,
Preferences, Restrictions of Shares

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

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

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

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

Meetings
of Shareholders

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

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

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

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

Limitations
of Shareholders

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

Limitations
on a Change of Control

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

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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. A
private placement in which our securities are traded only in a foreign market entitles us
to certain allowances as to the approvals necessary for such placement.

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

| |  | any
amendment to the Articles of Association;
| | - | ---------------------------------------------

| |  | an
increase of the company's authorized share capital;
| | - | ------------------------------------------------------

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

| |  | approval
of interested party transactions that require shareholder approval.
| | - | ----------------------------------------------------------------------------

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

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.

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# 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, the Israeli Parliament passed the Amendment to the Income
Tax Ordinance (No. 140 and Temporary Provision), which progressively reduces the tax rates
applicable to companies from 35% in 2004 to a rate of 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.

As
of December 31, 2005, we had operating loss carryforwards for tax purposes in the amount
of $4,613,000. The amount of our carryforward operating losses will be offset against
taxable future income for an indefinite period.

As
of December 31, 2005, the foreign subsidiaries had operating loss carryforwards for tax
purposes in the amount of $ 4,463,000. A portion of such losses expires over a period from
2006 through 2018.

Law
for the Encouragement of Capital Investments, 1959

General

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

Tax
Benefits

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

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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
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                  

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

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

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

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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.

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.

- 49 -

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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, 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.

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

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

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

Taxation
of Non-Residents of Israel

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

United
States Federal Income Tax Considerations

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

- 50 -

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| |  | 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.

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.

- 51 -

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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.

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-corporate 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 the U.S.
Holder elects to take into account 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 dividends 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.

- 52 -

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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):

| |  | 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 the Company is classified as a PFIC 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.

- 53 -

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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 2005. In addition, we believe that we will not be 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.

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.

- 54 -

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# 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 450 Fifth
Street, N.W., 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.

|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.

|ITEM 12. |  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|-------- |  | ----------------------------------------------------------

Not applicable.

# 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.

- 55 -

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|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, 2005. 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, 2005, that has materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting.

|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. 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 (a member of Ernst
& Young Global) (EY) Certified Public Accountants (Isr.) as independent
auditors to audit our financial statements for the fiscal year ended December 31, 2003. EY
was subsequently approved to audit our financial statements for the fiscal year ended
December 31, 2004 in our shareholders annual meeting held on December 21, 2004, and
our financial statements for the fiscal year ended December 31, 2005 in our
shareholders annual meeting held on November 15, 2005.

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,
2005 and 2004 were $109,000 and $69,000 respectively.

The
aggregate fees billed by Somekh Chaikan (a member firm of KPMG International)
(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,
2005 and December 31, 2004 were $47,000 and $5,000 respectively.

- 56 -

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# Tax Fees

For
the fiscal years ended December 31, 2005 and 2004 the aggregate fees billed for tax
compliance, tax advice and tax planning by EY were $13,000 and $30,400 respectively

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

# Non-Audit services

For the
fiscal years ended December 31, 2005 and 2004 the aggregate fees billed by EY for other
non-audit professional services, other than those services listed above, were $18,000 and
$44,000, respectively. Such services were comprised of accounting and other consultation.
For the fiscal year ended December 31, 2004 no fees were billed by KPMG for tax
compliance.

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

| |  | approved
by our audit committee; or
| | - | -----------------------------------

| |  | entered
into pursuant to pre-approval policies and procedures established by the audit committee,
provided the policies and procedures are detailed as to the particular service, the audit
committee is informed of each service, and such policies and procedures do not include
delegation of the audit committees responsibilities to management.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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-45.

- 57 -

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

|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
                     Oce 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 (incorporated by reference to exhibit 4.28 to the Companys annual report on Form 20-F for the fiscal year
ended December 31, 2004).
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|8 |  | List
of Subsidiaries (incorporated by reference to exhibit 8 to the Companys annual report on Form 20-F for the fiscal year ended
December 31, 2004).
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------

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

- 58 -

---

---



|Number |  | Description
|------ |  | -----------

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

|15.1 |  | Consent of Kost Forer Gabbay & Kasierer  member of Ernst & Young Global.
|---- |  | -------------------------------------------------------------------------

|15.2 |  | 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).
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------

- 59 -

---

---



# 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
Ido SchechterChief Executive Officer
| |  | ----------------------------------------------------------------------------------------------

Date: March 27, 2006



---

---



# TOP IMAGE SYSTEMS LTD.
AND ITS SUBSIDIARIES

# CONSOLIDATED FINANCIAL STATEMENTS

# AS OF DECEMBER 31, 2005

# IN U.S. DOLLARS

# INDEX



---

---



TOP IMAGE SYSTEMS LTD. AND ITS SUBSIDIARIES

CONSOLIDATED FINANCIAL STATEMENTS

AS OF DECEMBER 31, 2005

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       
|                                                             |           
|Consolidated 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-31
|                                                             |           

---

---



(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, 2004 and 2005, and the
related consolidated statements of operations, changes in shareholders equity and cash flows for each of the three years in the
period ended December 31, 2005.
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, 2004 and 2005, and the related consolidated results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2005, in conformity with U.S. generally accepted accounting
principles.

|                 |                                 
|---------------- | --------------------------------
|Tel-Aviv, Israel | KOST FORER
  GABBAY & KASIERER  
|March 26,
  2006 | 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, |       
|                                                                                                                              |  |              |       
|                                                                                                                              |  | 2004         |        | 2005 |  
|                                                                                                                              |  |              |        |      |  
|ASSETS                                                                                                                        |  |              |        |      |   |        | 
|                                                                                                                              |  |              |        |      |   |        | 
|CURRENT
  ASSETS:                                                                                                             |  |              |        |      |   |        | 
|Cash and cash equivalents                                                                                                     |  | $            | 10,136 |      | $ | 8,200  | 
|Marketable securities (Note 3)                                                                                                |  |              | 279    |      |   | 1,805  | 
|Trade receivables (net of allowance for
  doubtful accounts of $ 654 and $ 412 at December 31, 2004 and 2005,
  respectively) |  |              | 5,541  |      |   | 6,802  | 
|Other accounts receivable and prepaid
  expenses (Note 4)                                                                     |  |              | 566    |      |   | 622    | 
|                                                                                                                              |  |              |        |      |   |        | 
|                                                                                                                              |  |              |        |      |   |        | 
|Total
  current assets                                                                                                        |  |              | 16,522 |      |   | 17,429 | 
|                                                                                                                              |  |              |        |      |   |        | 
|                                                                                                                              |  |              |        |      |   |        | 
|LONG-TERM
  ASSETS:                                                                                                           |  |              |        |      |   |        | 
|Severance pay fund                                                                                                            |  |              | 571    |      |   | 654    | 
|Long-term deposits (Note 9b(2))                                                                                               |  |              | 147    |      |   | 135    | 
|Property and equipment, net (Note 5)                                                                                          |  |              | 618    |      |   | 577    | 
|Other intangible assets, net (Note 6)                                                                                         |  |              | 1,419  |      |   | 1,100  | 
|Goodwill                                                                                                                      |  |              | 465    |      |   | 465    | 
|                                                                                                                              |  |              |        |      |   |        | 
|                                                                                                                              |  |              |        |      |   |        | 
|Total
  long-term assets                                                                                                      |  |              | 3,220  |      |   | 2,931  | 
|                                                                                                                              |  |              |        |      |   |        | 
|                                                                                                                              |  |              |        |      |   |        | 
|Total
  assets                                                                                                                |  | $            | 19,742 |      | $ | 20,360 | 
|                                                                                                                              |  |              |        |      |   |        | 

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, |        
|                                                                                                          |  |              |        
|                                                                                                          |  | 2004         |         | 2005 |  
|                                                                                                          |  |              |         |      |  
|                                                                                                         
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                      |  |              |         |      |   |         |  
|                                                                                                          |  |              |         |      |   |         |  
|CURRENT
  LIABILITIES:                                                                                    |  |              |         |      |   |         |  
|Short-term bank loans (Note 7)                                                                            |  | $            | 1,707   |      | $ | 2,179   |  
|Trade payables                                                                                            |  |              | 405     |      |   | 900     |  
|Accrued expenses and other accounts payable
  (Note 8)                                                    |  |              | 2,178   |      |   | 2,213   |  
|                                                                                                          |  |              |         |      |   |         |  
|                                                                                                          |  |              |         |      |   |         |  
|Total
  current liabilities                                                                               |  |              | 4,290   |      |   | 5,292   |  
|                                                                                                          |  |              |         |      |   |         |  
|                                                                                                          |  |              |         |      |   |         |  
|ACCRUED
  SEVERANCE PAY                                                                                   |  |              | 757     |      |   | 850     |  
|                                                                                                          |  |              |         |      |   |         |  
|                                                                                                          |  |              |         |      |   |         |  
|COMMITMENTS,
  CONTINGENCIES AND CHARGES (Note 9)                                                         |  |              |         |      |   |         |  
|                                                                                                          |  |              |         |      |   |         |  
|SHAREHOLDERS
  EQUITY (Note 11):                                                                         |  |              |         |      |   |         |  
|Share capital:                                                                                            |  |              |         |      |   |         |  
|Ordinary shares of NIS 0.04 par value -                                                                   |  |              |         |      |   |         |  
|Authorized: 125,000,000 shares at December
  31, 2004 and 2005;                                           |  |              |         |      |   |         |  
|Issued and outstanding: 8,753,991 shares at December 31,
  2004 and 8,777,366 shares at December 31, 2005 |  |              | 97      |      |   | 97      |  
|Additional paid-in capital                                                                                |  |              | 29,579  |      |   | 29,561  |  
|Accumulated other comprehensive loss                                                                      |  |              | (2      | )    |   | -       |  
|Accumulated deficit                                                                                       |  |              | (14,979 | )    |   | (15,440 | )
|                                                                                                          |  |              |         |      |   |         |  
|                                                                                                          |  |              |         |      |   |         |  
|Total
  shareholders equity                                                                              |  |              | 14,695  |      |   | 14,218  |  
|                                                                                                          |  |              |         |      |   |         |  
|                                                                                                          |  |              |         |      |   |         |  
|Total
  liabilities and shareholders equity                                                              |  | $            | 19,742  |      | $ | 20,360  |  
|                                                                                                          |  |              |         |      |   |         |  

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, |          
|                                                                              |  |                           |          
|                                                                              |  | 2003                      |           | 2004 |   | 2005      |  
|                                                                              |  |                           |           |      |   |           |  
|Revenues
  (Note 12):                                                         |  |                           |           |      |   |           |   |   |           |  
|Products                                                                      |  | $                         | 6,211     |      | $ | 6,964     |   | $ | 9,888     |  
|Services                                                                      |  |                           | 2,108     |      |   | 4,214     |   |   | 6,932     |  
|                                                                              |  |                           |           |      |   |           |   |   |           |  
|                                                                              |  |                           |           |      |   |           |   |   |           |  
|Total
  revenues                                                              |  |                           | 8,319     |      |   | 11,178    |   |   | 16,820    |  
|                                                                              |  |                           |           |      |   |           |   |   |           |  
|                                                                              |  |                           |           |      |   |           |   |   |           |  
|Cost of revenues:                                                             |  |                           |           |      |   |           |   |   |           |  
|Products                                                                      |  |                           | 1,795     |      |   | 1,971     |   |   | 3,363     |  
|Services                                                                      |  |                           | 545       |      |   | 1,501     |   |   | 3,400     |  
|                                                                              |  |                           |           |      |   |           |   |   |           |  
|                                                                              |  |                           |           |      |   |           |   |   |           |  
|Total
  cost of revenues                                                      |  |                           | 2,340     |      |   | 3,472     |   |   | 6,763     |  
|                                                                              |  |                           |           |      |   |           |   |   |           |  
|                                                                              |  |                           |           |      |   |           |   |   |           |  
|Gross profit                                                                  |  |                           | 5,979     |      |   | 7,706     |   |   | 10,057    |  
|                                                                              |  |                           |           |      |   |           |   |   |           |  
|                                                                              |  |                           |           |      |   |           |   |   |           |  
|Operating costs and expenses:                                                 |  |                           |           |      |   |           |   |   |           |  
|Research and development                                                      |  |                           | 863       |      |   | 929       |   |   | 1,312     |  
|Selling and marketing                                                         |  |                           | 3,769     |      |   | 4,547     |   |   | 5,396     |  
|General and administrative                                                    |  |                           | 2,050     |      |   | 2,576     |   |   | 3,470     |  
|Liquidated damages related to
  September 2004 investment                     |  |                           | -         |      |   | -         |   |   | 164       |  
|                                                                              |  |                           |           |      |   |           |   |   |           |  
|                                                                              |  |                           |           |      |   |           |   |   |           |  
|Total
  operating costs and expenses                                          |  |                           | 6,682     |      |   | 8,052     |   |   | 10,342    |  
|                                                                              |  |                           |           |      |   |           |   |   |           |  
|                                                                              |  |                           |           |      |   |           |   |   |           |  
|Operating loss                                                                |  |                           | (703      | )    |   | (346      | ) |   | (285      | )
|Financial income (expenses), net (Note 14)                                    |  |                           | 109       |      |   | 178       |   |   | (146      | )
|                                                                              |  |                           |           |      |   |           |   |   |           |  
|                                                                              |  |                           |           |      |   |           |   |   |           |  
|Loss before taxes on income (Note 10)                                         |  |                           | (594      | )    |   | (168      | ) |   | (431      | )
|                                                                              |  |                           |           |      |   |           |   |   |           |  
|Taxes on income                                                               |  |                           | -         |      |   | -         |   |   | 30        |  
|                                                                              |  |                           |           |      |   |           |   |   |           |  
|                                                                              |  |                           |           |      |   |           |   |   |           |  
|Net loss                                                                      |  | $                         | (594      | )    | $ | (168      | ) | $ | (461      | )
|                                                                              |  |                           |           |      |   |           |   |   |           |  
|                                                                              |  |                           |           |      |   |           |   |   |           |  
|Basic and diluted net loss per share (Note 13)                                |  | $                         | (0.11     | )    | $ | (0.02     | ) | $ | (0.05     | )
|                                                                              |  |                           |           |      |   |           |   |   |           |  
|                                                                              |  |                           |           |      |   |           |   |   |           |  
|Weighted average number of
  shares used in computation of net loss per share |  |                           | 6,102,496 |      |   | 6,905,559 |   |   | 8,764,222 |  
|                                                                              |  |                           |           |      |   |           |   |   |           |  

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 (except share data) |                                              

|                                                                       |  |                 |        |                                |   |                                                     |   |                       |     |                      |   |         |   |   |      |   |   |        |  
|---------------------------------------------------------------------- |  | --------------- | ------ | ------------------------------ | - | --------------------------------------------------- | - | --------------------- | --- | -------------------- | - | ------- | - | - | ---- | - | - | ------ | -
|                                                                       |  | Share
  capital |        | Additional
  paid-in
  capital |   | Accumulated
  other
  comprehensive
  income (loss) |   | Accumulated
  deficit |     | Comprehensive
  loss |   | Total   |  
|                                                                       |  |                 |        |                                |   |                                                     |   |                       |     |                      |   |         |  
|                                                                       |  |                 |        |                                |   |                                                     |   |                       |     |                      |   |         |   |   |      |   |   |        |  
|Balance at January 1, 2003                                             |  | $               | 73     |                                | $ | 22,339                                              |   | $                     | 8   |                      | $ | (14,217 | ) |   |      |   | $ | 8,203  |  
|Net unrealized losses on available-for-sale
  securities               |  |                 | -      |                                |   | -                                                   |   |                       | (11 | )                    |   | -       |   | $ | (11  | ) |   | (11    | )
|Net loss                                                               |  |                 | -      |                                |   | -                                                   |   |                       | -   |                      |   | (594    | ) |   | (594 | ) |   | (594   | )
|                                                                       |  |                 |        |                                |   |                                                     |   |                       |     |                      |   |         |   |   |      |   |   |        |  
|Comprehensive loss                                                     |  |                 |        |                                |   |                                                     |   |                       |     |                      |   |         |   | $ | (605 | ) |   |        |  
|                                                                       |  |                 |        |                                |   |                                                     |   |                       |     |                      |   |         |   |   |      |   |   |        |  
|Exercise of stock options                                              |  |                 | *)   - |                                |   | 41                                                  |   |                       | -   |                      |   | -       |   |   |      |   |   | 41     |  
|                                                                       |  |                 |        |                                |   |                                                     |   |                       |     |                      |   |         |   |   |      |   |   |        |  
|                                                                       |  |                 |        |                                |   |                                                     |   |                       |     |                      |   |         |   |   |      |   |   |        |  
|Balance at December 31, 2003                                           |  |                 | 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 |  
|                                                                       |  |                 |        |                                |   |                                                     |   |                       |     |                      |   |         |   |   |      |   |   |        |  

*)          Represents
an amount lower than $ 1.

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

F-6

---

---



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

|                                                                              |  |                         |        |      |   |        |   |   |        |  
|----------------------------------------------------------------------------- |  | ----------------------- | ------ | ---- | - | ------ | - | - | ------ | -
|                                                                              |  | Year ended December
31, |       
|                                                                              |  |                         |       
|                                                                              |  | 2003                    |        | 2004 |   | 2005   |  
|                                                                              |  |                         |        |      |   |        |  
|                                                                             
|Cash flows from operating activities:                                         |  |                         |        |      |   |        |   |   |        |  
|                                                                              |  |                         |        |      |   |        |   |   |        |  
|Net loss                                                                      |  | $                       | (594   | )    | $ | (168   | ) | $ | (461   | )
|Adjustments to reconcile net
loss to net
  cash used in operating activities: |  |                         |        |      |   |        |   |   |        |  
|Stock-compensation due to
acceleration of
  vesting                           |  |                         | -      |      |   | -      |   |   | 44     |  
|Interest on short-term bank
loans                                             |  |                         | -      |      |   | -      |   |   | 3      |  
|Depreciation and
amortization                                                 |  |                         | 215    |      |   | 270    |   |   | 524    |  
|Accrued severance pay,
net                                                    |  |                         | 30     |      |   | (4     | ) |   | 10     |  
|Gain from marketable
securities, net                                          |  |                         | 11     |      |   | (1     | ) |   | (3     | )
|Increase in trade
receivables, net                                            |  |                         | (1,457 | )    |   | (935   | ) |   | (1,261 | )
|Increase in other accounts
receivable and
  prepaid expenses                  |  |                         | (115   | )    |   | (153   | ) |   | (56    | )
|Increase (decrease) in trade
payables                                         |  |                         | (47    | )    |   | 99     |   |   | 495    |  
|Increase (decrease) in
accrued expenses and
  other accounts payable          |  |                         | (537   | )    |   | (182   | ) |   | 284    |  
|                                                                              |  |                         |        |      |   |        |   |   |        |  
|                                                                              |  |                         |        |      |   |        |   |   |        |  
|Net cash
  used in operating activities                                       |  |                         | (2,516 | )    |   | (1,074 | ) |   | (421   | )
|                                                                              |  |                         |        |      |   |        |   |   |        |  
|Cash flows
  from investing activities:                                       |  |                         |        |      |   |        |   |   |        |  
|                                                                              |  |                         |        |      |   |        |   |   |        |  
|Acquisition of business
activity (a)                                          |  |                         | -      |      |   | (1,763 | ) |   | -      |  
|Payment of accrued expenses
on account of
  acquisition                       |  |                         | -      |      |   | -      |   |   | (73    | )
|Purchase of property and
equipment                                            |  |                         | (72    | )    |   | (416   | ) |   | (164   | )
|Proceeds from sale of
marketable securities                                   |  |                         | 253    |      |   | 138    |   |   | 279    |  
|Purchase of marketable
securities                                             |  |                         | -      |      |   | (138   | ) |   | (1,800 | )
|Decrease (increase) in
long-term deposits                                     |  |                         | 4      |      |   | (61    | ) |   | 12     |  
|                                                                              |  |                         |        |      |   |        |   |   |        |  
|                                                                              |  |                         |        |      |   |        |   |   |        |  
|Net cash
  provided by (used in) investing activities                         |  |                         | 185    |      |   | (2,240 | ) |   | (1,746 | )
|                                                                              |  |                         |        |      |   |        |   |   |        |  
|                                                                              |  |                         |        |      |   |        |   |   |        |  
|Cash flows
  from financing activities:                                       |  |                         |        |      |   |        |   |   |        |  
|                                                                              |  |                         |        |      |   |        |   |   |        |  
|Proceeds from exercise of
stock options                                       |  |                         | 41     |      |   | 240    |   |   | 15     |  
|Increase in short-term bank
loans, net                                        |  |                         | 744    |      |   | 115    |   |   | 469    |  
|Proceeds from issuance of
shares, net                                         |  |                         | -      |      |   | 7,240  |   |   | -      |  
|Payment of accrued issuance
expenses                                          |  |                         | -      |      |   | -      |   |   | (253   | )
|                                                                              |  |                         |        |      |   |        |   |   |        |  
|                                                                              |  |                         |        |      |   |        |   |   |        |  
|Net cash
  provided by financing activities                                   |  |                         | 785    |      |   | 7,595  |   |   | 231    |  
|                                                                              |  |                         |        |      |   |        |   |   |        |  
|                                                                              |  |                         |        |      |   |        |   |   |        |  
|Increase
  (decrease) in cash and cash equivalents                            |  |                         | (1,546 | )    |   | 4,281  |   |   | (1,936 | )
|Cash and
  cash equivalents at the beginning of the year                      |  |                         | 7,401  |      |   | 5,855  |   |   | 10,136 |  
|                                                                              |  |                         |        |      |   |        |   |   |        |  
|                                                                              |  |                         |        |      |   |        |   |   |        |  
|Cash and
  cash equivalents at the end of the year                            |  | $                       | 5,855  |      | $ | 10,136 |   | $ | 8,200  |  
|                                                                              |  |                         |        |      |   |        |   |   |        |  

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

F-7

---

---



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

|                                                    |  |                           |    |      |   |      |  |   |    | 
|--------------------------------------------------- |  | ------------------------- | -- | ---- | - | ---- |  | - | -- | 
|                                                    |  | Year ended
  December 31, |   
|                                                    |  |                           |   
|                                                    |  | 2003                      |    | 2004 |   | 2005 | 
|                                                    |  |                           |    |      |   |      | 
|                                                   
|Supplemental
  disclosure of cash flows activities: |  |                           |    |      |   |      |  |   |    | 
|                                                    |  |                           |    |      |   |      |  |   |    | 
|Cash paid during the year
for:                      |  |                           |    |      |   |      |  |   |    | 
|                                                    |  |                           |    |      |   |      |  |   |    | 
|Interest                                            |  | $                         | 20 |      | $ | 72   |  | $ | 97 | 
|                                                    |  |                           |    |      |   |      |  |   |    | 
|                                                    |  |                           |    |      |   |      |  |   |    | 
|Non-cash
  activities:                              |  |                           |    |      |   |      |  |   |    | 
|                                                    |  |                           |    |      |   |      |  |   |    | 
|Accrued issuance
expenses                           |  | $                         | -  |      | $ | 257  |  | $ | 77 | 
|                                                    |  |                           |    |      |   |      |  |   |    | 
|                                                    |  |                           |    |      |   |      |  |   |    | 
|Accrued expenses on account
of acquisition          |  | $                         | -  |      | $ | 202  |  | $ | -  | 
|                                                    |  |                           |    |      |   |      |  |   |    | 

|    |                                                                                      |  |  |  |  |   |       |   |  |  | 
|--- | ------------------------------------------------------------------------------------ |  |  |  |  | - | ----- | - |  |  | 
|(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

---

---



|                                           |                                              
|------------------------------------------ | ---------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS | TOP IMAGE SYSTEMS LTD.
  AND ITS SUBSIDIARIES
|                                          
|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 most 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 System (NASDAQ)
in
  the United States.                                                                                                                              
|            |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|            |         | As for
  information regarding the principal customers of the Company, see Note 12b.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|            |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|            | 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, 2005, total accrued royalties amounted to $ 19.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|            |         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|            |         | 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

---

---



|                                           |                                              
|------------------------------------------ | ---------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS | TOP IMAGE SYSTEMS LTD.
  AND ITS SUBSIDIARIES
|                                          
|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 four
  months ended December 31, 2004 and for the year ended December 31, 2005, the
  revenues and net income (loss) included in the consolidated financial
  statements in respect of the acquired business amounted to $ 531, $ 2,831, $ 136
  and $ 174, 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.                                                                                                                                                                                               | 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.
|            |                                                                                                                                                                                                  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|            |                                                                                                                                                                                                  | 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.                                                                                                                                                      

F-10

---

---



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

|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|----------- | --------------------------------------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2:    | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|            |                                        
|            | c.                                      | 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.                                                                                                                                                                                            
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|            | 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.                                      | Marketable
  securities:                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|            |                                         | Marketable
  securities consist of mutual fund certificates as of December 31, 2004 and
  auction rate securities as of December 31, 2005.                                                                                                                                                                                                                                                                                                                                   
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|            |                                         | 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 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 year ended
  December 31, 2005.                                                                                                                                                                                                  
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|            | f.                                      | Long-term
  deposits:                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|            |                                         | Consist
  mainly of long-term prepaid expenses for motor vehicle and rent leasing.                                                                                                                                                                                                                                                                                                                                                                                           
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|            | g.                                      | 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
| |                                      |                                                             

F-11

---

---



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

|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|----------- | --------------------------------------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2:    | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|            |                                        
|            | h.                                      | 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, 2003, 2004 and 2005, no impairment indicators have been
  identified.                                               
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|            | i.                                      | 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, 2004 and 2005, no
  impairment indicators have been identified.                                                                                                                                                            
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|            | j.                                      | Other
  intangible assets:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|            |                                         | Intangible
  assets are comprised of acquired technology and customer relations, and 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.                                                                                                                                                                                                                                                                                                                                                                                                                                           
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|            | k.                                      | Revenue
  recognition:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|            |                                         | Product
  revenues include mainly sales of software and related hardware.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|            |                                         | The Company accounts for
  software sales in accordance with Statement of Position No. 97-2,
  Software Revenue Recognition 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). 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.

F-12

---

---



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

|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|----------- | --------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2:    | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|            |                                        
|            |                                         | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|            |                                         | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|            |                                         | 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 basis, provided that the revenues are fixed or can be reasonably
  estimated, collection is probable, costs related to performing the work are
  determinable or can be reasonably determined, there is no substantial
  uncertainty regarding the ability of the Company to complete the contract and
  to meet the contractual terms. 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.
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|            | l.                                      | Accounting
  for stock-based compensation:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|            |                                         | The Company
  has elected to follow Accounting Principles Board Opinion No. 25, Accounting
  for Stock Issued to Employees (APB No. 25) and FASB Interpretation
  No. 44, Accounting for Certain Transactions Involving Stock
  Compensation (FIN No. 44) in accounting for its employee stock
options
  plans. Under APB No. 25, when the exercise price of the Companys stock
  options is less than the market price of the underlying shares on the date of
  grant, compensation expense is recognized over the options vesting
period.                                                                                                                                                                                                                                                                                                                                                
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|            |                                         | Pro forma
  information regarding the Companys net income (loss) and net earnings (loss)
  per share is required by SFAS No. 123, Accounting for Stock-Based
  Compensation, as amended by SFAS No. 148, Accounting for Stock-Based
  Compensation - Transition and Disclosure (SFAS No. 123) and has been
  determined as if the Company had accounted for its employee stock options
  under the fair value method prescribed by SFAS No. 123.                                                                                                                                                                                                                                                                                                                                                                                                                                               

F-13

---

---



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

|            |                                         |                                                                                                                                                                                                                
|----------- | --------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2:    | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|            |                                        
|            |                                         | The fair
  value for options granted is amortized over their vesting period and
  estimated at the date of grant using a Black-Scholes options pricing model
  with the following weighted average assumptions:

| |                            |  |      |   |      |      |      |  |        |   | 
| | -------------------------- |  | ---- | - | ---- | ---- | ---- |  | ------ | - | 
| |                            |  | 2003 |   | 2004 |      | 2005 | 
| |                            |  |      |   |      |      |      | 
| |                            |  |      |   |      |      |      |  |        |   | 
| | Dividend
  yield           |  | 0    | % |      | 0    | %    |  | 0      | % | 
| | Expected
  volatility      |  | 116  | % |      | 83.8 | %    |  | 106.79 | % | 
| | Risk-free
  interest       |  | 2    | % |      | 3.14 | %    |  | 4.25   | % | 
| | Expected
  life (in years) |  | 4    |   |      | 4    |      |  | 3.36   |   | 

| |  |                                                           
| |  | ----------------------------------------------------------
| |  | Pro forma
  information under SFAS No. 123, is as follows:

| |                                                                                              |  |                           |       |      |   |       |   |   |         |  
| | -------------------------------------------------------------------------------------------- |  | ------------------------- | ----- | ---- | - | ----- | - | - | ------- | -
| |                                                                                              |  | Year ended
  December 31, |      
| |                                                                                              |  |                           |      
| |                                                                                              |  | 2003                      |       | 2004 |   | 2005  |  
| |                                                                                              |  |                           |       |      |   |       |  
| |                                                                                              |  |                           |       |      |   |       |   |   |         |  
| | Net
  loss as reported                                                                       |  | $                         | (594  | )    | $ | (168  | ) | $ | (461    | )
| |                                                                                              |  |                           |       |      |   |       |   |   |         |  
| | Deduct
  - stock-based employee compensation - intrinsic value                               |  |                           | -     |      |   | -     |   |   | 44      |  
| |                                                                                              |  |                           |       |      |   |       |   |   |         |  
| | Add
  - stock-based compensation expense determined under fair value method for all
  awards |  |                           | (104  | )    |   | (178  | ) |   | *)
(815 | )
| |                                                                                              |  |                           |       |      |   |       |   |   |         |  
| |                                                                                              |  |                           |       |      |   |       |   |   |         |  
| | Pro
  forma net loss                                                                         |  | $                         | (698  | )    | $ | (346  | ) | $ | (1,232  | )
| |                                                                                              |  |                           |       |      |   |       |   |   |         |  
| |                                                                                              |  |                           |       |      |   |       |   |   |         |  
| | Basic
  and diluted net loss per share, as reported                                          |  | $                         | (0.11 | )    | $ | (0.02 | ) | $ | (0.05   | )
| |                                                                                              |  |                           |       |      |   |       |   |   |         |  
| |                                                                                              |  |                           |       |      |   |       |   |   |         |  
| | Pro
  forma basic and diluted net loss per share                                             |  | $                         | (0.11 | )    | $ | (0.05 | ) | $ | (0.14   | )
| |                                                                                              |  |                           |       |      |   |       |   |   |         |  

| |    |                                                                                                                                                                                                                                                                                                                                                                                               |                                                                                                                                                      
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -----------------------------------------------------------------------------------------------------------------------------------------------------
| |    | *)                                                                                                                                                                                                                                                                                                                                                                                            | The stock
  based compensation costs under SFAS No. 123 increased by approximately $ 568
  as a result of the acceleration of vesting (see Note 11c).
| |    |                                                                                                                                                                                                                                                                                                                                                                                               |                                                                                                                                                      
| | m. | 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 detail program design. Costs incurred by the
  Company between completion of the detail program design and the point at
  which the products are ready for general release have been insignificant.
  Therefore, all research and development costs have been expensed.

F-14

---

---



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

|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|----------- | --------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2:    | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|            |                                        
|            | n.                                      | 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 2005. Total royalties paid amounted to
  $ 7, $ 15 and $ 1 in 2003, 2004 and 2005, respectively and were recorded as part
  of the cost of revenues.                                                                                                                                       
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            | o.                                      | Basic and
  diluted net loss per share:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            |                                         | Basic net
  loss per share is computed based on the weighted average number of Ordinary
  shares outstanding during each year. Diluted net 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).                                                                                                                                                                                                                                   
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            |                                         | Outstanding
  stock options and warrants have been excluded from the calculation of the
  diluted net loss per share because all such securities are anti-dilutive for
  2003, 2004 and 2005. The total number of shares related to the outstanding
  options and warrants excluded from the calculations of diluted net loss per
  share was 522,875, 1,781,563 and 2,084,188 for the years ended December 31,
  2003, 2004 and 2005, respectively.                                                                                                                                                                                                                 
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            | p.                                      | 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.
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            | q.                                      | 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.                                                                                                                                                                                                         

F-15

---

---



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

|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|----------- | --------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2:    | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|            |                                        
|            |                                         | The Companys
  marketable securities include investments in mutual funds and auction rate
  U.S. Federal securities. 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.                                                                                                                                                                                                   
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|            |                                         | The Company and its subsidiaries have no off-balance-sheet
  concentration of credit risk such as foreign exchange contracts, option
  contracts or other foreign hedging arrangements.                                                                                                                                                                                                                                                                                                                                                                                       
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|            | r.                                      | 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, 2003, 2004 and 2005 amounted to
  approximately $ 57, $ 94 and $ 102, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                     
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|            | s.                                      | 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.                                                                                                                                                                                                                                                                                                                

F-16

---

---



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

|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|----------- | --------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 2:    | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|            |                                        
|            | t.                                      | Advertising
  expenses:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            |                                         | Advertising expenses are charged to selling
  and marketing expenses, as incurred. Advertising expenses for
  the years ended December 31, 2003, 2004 and 2005 were $ 217, $ 175 and $ 91,
  respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            | u.                                      | Impact of
  recently issued Accounting Standards:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            |                                         | On December 16, 2004, the FASB issued SFAS
  No. 123(R), Share-Base Payment (SFAS 123R) which revises the previously
  effective SFAS No. 123 and supersedes APB No. 25. SFAS 123R requires all
  share-based payments to employees, including grants of employee stock
  options, to be recognized in the financial statements based upon their fair
  values, beginning with the first interim or annual period after December 15,
  2005, with early adoption encouraged.                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            |                                         | The Company has the option to choose either
  the modified prospective or modified retrospective method. The Company
  expects to adopt SFAS 123R in the first quarter of 2006, using the modified
  prospective method of adoption which requires that compensation expense be
  recorded over the expected remaining life of all unvested stock options and
  for any new grants thereof at the beginning of the first quarter of adoption
  of SFAS 123R.                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            |                                         | Had the
  Company adopted SFAS 123(R) in prior periods, the impact of that statement
  would have approximated the impact of SFAS 123 as described in the disclosure
  of pro forma net loss and net loss per share of Ordinary stock in Note 13 to
  the consolidated financial statements.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            |                                         | In March
  2005, the SEC released SEC Staff Accounting Bulletin No. 107, Share-Based
  Payment (SAB 107). SAB 107 provides the SEC staffs position regarding the
  application of SFAS 123R and contains interpretive guidance related to the
  interaction between SFAS 123R and certain SEC rules and regulations, and also
  provides the SEC staffs views regarding the valuation of share-based payment
  arrangements for public companies. SAB 107 highlights the importance of
  disclosures made relating to the accounting for share-based payment
  transactions.                                                                                                                                                                                                                                                                                                                                                     
|            |                                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            |                                         | In May 2005,
  the FASB issued Statement of Financial Accounting Standard No. 154 (SFAS
  154), Accounting Changes and Error Corrections, a replacement of APB No.
  20, Accounting Changes and SFAS No. 3, Reporting Accounting Changes in
  Interim Financial Statements. SFAS 154 provides guidance on the accounting
  for and reporting of accounting changes and error corrections. APB No. 20
  previously required that most voluntary changes in accounting principles be
  recognized by including in net income for the period of the change the
  cumulative effect of changing to the new accounting principle. SFAS 154
  requires retroactive application to prior periods financial statements of a
  voluntary change in accounting principles unless it is impracticable. SFAS
  154 is effective for accounting changes and corrections of errors made in
  fiscal years beginning after December 15, 2005.

F-17

---

---



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

|            |                                                                                                                                                   
|----------- | --------------------------------------------------------------------------------------------------------------------------------------------------
|NOTE 3:    | MARKETABLE SECURITIES                                                                                                                             
|            |                                                                                                                                                   
|            | The Company
  invests in marketable securities, which are classified as available-for-sale.
  The following is a summary of marketable securities:

| |                                                |  |               |     |                  |   |             |   |               |     |                 |   |             |  |   |   |  |   |       | 
| | ---------------------------------------------- |  | ------------- | --- | ---------------- | - | ----------- | - | ------------- | --- | --------------- | - | ----------- |  | - | - |  | - | ----- | 
| |                                                |  | December 31,  |    
| |                                                |  |               |    
| |                                                |  | 2004          |     | 2005             |  
| |                                                |  |               |     |                  |  
|
| |                                                |  | Amortizedcost |     | Unrealizedlosses |   | Marketvalue |   | Amortizedcost |     | Unrealizedgains |   | Marketvalue | 
| |                                                |  |               |     |                  |   |             |   |               |     |                 |   |             | 
| | Available-for-sale:                            |  |               |     |                  |   |             |   |               |     |                 |   |             |  |   |   |  |   |       | 
| |                                                |  |               |     |                  |   |             |   |               |     |                 |   |             |  |   |   |  |   |       | 
| | Mutual fund participation certificates         |  | $             | 281 |                  | $ | (2          | ) | $             | 279 |                 | $ | -           |  | $ | - |  | $ | -     | 
| | Auction rate U.S. Federal securities           |  |               | -   |                  |   | -           |   |               | -   |                 |   | 1,805       |  |   | - |  |   | 1,805 | 
| |                                                |  |               |     |                  |   |             |   |               |     |                 |   |             |  |   |   |  |   |       | 
| |                                                |  |               |     |                  |   |             |   |               |     |                 |   |             |  |   |   |  |   |       | 
| | Total available-for-sale marketable securities |  | $             | 281 |                  | $ | (2          | ) | $             | 279 |                 | $ | 1,805       |  | $ | - |  | $ | 1,805 | 
| |                                                |  |               |     |                  |   |             |   |               |     |                 |   |             |  |   |   |  |   |       | 

|            |                                                                                                           
|----------- | ----------------------------------------------------------------------------------------------------------
|            | During 2005,
  the Company recorded proceeds from sales of marketable securities in the
  amount of $ 279.
|            |                                                                                                           
|NOTE 4:    | OTHER ACCOUNTS RECEIVABLE AND PREPAID EXPENSES                                                            

| |                        |  |                |     |      |   |     | 
| | ---------------------- |  | -------------- | --- | ---- | - | --- | 
| |                        |  | December
  31, |    
| |                        |  |                |    
| |                        |  | 2004           |     | 2005 |  
| |                        |  |                |     |      |  
| |                        |  |                |     |      |  
| | Employees and others   |  | $              | 45  |      | $ | 130 | 
| | Government authorities |  |                | 318 |      |   | 316 | 
| | Prepaid expenses       |  |                | 203 |      |   | 176 | 
| |                        |  |                |     |      |   |     | 
| |                        |  |                |     |      |   |     | 
| |                        |  | $              | 566 |      | $ | 622 | 
| |                        |  |                |     |      |   |     | 

F-18

---

---



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

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

| |                                      |  |                |       |      |   |       | 
| | ------------------------------------ |  | -------------- | ----- | ---- | - | ----- | 
| |                                      |  | December
  31, |      
| |                                      |  |                |      
| |                                      |  | 2004           |       | 2005 |  
| |                                      |  |                |       |      |  
| |                                      |  |                |       |      |   |       | 
| | Cost:                                |  |                |       |      |   |       | 
| | Computers
  and peripheral equipment |  | $              | 1,568 |      | $ | 1,674 | 
| | Furniture
  and office equipment     |  |                | 487   |      |   | 545   | 
| | Leasehold
  improvements             |  |                | 139   |      |   | 139   | 
| |                                      |  |                |       |      |   |       | 
| |                                      |  |                |       |      |   |       | 
| |                                      |  |                | 2,194 |      |   | 2,358 | 
| |                                      |  |                |       |      |   |       | 
| | Accumulated depreciation:            |  |                |       |      |   |       | 
| | Computers
  and peripheral equipment |  |                | 1,246 |      |   | 1,383 | 
| | Furniture
  and office equipment     |  |                | 261   |      |   | 309   | 
| | Leasehold
  improvement              |  |                | 69    |      |   | 89    | 
| |                                      |  |                |       |      |   |       | 
| |                                      |  |                |       |      |   |       | 
| |                                      |  |                | 1,576 |      |   | 1,781 | 
| |                                      |  |                |       |      |   |       | 
| |                                      |  |                |       |      |   |       | 
| | Depreciated cost                     |  | $              | 618   |      | $ | 577   | 
| |                                      |  |                |       |      |   |       | 

|            |                                                                                                                                 |                                  
|----------- | ------------------------------------------------------------------------------------------------------------------------------- | ---------------------------------
|            | Depreciation
  expense amounted to $ 215, $ 189 and $ 205 for the years ended December 31,
  2003, 2004 and 2005, respectively.
|            |                                                                                                                                 |                                  
|            | As to
  charges, see Note 9c(1).                                                                                               
|            |                                                                                                                                 |                                  
|NOTE 6:    | OTHER INTANGIBLE ASSETS                                                                                                        
|            |                                                                                                                                
|            | Other
  intangible assets arose from the acquisition of the business from Toyo in
  August 2004 (see Note 1b).                 
|            |                                                                                                                                 |                                  
|            | a.                                                                                                                              | Identifiable
  intangible assets:

| |                           |  |                |       |      |   |       | 
| | ------------------------- |  | -------------- | ----- | ---- | - | ----- | 
| |                           |  | December
  31, |      
| |                           |  |                |      
| |                           |  | 2004           |       | 2005 |  
| |                           |  |                |       |      |  
| | Original amount:          |  |                |       |      |   |       | 
| | Customer
  relations      |  | $              | 750   |      | $ | 750   | 
| | Acquired
  technology     |  |                | 750   |      |   | 750   | 
| |                           |  |                |       |      |   |       | 
| |                           |  |                |       |      |   |       | 
| |                           |  |                | 1,500 |      |   | 1,500 | 
| |                           |  |                |       |      |   |       | 
| | Accumulated amortization: |  |                |       |      |   |       | 
| | Customer
  relations      |  |                | 50    |      |   | 200   | 
| | Acquired
  technology     |  |                | 31    |      |   | 200   | 
| |                           |  |                |       |      |   |       | 
| |                           |  |                |       |      |   |       | 
| |                           |  |                | 81    |      |   | 400   | 
| |                           |  |                |       |      |   |       | 
| |                           |  |                |       |      |   |       | 
| | Amortized cost            |  | $              | 1,419 |      | $ | 1,100 | 
| |                           |  |                |       |      |   |       | 

F-19

---

---



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

|            |                                 |                                                                                                                   
|----------- | ------------------------------- | ------------------------------------------------------------------------------------------------------------------
|NOTE 6:    | OTHER INTANGIBLE ASSETS (Cont.)
|            |                                
|            | b.                              | Amortization
  expenses amounted to $ 81 and $ 319 for the years ended December 31, 2004 and
  2005, respectively.
|            |                                 |                                                                                                                   
|            | c.                              | Estimated
  amortization expenses for the year ended:                                                             

| |              |  |   |                             |  | 
| | ------------ |  | - | --------------------------- |  | 
| | December 31, |  |   | Other
  intangible
  assets | 
| |              |  |   |                             | 
| |              |  |   |                             | 
| | 2006         |  | $ | 300                         |  | 
| | 2007         |  | $ | 300                         |  | 
| | 2008         |  | $ | 300                         |  | 
| | 2009         |  | $ | 200                         |  | 

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

| |                           |  |               |  |              |  |      |       |      |   |       | 
| | ------------------------- |  | ------------- |  | ------------ |  | ---- | ----- | ---- | - | ----- | 
| |                           |  | Interest rate |  | December 31, | 
| |                           |  |               |  |              | 
| |                           |  | 2004          |  | 2005         |  | 2004 |       | 2005 |  
| |                           |  |               |  |              |  |      |       |      |  
| |                           |  | %             |  |              |  |      |       |      |  
| |                           |  |               |  |              |  |      |       |      |  
| | Short-term
  bank loans:  |  |               |  |              |  |      |       |      |   |       | 
| | In NIS                    |  | 5.3           |  | 5.8          |  | $    | 247   |      | $ | 740   | 
| |                           |  |               |  |              |  |      |       |      |   |       | 
| |                           |  |               |  |              |  |      |       |      |   |       | 
| | Short-term
  bank credit: |  |               |  |              |  |      |       |      |   |       | 
| | In NIS (1)                |  | Prime +
  1%  |  | Prime +
  1% |  |      | 150   |      |   | 85    | 
| | In U.S. dollars (2)       |  | Libor +
  2%  |  | Libor +
  2% |  |      | 1,310 |      |   | 1,354 | 
| |                           |  |               |  |              |  |      |       |      |   |       | 
| |                           |  |               |  |              |  |      |       |      |   |       | 
| |                           |  |               |  |              |  |      | 1,460 |      |   | 1,439 | 
| |                           |  |               |  |              |  |      |       |      |   |       | 
| |                           |  |               |  |              |  |      |       |      |   |       | 
| |                           |  |               |  |              |  | $    | 1,707 |      | $ | 2,179 | 
| |                           |  |               |  |              |  |      |       |      |   |       | 

| |    |                                                                                                                                                                                                       |                                                                                         
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------
| |    | (1)                                                                                                                                                                                                   | As of
  December 31, 2004 and 2005, the prime rate is 5.2% and 7%, respectively.        
| |    |                                                                                                                                                                                                       |                                                                                         
| |    | (2)                                                                                                                                                                                                   | As of
  December 31, 2004 and 2005, the Libor rate is 2.375% and 4.375%,
  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 9c(2)).
| |    |                                                                                                                                                                                                      
| | b. | Interest
  expenses amounted to $ 68, $ 72 and $ 100 for the years ended 2003, 2004 and
  2005, respectively.                                                                                        

F-20

---

---



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

|            |                                           
|----------- | ------------------------------------------
|NOTE 8:    | ACCRUED EXPENSES ANDOTHER ACCOUNTS PAYABLE

| |                                      |  |                |       |      |   |       | 
| | ------------------------------------ |  | -------------- | ----- | ---- | - | ----- | 
| |                                      |  | December
  31, |      
| |                                      |  |                |      
| |                                      |  | 2004           |       | 2005 |  
| |                                      |  |                |       |      |  
| |                                      |  |                |       |      |   |       | 
| | Employees                            |  | $              | 171   |      | $ | 172   | 
| | Government authorities               |  |                | 398   |      |   | 575   | 
| | Accrued expenses and other           |  |                | 1,066 |      |   | 772   | 
| | Provision for accrued
  vacation pay |  |                | 243   |      |   | 254   | 
| | Deferred revenues                    |  |                | 300   |      |   | 440   | 
| |                                      |  |                |       |      |   |       | 
|
| |                                      |  | $              | 2,178 |      | $ | 2,213 | 
| |                                      |  |                |       |      |   |       | 

|            |                                       
|----------- | --------------------------------------
|NOTE 9:    | COMMITMENTS, CONTINGENCIES AND CHARGES

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                             
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a. | Legal
  proceedings:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |    | During 2003,
  the Company was named as a defendant in a case brought by Millennium LP
  (Millennium), in the District Court for the Southern District of New York.
  In the case, Millennium asserted that certain image processing systems sold
  or offered for sale by the Company in the United States infringed on certain
  U.S. patents held by Millennium. In 2004, the Company settled the matter for
  $ 250, of which the Company paid $ 100 at the time the settlement agreement was
  finalized. The remainder is being paid in monthly installments of $ 6.25 over
  a period of 24 months. Pursuant to the settlement agreement, Millennium
  released the Company from any past and future infringement claims until the
  expiration of the patents.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | b. | Commitments:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |    | 1.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | 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 $ 67 and $ 66 as of December 31, 2004 and 2005, respectively.                                                                                                                                    
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                             
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          | 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.                                                                                                                                                                                                               

F-21

---

---



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

|            |                                                 
|----------- | ------------------------------------------------
|NOTE 9:    | COMMITMENTS, CONTINGENCIES AND CHARGES
  (Cont.)

| |  |    |                                                                                                                                                                                                                                                                                                                                
| |  | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 2. | The Company
  has entered into an 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, 2005, commitments are as follows:

| |       |  |   |     | 
| | ----- |  | - | --- | 
| | 2006  |  | $ | 152 | 
| | 2007  |  |   | 79  | 
| | 2008  |  |   | 15  | 
| |       |  |   |     | 
|
| | Total |  | $ | 246 | 
| |       |  |   |     | 

| |  |    |                                                                                                                                                                                                                           
| |  | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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,
  2005, commitments for such leases are as follows:

| |       |  |   |     | 
| | ----- |  | - | --- | 
| | 2006  |  | $ | 257 | 
| | 2007  |  |   | 203 | 
| |       |  |   |     | 
|
| | Total |  | $ | 460 | 
| |       |  |   |     | 

| |  |  |                                                                                     
| |  |  | ------------------------------------------------------------------------------------
| |  |  | Part of the
  lease agreements is secured by a bank guarantee in the amount of $ 53.

| |  |    |                                                                                                                                                                                                                                                                                                                                                                                                             
| |  | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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 year 2005 the Company paid annual fees of $300.
| |  |    |                                                                                                                                                                                                                                                                                                                                                                                                             

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

F-22

---

---



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

|            |                
|----------- | ---------------
|NOTE 10:   | TAXES ON INCOME

| |    |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | -- | ----------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a. | Israeli
  income taxes:
| |    |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    | 1.                      | The Law for
  the Encouragement of Capital Investments, 1959 (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 years of tax at a reduced rate (25%). Additionally,
  the Company is a foreign investors company, as defined by that law and, as
  such, is entitled to additional reduction of the tax to 15% - 20% (based on
  the percentage of foreign ownership in each tax year) and an extension of
  three years for the benefit period. Since the Company has had no taxable
  income, the benefits have not yet commenced for any of the programs.
| |    |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    |                         | The period
  of tax benefits, detailed above, is subject to limit of 12 years from the
  commencement of production, or 14 years from the approval date, whichever is
  earlier.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    |                         | The Company
  received approvals for the first program and two of its expansions during the
  years 1990, 1991 and 1999, of which the first two programs have already
  expired. The period of benefits for the third expansion has not yet
  commenced.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |    |                         |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    |                         | 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,
  2005, 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 15%-20% for an Approved Enterprise. As of December 31, 2005, 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              

F-23

---

---



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

|            |                        
|----------- | -----------------------
|NOTE 10:   | TAXES ON INCOME (Cont.)

| |  |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |  | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  |    | On April 1,
  2005, an amendment to the Investment Law came into effect (the Amendment)
  and has significantly changed the provisions of the Investment Law. The
  Amendment limits the scope of enterprises which may be approved by the
  Investment Center by setting criteria for the approval of a facility as an
  Approved Enterprise, such as provisions generally requiring that at least 25%
  of the Approved Enterprises income will be derived from export. Additionally,
  the Amendment enacted major changes in the manner in which tax benefits are
  awarded under the Investment Law so that companies no longer require
  Investment Center approval in order to qualify for tax benefits.                                                                                                                                                                                                      
| |  |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |  |    | However, the
  Investment Law provides that terms and benefits included in any certificate
  of approval already granted will remain subject to the provisions of the law
  as they were on the date of such approval. Therefore, TIS Israel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, 2005, the Company did not generate income under the provisions of the
  Amendment.                                                                                                                                                                              
| |  |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |  | 2. | Measurement
  of taxable income:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |  |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |  |    | Under the
  Income Tax (Inflationary Adjustments) Law, 1985 (the Israeli
  law), results for tax purposes in Israel are measured in real terms,
  in accordance with the changes in the Israeli Consumer Price Index (Israeli
  CPI). Accordingly, until 2002, results for tax purposes were measured in
  terms of earnings in NIS after certain adjustments for increases in the
  Israeli CPI. Commencing in taxable year 2003, the Company has elected to
  measure its taxable income and file its tax return under the Israeli Income
  Tax Regulations (Principles Regarding the Management of Books of Account of
  Foreign Invested Companies and Certain Partnerships and the Determination of
  Their Taxable Income), 1986. Such an elective obligates the Company for three
  years. Accordingly, commencing taxable year 2003, results for tax purposes are
  measured in terms of earnings in dollar.
| |  |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |  | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  

F-24

---

---



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

|            |                        
|----------- | -----------------------
|NOTE 10:   | TAXES ON INCOME (Cont.)

| |    |                                                                                                                                                                                                                                                                                                                                                                                                            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    | 4.                                                                                                                                                                                                                                                                                                                                                                                                         | Tax rates:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |    |                                                                                                                                                                                                                                                                                                                                                                                                            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    |                                                                                                                                                                                                                                                                                                                                                                                                            | Until
  December 31, 2003, the regular tax rate applicable to income of companies
  (which are not entitled to benefits due to approved enterprise, as
  described above) was 36%. In June 2004, an amendment to the Income Tax
  Ordinance (No. 140 and Temporary Provision), 2004 was passed by the Knesset
  (Israeli parliament) and on July 25, 2005, another law was passed, the
  amendment to the Income Tax Ordinance (No. 147) 2005, according to which the
  corporate tax rate is to be progressively reduced to the following tax rates:
  2004 - 35%, 2005 - 34%, 2006 - 31%, 2007 - 29%, 2008 - 27%, 2009 - 26%, 2010
  and thereafter - 25%.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    | 5.                                                                                                                                                                                                                                                                                                                                                                                                         | The Company
  has received final tax assessments through the 1999 tax year.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    |                                                                                                                                                                                                                                                                                                                                                                                                            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | 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 and the effect of the Approved
  Enterprise.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                           
| |    | The tax
  expenses in the amount of $ 30 in the financial statements are a result of
  taxes paid on income of the German subsidiary, due to the transfer pricing
  between the subsidiary and the parent company.                                                                                                                                                                                        
| |    |                                                                                                                                                                                                                                                                                                                                                                                                           
| | c. | Carryforward
  losses:                                                                                                                                                                                                                                                                                                                                                                                    
| |    |                                                                                                                                                                                                                                                                                                                                                                                                           
| |    | As of
  December 31, 2005, the Company had operating losses carryforward for tax
  purposes in the amount of $ 4,613. The amount of the Companys carryforward
  operating losses will be offset against taxable future income for an
  indefinite period.                                                                                                                                                
| |    |                                                                                                                                                                                                                                                                                                                                                                                                           
| |    | As of
  December 31, 2005, the subsidiaries had operating losses carryforward for tax
  purposes in the amount of $ 4,463. A portion of such losses expires over a
  period from 2006 through 2018.                                                                                                                                                                                                       
| |    |                                                                                                                                                                                                                                                                                                                                                                                                           
| | d. | Loss before
  taxes on income:                                                                                                                                                                                                                                                                                                                                                                            

| |          |  |                           |      |      |   |      |   |   |      |  
| | -------- |  | ------------------------- | ---- | ---- | - | ---- | - | - | ---- | -
| |          |  | Year ended
  December 31, |     
| |          |  |                           |     
| |          |  | 2003                      |      | 2004 |   | 2005 |  
| |          |  |                           |      |      |   |      |  
| |          |  |                           |      |      |   |      |   |   |      |  
| | Domestic |  | $                         | (48  | )    | $ | (75  | ) | $ | (22  | )
| | Foreign  |  |                           | (546 | )    |   | (93  | ) |   | (409 | )
| |          |  |                           |      |      |   |      |   |   |      |  
| |          |  |                           |      |      |   |      |   |   |      |  
| |          |  | $                         | (594 | )    | $ | (168 | ) | $ | (431 | )
| |          |  |                           |      |      |   |      |   |   |      |  

F-25

---

---



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

|            |                        
|----------- | -----------------------
|NOTE 10:   | TAXES ON INCOME (Cont.)

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

| |                                                      |  |              |        |      |   |        |  
| | ---------------------------------------------------- |  | ------------ | ------ | ---- | - | ------ | -
| |                                                      |  | December 31, |       
| |                                                      |  |              |       
| |                                                      |  | 2004         |        | 2005 |  
| |                                                      |  |              |        |      |  
| |                                                      |  |              |        |      |   |        |  
| | Carryforward losses                                  |  | $            | 3,920  |      | $ | 2,538  |  
| | Accrued severance pay                                |  |              | 63     |      |   | 59     |  
| | Accrued vacation pay                                 |  |              | 83     |      |   | 81     |  
| | Allowance for doubtful accounts                      |  |              | 312    |      |   | 131    |  
| | Provision, bonuses and other special
  charges       |  |              | 44     |      |   | -      |  
| |                                                      |  |              |        |      |   |        |  
| |                                                      |  |              |        |      |   |        |  
| | Net deferred tax assets before valuation
  allowance |  |              | 4,422  |      |   | 2,809  |  
| | Valuation allowance                                  |  |              | (4,422 | )    |   | (2,809 | )
| |                                                      |  |              |        |      |   |        |  
| |                                                      |  |              |        |      |   |        |  
| | 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.

|            |                     
|----------- | --------------------
|NOTE 11:   | 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.                                                                                                                                                                                                  
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    | 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.

F-26

---

---



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

|            |                             
|----------- | ----------------------------
|NOTE 11:   | SHAREHOLDERS EQUITY (Cont.)

| |    |                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | -- | ------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | b. | Employee
  stock options:
| |    |                          
| |    | 1.                        | The Company
  has 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, 2005, 17,875 options are outstanding and exercisable at prices
  ranging between $ 2.77 and $ 5 per share.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    |                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    | 2.                        | 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, 2005, options to purchase 82,625 Ordinary shares are outstanding
  under the plan at exercise prices between $ 0.52 and $ 5 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.                                                                                                                                                                                                                                                                                             
| |    |                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    | 3.                        | 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, 2005, 135,500 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.                                                                                                                                                                                                                                                                                                                                       
| |    |                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    | 4.                        | 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.                                                                                                                                                                                                                                                                                                                                                                                                                         
| |    |                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    |                           | 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.

F-27

---

---



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

|            |                             
|----------- | ----------------------------
|NOTE 11:   | SHAREHOLDERS EQUITY (Cont.)

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |                                                                                                                                                                                            
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | In May 2004,
  the Board of Directors and the shareholders of the Company approved the
  issuance of options to purchase an additional 650,000 Ordinary shares
  pursuant to the ESOP 2003.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |                                                                                                                                                                                            
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | As of
  December 31, 2005, 586,000 options are outstanding. All the options have an
  exercise price between $ 1.31 and $ 3.27 per share.                                                  
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |                                                                                                                                                                                            
| |    | 5.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 | As of
  December 31, 2005, an aggregate amount of 359,917 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, shall be 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 by approximately
  $ 568 (see Note 2l).                                                                                                                                                                                                                                                                                                                                                                                                                                       

F-28

---

---



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

|            |                             
|----------- | ----------------------------
|NOTE 11:   | SHAREHOLDERS EQUITY (Cont.)

| |  |                                                                                                                                | 
| |  | ------------------------------------------------------------------------------------------------------------------------------ | 
| |  | 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, |         
| |                                                                  |  |                           |         
| |                                                                  |  | 2003                      |          | 2004                                  |   | 2005                | 
| |                                                                  |  |                           |          |                                       |   |                     | 
| |                                                                  |  | Number of
  options       |          | Weighted
  average
  exercise
  price |   | Number of
  options |  | Weighted
  average
  exercise
  price |         | Number of
  options |   | Weighted
  average
  exercise price | 
| |                                                                  |  |                           |          |                                       |   |                     |  |                                       |         |                     |   |                                     | 
| | Outstanding at the beginning of the year                         |  |                           | 434,500  |                                       | $ | 2.81                |  |                                       | 417,875 |                     | $ | 2.46                                |  |  | 499,375 |   | $ | 2.60 | 
| | Granted                                                          |  |                           | 116,000  |                                       | $ | 1.34                |  |                                       | 153,000 |                     | $ | 3.08                                |  |  | 350,000 |   | $ | 2.72 | 
| | Exercised                                                        |  |                           | (6,875   | )                                     | $ | 1.59                |  |                                       | (23,875 | )                   | $ | 2.93                                |  |  | (3,375  | ) | $ | 1.66 | 
| | Forfeited                                                        |  |                           | (125,750 | )                                     | $ | 2.70                |  |                                       | (47,625 | )                   | $ | 2.75                                |  |  | (24,000 | ) | $ | 2.38 | 
| |                                                                  |  |                           |          |                                       |   |                     |  |                                       |         |                     |   |                                     |  |  |         |   |   |      | 
| | Outstanding at the end of the year                               |  |                           | 417,875  |                                       | $ | 2.46                |  |                                       | 499,375 |                     | $ | 2.60                                |  |  | 822,000 |   | $ | 2.65 | 
| |                                                                  |  |                           |          |                                       |   |                     |  |                                       |         |                     |   |                                     |  |  |         |   |   |      | 
| |                                                                  |  |                           |          |                                       |   |                     |  |                                       |         |                     |   |                                     |  |  |         |   |   |      | 
| | Exercisable at the end of the year                               |  |                           | 246,000  |                                       |   |                     |  |                                       | 260,375 |                     |   |                                     |  |  | 620,500 |   |   |      | 
| |                                                                  |  |                           |          |                                       |   |                     |  |                                       |         |                     |   |                                     |  |  |         |   |   |      | 
| |                                                                  |  |                           |          |                                       |   |                     |  |                                       |         |                     |   |                                     |  |  |         |   |   |      | 
| | Weighted average fair value of options
  granted during the year |  |                           |          |                                       | $ | 1.15                |  |                                       |         |                     | $ | 1.93                                |  |  |         |   | $ | 1.84 | 
| |                                                                  |  |                           |          |                                       |   |                     |  |                                       |         |                     |   |                                     |  |  |         |   |   |      | 

| |  |                                                                                                                   
| |  | ------------------------------------------------------------------------------------------------------------------
| |  | The options
  outstanding as of December 31, 2005, have been separated into ranges of
  exercise price as follows:

| |                             |  |                                                     |         |                                                             |  |                                       |  |                                                     |      |                                                                  |  |         |  |   |      | 
| | --------------------------- |  | --------------------------------------------------- | ------- | ----------------------------------------------------------- |  | ------------------------------------- |  | --------------------------------------------------- | ---- | ---------------------------------------------------------------- |  | ------- |  | - | ---- | 
| | Range of
  exercise
  price |  | Options
  Outstanding
  as of
  December 31,
  2005 |         | Weighted
  average
  remaining
  contractual
  life (years) |  | Weighted
  average
  exercise
  price |  | Options
  exercisable
  as of
  December 31,
  2005 |      | Weighted
  average
  exercise
  price of
  options
  exercisable | 
| |                             |  |                                                     |         |                                                             |  |                                       |  |                                                     |      |                                                                  | 
| |                             |  |                                                     |         |                                                             |  |                                       |  |                                                     |      |                                                                  |  |         |  |   |      | 
| | $ 0.99-$ 1.70               |  |                                                     | 142,000 |                                                             |  | 6.63                                  |  | $                                                   | 1.33 |                                                                  |  | 73,000  |  | $ | 1.35 | 
| | $ 2.08-$ 2.92               |  |                                                     | 519,000 |                                                             |  | 8.56                                  |  | $                                                   | 2.70 |                                                                  |  | 406,500 |  | $ | 2.69 | 
| | $ 3-$ 4.125                 |  |                                                     | 145,000 |                                                             |  | 7.07                                  |  | $                                                   | 3.54 |                                                                  |  | 125,000 |  | $ | 3.58 | 
| | $ 5                         |  |                                                     | 16,000  |                                                             |  | 1                                     |  | $                                                   | 5.00 |                                                                  |  | 16,000  |  | $ | 5.00 | 
| |                             |  |                                                     |         |                                                             |  |                                       |  |                                                     |      |                                                                  |  |         |  |   |      | 
| |                             |  |                                                     |         |                                                             |  |                                       |  |                                                     |      |                                                                  |  |         |  |   |      | 
| |                             |  |                                                     | 822,000 |                                                             |  |                                       |  | $                                                   | 2.66 |                                                                  |  | 620,500 |  | $ | 2.77 | 
| |                             |  |                                                     |         |                                                             |  |                                       |  |                                                     |      |                                                                  |  |         |  |   |      | 

| |  |    |                                                                                                                                                                                                                                                                                                                                                                                
| |  | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | d. | Share
  purchase agreement:                                                                                                                                                                                                                                                                                                                                                    
| |  |    |                                                                                                                                                                                                                                                                                                                                                                                
| |  |    | In
  consideration of the purchase of 990,000 of E - Mobilis shares, the Board of
  Directors of the Company granted the sellers on November 8, 2001, options to
  purchase 100,000 Ordinary shares that vested immediately, at an exercise
  price of $ 2 per share. During 2003, 15,000 options were exercised and the
  remaining 85,000 options were exercised during 2004.
| |  |    |                                                                                                                                                                                                                                                                                                                                                                                
| |  | e. | Options to
  directors:                                                                                                                                                                                                                                                                                                                                                        
| |  |    |                                                                                                                                                                                                                                                                                                                                                                                
| |  |    | On November
  25, 2002, the shareholders of the Company approved the grant of an option to
  purchase 20,000 fully vested Ordinary shares at an exercise price of $ 0.46
  per share, to the Chairman of the Board of Directors. The exercise price was
  equal to the market price of the shares on the date of the grant. In August
  2005, all the options were exercised.  

F-29

---

---



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

|            |                             
|----------- | ----------------------------
|NOTE 11:   | SHAREHOLDERS EQUITY (Cont.)

|            |                          |                                                                                                                                                                                                                                                                                                                                     
|----------- | ------------------------ | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|            | 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.                                                                                                                                                                                                                                                       
|            |                          |                                                                                                                                                                                                                                                                                                                                     
|NOTE 12:   | 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, |      
| |                                                                      |  |                           |      
| |                                                                      |  | 2003                      |       | 2004 |   | 2005   |  
| |                                                                      |  |                           |       |      |   |        |  
| | Product
  sales:                                                     |  |                           |       |      |   |        |   |   |        |  
| | Israel                                                               |  | $                         | 10    |      | $ | 142    |   | $ | 60     |  
| | Far East
  (excluding Japan)                                         |  |                           | 1,316 |      |   | 598    |   |   | 2,020  |  
| | Europe                                                               |  |                           | 4,280 |      |   | 5,356  |   |   | 5,604  |  
| | North
  America                                                      |  |                           | 43    |      |   | 607    |   |   | 734    |  
| | South
  America                                                      |  |                           | 506   |      |   | -      |   |   | 210    |  
| | Africa                                                               |  |                           | 56    |      |   | 166    |   |   | 512    |  
| | Japan                                                                |  |                           | -     |      |   | 95     |   |   | 748    |  
| |                                                                      |  |                           |       |      |   |        |   |   |        |  
|
| |                                                                      |  |                           | 6,211 |      |   | 6,964  |   |   | 9,888  |  
| |                                                                      |  |                           |       |      |   |        |   |   |        |  
| | Service
  revenues:                                                  |  |                           |       |      |   |        |   |   |        |  
| | Israel                                                               |  |                           | 21    |      |   | 42     |   |   | 78     |  
| | Far East (excluding
  Japan)                                         |  |                           | 139   |      |   | 326    |   |   | 375    |  
| | Europe                                                               |  |                           | 1,449 |      |   | 2,610  |   |   | 3,396  |  
| | North
  America                                                      |  |                           | 349   |      |   | 647    |   |   | 868    |  
| | South
  America                                                      |  |                           | 10    |      |   | -      |   |   | 15     |  
| | Africa and
  Middle East (excluding Israel)                          |  |                           | 89    |      |   | 14     |   |   | 53     |  
| | Japan                                                                |  |                           | 51    |      |   | 575    |   |   | 2,147  |  
| |                                                                      |  |                           |       |      |   |        |   |   |        |  
|
| |                                                                      |  |                           | 2,108 |      |   | 4,214  |   |   | 6,932  |  
| |                                                                      |  |                           |       |      |   |        |   |   |        |  
|
| | Total
  revenues                                                     |  | $                         | 8,319 |      | $ | 11,178 |   | $ | 16,820 |  
| |                                                                      |  |                           |       |      |   |        |   |   |        |  
| |                                                                      |  |                           |       |      |   |        |   |   |        |  
| | Sales to
  single customers exceeding 10% of revenues:               |  |                           |       |      |   |        |   |   |        |  
| | Customer A                                                           |  |                           | 17    | %    |   | 10     | % |   | *) -   |  
| |                                                                      |  |                           |       |      |   |        |   |   |        |  
|
| | Customer B                                                           |  |                           | *) -  |      |   | *) -   |   |   | 10     | %
| |                                                                      |  |                           |       |      |   |        |   |   |        |  
|
| | *) Less than
  10%                                                   |  |                           |       |      |   |        |   |   |        |  
|
| | The
  Companys substantial long-lived assets are located in Israel. | 

F-30

---

---



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

|            |                                                                                            
|----------- | -------------------------------------------------------------------------------------------
|NOTE 13:   | BASIC AND DILUTED NET LOSS PER SHARE                                                       
|            |                                                                                            
|            | The
  following table sets forth the computation of basic and diluted net loss per
  share:

| |                                                                                           |  |                           |           |      |   |           |   |   |           |  
| | ----------------------------------------------------------------------------------------- |  | ------------------------- | --------- | ---- | - | --------- | - | - | --------- | -
| |                                                                                           |  | Year ended
  December 31, |          
| |                                                                                           |  |                           |          
| |                                                                                           |  | 2003                      |           | 2004 |   | 2005      |  
| |                                                                                           |  |                           |           |      |   |           |  
|
| | Numerator for basic and diluted net loss
  per share - net loss available to shareholders |  | $                         | (594      | )    | $ | (168      | ) | $ | (461      | )
| |                                                                                           |  |                           |           |      |   |           |   |   |           |  
| |                                                                                           |  |                           |           |      |   |           |   |   |           |  
| | Weighted average shares outstanding:                                                      |  |                           |           |      |   |           |   |   |           |  
| |                                                                                           |  |                           |           |      |   |           |   |   |           |  
| | Denominator for basic net loss per share                                                  |  |                           | 6,102,496 |      |   | 6,905,559 |   |   | 8,764,222 |  
| | Effect of dilutive securities                                                             |  |                           | *)     -  |      |   | *)     -  |   |   | *)     -  |  
| |                                                                                           |  |                           |           |      |   |           |   |   |           |  
| |                                                                                           |  |                           |           |      |   |           |   |   |           |  
| | Denominator for diluted net loss per share                                                |  |                           | 6,102,496 |      |   | 6,905,559 |   |   | 8,764,222 |  
| |                                                                                           |  |                           |           |      |   |           |   |   |           |  
| |                                                                                           |  |                           |           |      |   |           |   |   |           |  
| | Basic and diluted net loss per share                                                      |  | $                         | (0.11     | )    | $ | (0.02     | ) | $ | (0.05     | )
| |                                                                                           |  |                           |           |      |   |           |   |   |           |  

|            |                                 
|----------- | --------------------------------
|            | *)          Anti
  dilutive.    
|            |                                 
|NOTE 14:   | FINANICAL INCOME (EXPENSES), NET

| |                                            |  |                           |     |      |   |      |  |   |         |  
| | ------------------------------------------ |  | ------------------------- | --- | ---- | - | ---- |  | - | ------- | -
| |                                            |  | Year ended
  December 31, |    
| |                                            |  |                           |    
| |                                            |  | 2003                      |     | 2004 |   | 2005 | 
| |                                            |  |                           |     |      |   |      | 
|
| | Interest income, net                       |  | $                         | 61  |      | $ | 84   |  | $ | 140     |  
| | Exchange rate gain (loss) and bank charges |  |                           | 59  |      |   | 93   |  |   | *) (326 | )
| | Gain (loss) from marketable securities     |  |                           | (11 | )    |   | 1    |  |   | 40      |  
| |                                            |  |                           |     |      |   |      |  |   |         |  
| |                                            |  |                           |     |      |   |      |  |   |         |  
| |                                            |  | $                         | 109 |      | $ | 178  |  | $ | (146    | )
| |                                            |  |                           |     |      |   |      |  |   |         |  

|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|----------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|            | *)        Includes
  income from forward transactions in the amount of $ 109.                                                                                                                                                                                                                                                                                                                                                                                        
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|NOTE 15:   | 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 $114 for consulting fees related
  to other business development affairs in 2005.  In addition, during 2005, the director received $6 for his
  service as a Board member

F-31

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