SECURITIES AND EXCHANGE COMMISSION
                              Washington D.C. 20549

                                    FORM 20-F

[ ]   REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF
      THE SECURITIES EXCHANGE ACT OF 1934
                                       OR
[X]   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
      THE SECURITIES EXCHANGE ACT OF 1934

                   For the fiscal year ended December 31, 2005
                                       OR
[ ]   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
      THE SECURITIES EXCHANGE ACT OF 1934

              For the transition period from _________ to _________

                                                      OR
[ ]   SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
      THE SECURITIES EXCHANGE ACT OF 1934

              Date of event requiring this shell company report

                         Commission file number: 0-28950

                        MER TELEMANAGEMENT SOLUTIONS LTD.
              (Exact name of Registrant as specified in its charter
               and translation of Registrant's name into English)
                                     Israel
                        (Jurisdiction of incorporation or
                         organization) 22 Zarhin Street,
                         Ra'anana 43662, Israel (Address
                         of principal executive offices)

Securities registered or to be registered pursuant to Section 12(b) of the Act:
None

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

                       Ordinary Shares, NIS 0.01 Par Value
                                (Title of Class)

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, par value NIS 0.01 per share ............ 5,733,504
                            (as of December 31, 2005)

<PAGE>

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

                                 Yes ___ 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 ___ No _X_

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 ___

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

                             Item 17 ___ 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 ___ No _X_

This Report on Form 20-F is incorporated by reference into our Form F-3
Registration Statement File No. 333-128225 and into our Form S-8 Registration
Statements File No. 333-12014 and 333-123321.

<PAGE>

                                  INTRODUCTION

         Mer Telemanagement Solutions Ltd. is a total solutions provider in the
telecom expense and billing arenas. We design, develop, market and support a
comprehensive line of telecommunication management, expense management and
customer care and billing, or CC&B, solutions that enable business organizations
and other enterprises to improve the efficiency and performance of their
Internet Protocol, or IP, operations and to significantly reduce associated
costs. Our products include call accounting and management products, fault
management systems and Web-based management solutions for converged voice, voice
over IP, IP data and video and CC&B solutions. These products are designed to
provide telecommunication and information technology managers with tools to
reduce communication costs, recover charges payable by third parties, detect and
report the abuse and misuse of telephone networks, monitor and detect hardware
and software faults in telecommunications networks and generate
telecommunications usage information for use in the management of an enterprise.
We were among the first to offer PC-based call accounting systems when we
introduced our TABS product in 1985. To date, over 70,000 TABS call accounting
systems have been sold to end-users in more than 80 countries. In the service
provider and carrier market, our billing solutions provide for retail billing,
interconnect billing and partner revenue management.

         Since our public offering in May 1997, our ordinary shares have been
listed on the NASDAQ Stock Market (symbol: MTSL). As used in this annual report,
the terms "we," "us" and "our" mean Mer Telemanagement Solutions Ltd. and its
subsidiaries, unless otherwise indicated.

         We have obtained a trademark registration for TABS by MER(R) and
applied for trademark registrations for TABS.IT(TM), eTABS(TM), VoIPTABS(TM),
wTABS(TM), FaciliTRAK(TM), TABSbill(TM), TOPS(TM) and PMSi(TM). We have been
using "Application Suite" as a trade name for our suite of modules for a
comprehensive telecommunications expense management solution. We have also
acquired the rights in the TOTAL-e(TM) trademark in connection with the products
we acquired from Teleknowledge Group Ltd. in December 2004. All other trademarks
and trade names appearing in this annual report are owned by their respective
holders.

         Our consolidated financial statements appearing in this annual report
are prepared in U.S. dollars and in accordance with generally accepted
accounting principles in the United States, or U.S. GAAP. All references in this
annual report to "dollars" or "$" are to U.S. dollars and all references in this
annual report to "NIS" are to New Israeli Shekels.

         Statements made in this annual report concerning the contents of any
contract, agreement or other document are summaries of such contracts,
agreements or documents and are not complete descriptions of all of their terms.
If we filed any of these documents as an exhibit to this annual report or to any
registration statement or annual report that we previously filed, you may read
the document itself for a complete description of its terms.

         Except for the historical information contained in this annual report,
the statements contained in this annual report are "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended, and the Private
Securities Litigation Reform Act of 1995, as amended, with respect to

                                       i
<PAGE>

our business, financial condition and results of operations. Such
forward-looking statements reflect our current view with respect to future
events and financial results. We urge you to consider that statements which use
the terms "anticipate," "believe," "do not believe," "expect," "plan," "intend,"
"estimate," "anticipate" and similar expressions are intended to identify
forward-looking statements. We remind readers that forward-looking statements
are merely predictions and therefore inherently subject to uncertainties and
other factors and involve known and unknown risks that could cause the actual
results, performance, levels of activity, or our achievements, or industry
results, to be materially different from any future results, performance, levels
of activity, or our achievements expressed or implied by such forward-looking
statements. Such forward-looking statements are also included in Item 4 -
"Information on the Company" and Item 5 - "Operating and Financial Review and
Prospects." Readers are cautioned not to place undue reliance on these
forward-looking statements, which speak only as of the date hereof. Except as
required by applicable law, including the securities laws of the United States,
we undertake no obligation to publicly release any update or revision to any
forward-looking statements to reflect new information, future events or
circumstances, or otherwise after the date hereof. We have attempted to identify
significant uncertainties and other factors affecting forward-looking statements
in the Risk Factors section that appears in Item 3D. "Key Information - Risk
Factors"

                                       ii
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<TABLE>
<CAPTION>
                                TABLE OF CONTENTS

                                                                                                               Page
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<S>                                                                                                             <C>
PART I...........................................................................................................5

ITEM 1.       IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS..............................................5
ITEM 2.      OFFER STATISTICS AND EXPECTED TIMETABLE.............................................................5
ITEM 3.      KEY INFORMATION.....................................................................................5
               A. Selected Financial Data........................................................................5
               B. Capitalization and Indebtedness................................................................6
               C. Reasons for the Offer and Use of Proceeds......................................................6
               D. Risk Factors...................................................................................6
ITEM 4.      INFORMATION ON THE COMPANY..........................................................................19
               A. History and Development of the Company.........................................................19
               B. Business Overview..............................................................................22
               C. Organizational Structure.......................................................................32
               D. Property, Plants and Equipment.................................................................32
ITEM 4A.     UNRESOLVED STAFF COMMENTS...........................................................................32
ITEM 5.      OPERATING AND FINANCIAL REVIEW AND PROSPECTS........................................................32
               A. Operating Results..............................................................................32
               B. Liquidity and Capital Resources................................................................47
               C. Research and Development.......................................................................48
               D. Trend Information..............................................................................49
               E. Off-Balance Sheet Arrangements.................................................................49
               F. Tabular Disclosure of Contractual Obligations..................................................49
ITEM 6.      DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES..........................................................49
               A. Directors and Senior Management................................................................49
               B. Compensation...................................................................................52
               C. Board Practices................................................................................53
               D. Employees......................................................................................59
               E. Share Ownership................................................................................60
ITEM 7.      MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS...................................................64
               A. Major Shareholders.............................................................................64
               B. Related Party Transactions.....................................................................65
               C. Interests of Experts and Counsel...............................................................66
ITEM 8.      FINANCIAL INFORMATION...............................................................................66
               A. Consolidated Statements and Other Financial Information........................................66
               B. Significant Changes............................................................................67
ITEM 9.      THE OFFER AND LISTING...............................................................................68
               A. Offer and Listing Details......................................................................68
               B. Plan of Distribution...........................................................................69
               C. Markets........................................................................................69
               D. Selling Shareholders...........................................................................69
               E. Dilution.......................................................................................69
               F. Expense of the Issue...........................................................................69
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                                      iii
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<TABLE>
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<S>                                                                                                             <C>
ITEM 10.     ADDITIONAL INFORMATION..............................................................................69
               A. Share Capital..................................................................................69
               B. Memorandum and Articles of Association.........................................................69
               C. Material Contracts.............................................................................72
               D. Exchange Controls..............................................................................73
               E. Taxation.......................................................................................73
               F. Dividend and Paying Agents.....................................................................87
               G. Statement by Experts...........................................................................87
               H. Documents on Display...........................................................................87
               I. Subsidiary Information.........................................................................88
ITEM 11.     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS.........................................88
ITEM 12.     DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES..............................................89

PART II..........................................................................................................89

ITEM 13.     DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES.....................................................89
ITEM 14.     MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS........................89
ITEM 15.     CONTROLS AND PROCEDURES.............................................................................89
ITEM 16.     [RESERVED]..........................................................................................89
ITEM 16A.    AUDIT COMMITTEE FINANCIAL EXPERT....................................................................89
ITEM 16B.    CODE OF ETHICS......................................................................................90
ITEM 16C.    PRINCIPAL ACCOUNTING FEES AND SERVICES..............................................................90
ITEM 16D.    EXEMPTIONS FROM THE LISTING REQUIREMENTS AND STANDARDS FOR AUDIT COMMITTEE..........................91
ITEM 16E.    PURCHASE OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATES AND PURCHASERS...........................91

PART III.........................................................................................................91

ITEM 17.     FINANCIAL STATEMENTS................................................................................91
ITEM 18.     FINANCIAL STATEMENTS................................................................................91
ITEM 19.     EXHIBITS............................................................................................92

S I G N A T U R E S..............................................................................................94
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                                       iv
<PAGE>

                                     PART I


ITEM 1.  IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

         Not applicable.

ITEM 2.  OFFER STATISTICS AND EXPECTED TIMETABLE

         Not applicable.

ITEM 3.  KEY INFORMATION

A.       SELECTED FINANCIAL DATA

         The following selected consolidated financial data for and as of the
five years ended December 31, 2005 are derived from our audited consolidated
financial statements, which have been prepared in accordance with U.S. GAAP. Our
audited consolidated financial statements with respect to the three years ended
December 31, 2005 and as of December 31, 2004 and 2005 appear elsewhere in this
Annual Report. Our selected consolidated financial data as of December 31, 2003,
2002 and 2001 and for the years ended December 31, 2002 and 2001 have been
derived from audited consolidated financial statements not included in this
Annual Report. The selected consolidated financial data set forth below should
be read in conjunction with Item 5. "Operating and Financial Review and
Prospects," and our consolidated financial statements and notes thereto included
elsewhere in this annual report.

Statement of Operations Data:

<TABLE>
<CAPTION>
                                                     -----------------------------------------------------------------------
                                                                            Year Ended December 31,
                                                     -----------------------------------------------------------------------
                                                        2001           2002           2003           2004            2005
                                                     -----------    -----------    -----------    -----------    -----------
                                                                 (in thousands, except share and per share data)
<S>                                                  <C>            <C>            <C>            <C>            <C>
Revenues .........................................   $    10,725    $     9,787    $     9,230    $     9,413    $    11,563
Cost of revenues .................................         2,552          1,896          1,849          2,814          3,802
                                                     -----------    -----------    -----------    -----------    -----------
Gross profit .....................................         8,173          7,891          7,381          6,599          7,761
Selling and marketing ............................         4,911          3,954          3,916          6,300          4,797
Research and development, net ....................         3,562          2,127          1,825          2,362          4,395
General and administrative .......................         1,943          1,858          1,830          2,101          2,830
                                                     -----------    -----------    -----------    -----------    -----------
Operating loss ...................................        (2,243)           (48)          (190)        (4,164)        (4,261)
Financial income (expenses), net .................          (141)            (6)           130             78             53
Other expenses ...................................          (375)          --             --             --             --
                                                     -----------    -----------    -----------    -----------    -----------
Loss before taxes on income ......................        (2,759)           (54)           (60)        (4,086)        (4,208)
Taxes on income ..................................            16             52            198            266             10
                                                     -----------    -----------    -----------    -----------    -----------
Net loss before equity in earnings of affiliate ..        (2,775)          (106)          (258)
Equity in earnings of affiliate ..................           221            236            345            225              2
                                                     -----------    -----------    -----------    -----------    -----------
Net income (loss) ................................   $    (2,554)   $       130    $        87    $    (4,127)   $    (4,216)
                                                     ===========    ===========    ===========    ===========    ===========
Basic and diluted net earnings (loss) per share ..   $     (0.53)   $      0.03    $      0.02    $     (0.89)   $     (0.83)
                                                     ===========    ===========    ===========    ===========    ===========
Weighted average number of ordinary shares used in
computing basic net earnings (loss) per share ....     4,826,126      4,709,796      4,617,099      4,634,413      5,092,117
                                                     ===========    ===========    ===========    ===========    ===========
Weighted average number of ordinary shares used in
computing diluted net earnings (loss) per share ..     4,826,126      4,709,796      4,628,249      4,634,413      5,092,117
                                                     ===========    ===========    ===========    ===========    ===========
</TABLE>

                                       5
<PAGE>

Balance Sheet Data:

                                           As of December 31,
                            -----------------------------------------------
                              2001     2002       2003      2004     2005
                            -------   -------   -------   -------   -------
                                            (in thousands)
                            -----------------------------------------------
Working capital ..........  $ 9,060   $ 9,244   $ 9,437   $ 2,773   $ 2,065
Total assets .............   18,095    17,707    18,182    15,323    13,816
Long-term loans ..........       13         8      --        --        --
Shareholders' equity......   13,856    14,013    14,464    10,657     9,174
Capital stock ............   12,861    12,861    12,627    12,893    15,983


B.       CAPITALIZATION AND INDEBTEDNESS

         Not applicable.

C.       REASONS FOR THE OFFER AND USE OF PROCEEDS

         Not applicable.

D.       RISK FACTORS

         Investing in our ordinary shares involves a high degree of risk and
uncertainty. You should carefully consider the risks and uncertainties described
below before investing in our ordinary shares. If any of the following risks
actually occurs, our business, prospects, financial condition and results of
operations could be harmed. In that case, the value of our ordinary shares could
decline, and you could lose all or part of your investment.

Risks Relating to Our Business and Market

We have had a recent history of operating losses and may not achieve or sustain
profitability in the future.

         We have incurred operating losses in each of the five last fiscal years
and we may not be able to achieve or sustain profitable operations in the
future. To the extent that we continue to incur operating losses, we may not
have sufficient working capital to fund our operations in the future. If we do
not generate sufficient cash from operations, we will be required to obtain
additional financing or reduce level of expenditure. Such financing may not be
available in the future, or, if available, may not be on terms satisfactory to
us.

Our operating results fluctuate significantly.

         Our quarterly results have fluctuated significantly in the past and are
likely to fluctuate significantly in the future. Our future operating results
will depend on many factors, including, but not limited to the following:

         o     demand for our products;

         o     changes in our pricing policies or those of our competitors;

                                       6
<PAGE>

         o     new product announcements by us and our competitors;

         o     the number, timing and significance of product enhancements;

         o     product life cycles;

         o     our ability to develop, introduce and market new and enhanced
               products on a timely basis;

         o     changes in the level of our operating expenses;

         o     budgeting cycles of our customers;

         o     customer order deferrals in anticipation of enhancements or
               new products that we or our competitors offer;

         o     changes in our strategy;

         o     seasonal trends and general domestic and international
               economic and political conditions, among others; and

         o     currency exchange rate fluctuations and economic conditions in
               the geographic areas where we operate.

         Due to the foregoing factors, quarterly revenues and operating results
are difficult to forecast, and it is likely that our future operating results
will be adversely affected by these or other factors.

         Revenues are also difficult to forecast because the market for
telecommunication management and billing solutions is rapidly evolving and our
sales cycle for our solutions, from initial evaluation to purchase, is lengthy
and varies substantially from customer to customer. We typically ship orders for
our TABS product line shortly after receipt of a purchase order and,
consequently, order backlog at the beginning of any quarter has in the past
represented only a small portion of that quarter's revenues. As a result,
license revenues from our TABS product line in any quarter depend substantially
on orders for TABS products that have been booked and shipped in that quarter.
Also, we can not predict whether revenues from our Application Suite will be
recognized in any quarter because the delivery and implementation of all the
components of the Application Suite (including among, other things, customer
training) are dependent on the customers individual timing requirements, which
can delay the completion of these orders. In addition, revenues from our billing
solutions are generated by using contract accounting on a percentage of
completion method and because the completion pace varies from quarter to quarter
and is dependent on different variables that are out of our control, billing
solutions revenues in any quarter depend on our ability to progress and complete
the projects.

         Due to all of the foregoing, we cannot predict revenues for any future
quarter with any significant degree of accuracy. Accordingly, we believe that
period-to-period comparisons of our operating results are not necessarily
meaningful and you should not rely upon them as indications of future
performance. Although our revenues increased in 2004 and 2005, we may not be
able to sustain revenue growth in the future.

                                       7
<PAGE>

Our quarterly financial performance varies significantly.

         We have often recognized a substantial portion of our revenues in the
last quarter of the year and in the last month, or even weeks or days, of a
quarter. Our expense levels are substantially based on our expectations for
future revenues and are therefore relatively fixed in the short term. If revenue
levels fall below expectations, our quarterly results are likely to be
disproportionately adversely affected because a proportionately smaller amount
of our expenses varies with our revenues.

         Our operating results are generally not characterized by a seasonal
pattern, except that our sales in Europe are generally lower in the summer
months.

         Due to the foregoing, our quarterly financial performance has in the
past and may in the future vary significantly. Our revenues and operating
results in any quarter may not be indicative of our future performance and it
may be difficult for investors to evaluate our prospects. In some future
quarter, our operating results may be below the expectations of public market
analysts and investors. In such event, it is likely that the price of our
ordinary shares would be materially and adversely affected.

We depend on the market for telemanagement products, which market has declined
in recent years.

         Until 2005, we derived substantially all of our revenues from our
TABS.IT call accounting and billing products. In late 2004, we implemented a new
strategy that has led to the development and introduction of our Application
Suite. The Application Suite is built on the Microsoft.Net platform and
establishes a framework for us to provide customized solutions that include
customer care and billing in addition to our traditional telemanagement
solutions. The main functions of our TABS.IT and the WinTrak families of
products were incorporated into the Application Suite. In 2005, we expanded and
enhanced the functionality of the Application Suite to include invoice
management, which facilitates bill reconciliation and dispute management. Our
future financial performance will depend, in significant part, on the successful
introduction, marketing and customer acceptance of the Application Suite and
related telemanagement products. The market for our legacy telemanagement
products declined each year from 1999 until 2003 and although revenues increased
in both 2004 and 2005, attributable to revenues from billing solutions that were
based on the technology that we acquired from Teleknowledge, revenues may not
grow in the future. If the market for our new telemanagement products grows more
slowly than we currently anticipate, our business, operating results and
financial condition would be materially and adversely affected.

We depend on business telephone system manufacturers, vendors and distributors
for our sales.

         One of the primary distribution channels for our call accounting
management products are private branch exchange, or PBX, original equipment
manufacturers, or OEMs, and vendors who market our products to end-users in
conjunction with their own products. We are highly dependent upon the active
marketing and distribution efforts of our PBX OEMs. In 2003, 2004

                                       8
<PAGE>

and 2005, our three major OEMs, Siemens Gmbh, Philips Communications Systems
B.V. and Ericsson, generated together 51.0%, 47.0% and 42.0%, respectively, of
our consolidated revenues. The percentage of sales attributable to each of these
OEMs in each of the three years ended December 31, 2005 are as follows:

                                2003           2004             2005
                                ----           ----             ----
         Siemens............    40.0%          38.0%            36.0%
         Philips............    7.0%           5.0%             4.0%
         Ericsson...........    4.0%           4.0%             2.0%

         As these and other PBX vendors expand their product offerings to offer
a wider range of newer technologies such as the Internet, WiFi, and VoIP, we
have enhanced our Application Suite to accommodate these new services. In late
2004 and early 2005, we entered into partnership agreements with each of NEC and
Avaya, for the integration of our products with their own products and the
marketing of our integrated product. Sales by PBX manufacturers and vendors have
declined markedly in the recent past, and sales through this channel may not
recover. Our success will be dependent to a substantial degree on the marketing
and sales efforts of such third parties in marketing and integrating our
products. These third parties may not give priority to the sale of our products
as an enhancement to their products. Although most of the major business
telephone switching systems manufacturers and vendors currently rely on
third-party suppliers to provide call accounting and other telemanagement
products, these manufacturers and vendors, including our current customers, may
develop their own competing products or purchase competing products from others.

         Because we sell our products through local master distributors in
countries where we do not have a marketing subsidiary, we are highly dependent
upon the active marketing and distribution efforts of our distributors. We also
depend in large part upon our distributors for product maintenance and support.
Our distributors may not continue to provide adequate maintenance and support to
end-users or provide maintenance and support for new products, which might cause
us to seek new or additional distributors or incur additional service and
support costs. The distributors to whom we sell our products are generally not
contractually required to make future purchases of our products and could,
therefore, discontinue carrying our products at any time. None of our
distributors or resellers is subject to any minimum purchase requirements under
their agreements with us. We may not be able to continue our relationships with
our OEM customers or, if such relationships are not maintained, we may not be
able to attract and retain comparable PBX original equipment manufacturers. The
loss of any of our major reseller or OEM relationships, either to competitive
products offered by other companies or products developed by such resellers,
would have a material adverse effect on our business, financial condition and
results of operations. Our future performance will depend, in part, on our
ability to attract additional PBX manufacturers and vendors that will be able to
market and support our products effectively, especially in markets in which we
have not previously distributed our products.

                                       9
<PAGE>

In December 2004, we acquired certain assets and liabilities of Teleknowledge
Group Ltd. and we may not be able to successfully exploit the acquired products.

         In December 2004, we completed the acquisition of certain assets and
liabilities of Teleknowledge Group Ltd., or Teleknowledge, a provider of carrier
class billing and related solutions. The acquisition of the Teleknowledge
billing solution enables us to offer an end-to-end customer care and billing
solution, including pre/post paid billing, Web self-care, assets management,
partner management, help desk and order management modules. These products offer
a complementary solution to our own products. In 2005, we recorded $1.5 million
in revenues from billing products based on the technology acquired from
Teleknowledge. We may not be able to continue to successfully exploit the
products we acquired from Teleknowledge.

We face risks associated with expanding and maintaining our distribution
network.

         We sell our products through distributors, business telephone switching
systems manufacturers and vendors, post, telephone and telegraph authorities, or
PTTs and our direct sales force. Our ability to achieve revenue growth in the
future will depend in large part on our success in establishing and maintaining
relationships with business telephone switching systems manufacturers and
vendors and PTTs, and establishing and maintaining relationships with
distributors. Historically, we have at times experienced difficulty in
establishing effective distribution relationships. We may not be able to
successfully expand our distribution channels or any such expansion may not
result in an increase in revenues. The failure to expand or maintain our
distribution channels could have a material adverse effect on our business,
operating results and financial condition.

We are subject to risks associated with international operations.

         We are based in Israel and generate a large percentage of our sales
outside the United States. Our sales in the United States accounted for 53.0%,
53.0% and 52.0% of our total revenues for the years ended December 31, 2003,
2004 and 2005, respectively. We may not be able to maintain or increase
international market demand for our products. To the extent that we cannot do so
in a timely manner, our business, operating results and financial condition will
be materially and adversely affected.

         International operations are subject to inherent risks, including the
following:

         o     the impact of possible recessionary environments in multiple
               foreign markets;

         o     costs of localizing products for foreign markets;

         o     longer receivables collection periods and greater difficulty
               in accounts receivable collection;

         o     unexpected changes in regulatory requirements;

         o     difficulties and costs of staffing and managing foreign
               operations;

         o     reduced protection for intellectual property rights in some
               countries;

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<PAGE>

         o     potentially adverse tax consequences; and

         o     political and economic instability.

         Our distributors or resellers may not be able to sustain or increase
revenues from international operations or the foregoing factors may have a
material adverse effect on our future revenues and, as a result, on our
business, operating results and financial condition.

         We may be adversely affected by fluctuations in currency exchange
rates. While our revenues are generally denominated in U.S. dollars and Euros, a
significant portion of our expenses are incurred in NIS. We do not currently
engage in any currency hedging transactions intended to reduce the effect of
fluctuations in foreign currency exchange rates on our results of operations. If
we were to determine that it was in our best interests to enter into any hedging
transactions in the future, we may not be able to do so or such transactions, if
entered into, may not materially reduce the effect of fluctuations in foreign
currency exchange rates on our results of operations. In addition, if, for any
reason, exchange or price controls or other restrictions on the conversion of
foreign currencies into NIS were imposed, our business could be adversely
affected. Currency fluctuations in the future may have a material adverse effect
on revenues from international sales and, consequently, on our business,
operating results and financial condition.

We are subject to risks relating to proprietary rights and risks of
infringement.

         We are dependent upon our proprietary software technology and we rely
primarily on a combination of copyright and trademark laws, trade secrets,
confidentiality procedures and contractual provisions to protect our proprietary
rights. We try to protect our software, documentation and other written
materials under trade secret and copyright laws, which afford only limited
protection. It is possible that others will develop technologies that are
similar or superior to our technology. Unauthorized parties may attempt to copy
aspects of our products or to obtain and use information that we regard as
proprietary. It is difficult to police the unauthorized use of our products, and
we expect software piracy to be a persistent problem, although we are unable to
determine the extent to which piracy of our software products exists. In
addition, the laws of some foreign countries do not protect our proprietary
rights as fully as do the laws of the United States. Our means of protecting our
proprietary rights in the United States or abroad may not be adequate or our
competition may independently develop similar technology.

         We are not aware that we are infringing upon any proprietary rights of
third parties. However, it is possible, that third parties will claim
infringement by us of their intellectual property rights. We believe that
software product developers will increasingly be subject to infringement claims
as the number of products and competitors in our industry segment grows and the
functionality of products in different industry segments overlaps. It would be
time consuming for us to defend any such claims, with or without merit, and any
such claims could:

         o     result in costly litigation;

         o     divert management's attention and resources;

                                       11
<PAGE>

         o     cause product shipment delays; or

         o     require us to enter into royalty or licensing agreements. Such
               royalty or licensing agreements, if required, may not be
               available on terms acceptable to us, if at all.

         If there is a successful claim of product infringement against us and
we are not able to license the infringed or similar technology, our business,
operating results and financial condition would be materially and adversely
affected.

         We rely upon certain software that we license from third parties,
including software that we integrate with our internally developed software.
These third-party software licenses may not continue to be available to us on
commercially reasonable terms. If we lose or are unable to maintain any such
software licenses, we could suffer shipment delays or reductions until
equivalent software could be developed, identified, licensed and integrated,
which would materially and adversely affect our business, operating results and
financial condition.

We may be unsuccessful in our defense of pending litigation.

         On April 18, 2005, Amdocs (Israel) Ltd. and Amdocs Ltd. filed a
complaint in the Tel Aviv District Court naming our company, our chief executive
officer and others as defendants (Civil File No. 32419-05/05). The complaint
alleges, among other things, that professional and commercial information
belonging to the plaintiffs was transferred to the defendants for use in our
company's activity. The plaintiffs are seeking an injunction prohibiting the
defendants from making any use of the information and trade secrets that were
allegedly transferred, and mandatory injunctions requiring the return of any
such information and the payment of estimated damages of NIS 14,775,000
(approximately US$3.2 million). On June 27, 2005, we and the other defendants
filed a statement of defense, claiming that the factual and legal allegations
made by the plaintiffs have no basis and the causes of action and relief
requested are without merit. Since such time, there have been no further
developments in connection with this claim. Due to the preliminary stage of this
litigation, we and our legal advisors cannot currently assess the outcome or
possible adverse effect on our financial position or results of operations.

         In April 2000, the tax authorities in Israel issued a demand for a tax
payment for the 1997-1999 period in the amount of approximately NIS 6.0 million
($1.3 million). We have appealed to the Israeli District Court in respect of
such tax demand and believe that certain defenses can be raised against the
demand of the tax authorities. We have made a provision in our financial
statements for this tax demand for the amount deemed probable.

         If we are unsuccessful in these matters or if actual results are not
consistent with our assumptions and judgments, we may be exposed to losses that
could be material to our company.

Our results may be adversely affected by competition.

         The market for telemanagement products is fragmented and is intensely
competitive. Competition in the industry is generally based on product
performance, depth of product line, technical support and price. We compete both
with international and local competitors (including providers of
telecommunications services), many of whom have significantly greater financial,
technical and marketing resources than us. We anticipate continuing competition
in

                                       12
<PAGE>

the telemanagement products market and the entrance of new competitors into the
market. Our existing and potential customers, including business telephone
switching system manufacturers and vendors, may be able to develop
telemanagement products and services that are as effective as, or more effective
or easier to use than, those offered by us. Such existing and potential
competitors may also enjoy substantial advantages over us in terms of research
and development expertise, manufacturing efficiency, name recognition, sales and
marketing expertise and distribution channels. We may not be able to compete
successfully against current or future competitors and that competition may have
a material adverse effect on our future revenues and, consequently, on our
business, operating results and financial condition.

We are subject to risks associated with rapid technological change and risks
associated with new versions and new products.

         The telecommunications management market in which we compete is
characterized by rapid technological change, introductions of new products,
changes in customer demands and evolving industry standards. Our future success
will depend upon our ability to keep pace with the technological developments
and to timely address the increasingly sophisticated needs of our customers by
supporting existing and new telecommunication technologies and services and by
developing and introducing enhancements to our current and new products. We may
not be successful in developing and marketing enhancements to our products that
will respond to technological change, evolving industry standards or customer
requirements, we may experience difficulties that could delay or prevent the
successful development, introduction and sale of such enhancements or such
enhancements may not adequately meet the requirements of the marketplace and
achieve any significant degrees of market acceptance. If release dates of any
new products or enhancements are delayed or, if when released, they fail to
achieve market acceptance, our business, operating results and financial
condition would be materially and adversely affected. In addition, the
introduction or announcement of new product offerings or enhancements by us or
our competitors may cause customers to defer or forgo purchases of current
versions of our product, which could have a material adverse effect on our
business, operating results and financial condition.

We may not be able to retain or attract key managerial, technical and research
and development personnel we need to succeed.

         Our success has largely depended and will depend in the future on our
skilled professional and technical employees. The competition for these
employees is intense. We may not be able to retain our present employees, or
recruit additional qualified employees as we require them.

Three of our shareholders are in a position to control matters requiring a
shareholder vote.

         Mr. Chaim Mer, our Chairman, and his wife, Dora Mer, our Israeli
counsel, currently control the vote of approximately 34.87% of our outstanding
ordinary shares, and Isaac Ben-Bassat, one of our directors, is the owner of
11.96% of our outstanding ordinary shares.

          As a result, such persons control and will continue to control the
election of our entire Board of Directors other than our two outside directors
and generally have the ability to direct our business and affairs.

                                       13
<PAGE>

We are subject to risks arising from product defects and potential product
liability.

         We provide free warranty and support for up to one year for end-users
and up to 15 months for our OEM distributors. Our sales agreements typically
contain provisions designed to limit our exposure to potential product liability
or related claims. The limitation of liability provisions contained in our
agreements may not be effective. Our products are used by businesses to reduce
communication costs, recover charges payable by third parties and prevent abuse
and misuse of telephone networks and, as a result, the sale of products by us
may entail the risk of product liability and related claims. A product liability
claim brought against us could have a material adverse effect upon our business,
operating results and financial condition. Products such as those offered by us
may contain undetected errors or failures when first introduced or when new
versions are released. Despite our testing and testing by current and potential
customers, errors may be found in new products or releases after commencement of
commercial shipments. The occurrence of these errors could result in adverse
publicity, loss of or delay in market acceptance or claims by customers against
us, any of which could have a material adverse effect upon our business,
operating results and financial condition.

The implementation of SFAS No. 123(R), which will require us to record
compensation expense based on fair value in connection with employees share
based compensation transactions commencing as of the first quarter of 2006, may
impact our financial results.

         On December 16, 2004, the Financial Accounting Standards Board, or
FASB, issued Statement No. 123 (revised 2004), Share-Based Payment, or SFAS No.
123(R), which is a revision of SFAS No. 123. Generally, the approach in SFAS No.
123(R) is similar to the approach described in SFAS No. 123. However, SFAS No.
123 permitted, but did not require, share-based payments to employees to be
recognized on the basis of their fair values while SFAS No. 123(R) requires, as
of the first quarter of 2006, all share-based payments to employees to be
recognized on the basis of their fair values. SFAS No. 123(R) also revises,
clarifies and expands guidance in several areas, including measuring fair value,
classifying an award as equity or as a liability and attributing compensation
cost to reporting periods. The adoption of SFAS No. 123(R) may have a
significant effect on our results of operations in the future. In addition, such
adoption could limit our ability to use stock options as an incentive and
retention tool, which could, in turn, negatively impact our ability to recruit
employees and retain existing employees. Had we adopted SFAS 123(R) in 2005, the
impact of that standard would have increased our net losses by approximately
$198,000, as described in the disclosure of pro forma net income (loss) and
earnings (loss) per share in our consolidated financial statements.

Risk Factors Related to Our Ordinary Shares

We may be classified as a passive foreign investment company, or PFIC, which
will subject our U.S. investors to adverse tax rules.

         Holders of our ordinary shares who are United States residents face
income tax risks. There is a substantial risk that we are a passive foreign
investment company, commonly referred to as PFIC. Our treatment as a PFIC could
result in a reduction in the after-tax return to the holders of our ordinary
shares and would likely cause a reduction in the value of such shares. For U.S.
Federal income tax purposes, we will be classified as a PFIC for any taxable
year in which either (i) 75% or more of our gross income is passive income, or
(ii) at least 50% of the average

                                       14
<PAGE>

value of all of our assets for the taxable year produce or are held for the
production of passive income. For this purpose, cash is considered to be an
asset, which produces passive income. As a result of our relatively substantial
cash position at the time, we believe that we were a PFIC in certain periods
over the last few years under a literal application of the asset test described
above, which looks solely to the market value. We do not believe that we were a
PFIC in 2005. If we are classified in the future as a PFIC for U.S. federal
income tax purposes, highly complex rules would apply to U.S. Holders owning
ordinary shares. Accordingly, you are urged to consult your tax advisors
regarding the application of such rules.

Our share price has been volatile in the past and may decline in the future.

         Our ordinary shares have experienced significant market price and
volume fluctuations in the past and may experience significant market price and
volume fluctuations in the future in response to factors such as the following,
some of which are beyond our control:

         o     quarterly variations in our operating results;

         o     operating results that vary from the expectations of
               securities analysts and investors;

         o     changes in expectations as to our future financial
               performance, including financial estimates by investors;

         o     announcements of technological innovations or new products by
               us or our competitors;

         o     announcements by us or our competitors of significant
               contracts, acquisitions, strategic partnerships, joint
               ventures or capital commitments;

         o     announcements by third parties of significant claims or
               proceedings against us;

         o     changes in the status of our intellectual property rights;

         o     additions or departures of key personnel;

         o     future sales of our ordinary shares; and

         o     general stock market prices and volume fluctuations.

         Domestic and international stock markets often experience extreme price
and volume fluctuations. Market fluctuations, as well as general political and
economic conditions, such as a recession or interest rate or currency rate
fluctuations or political events or hostilities in or surrounding Israel, could
adversely affect the market price of our ordinary shares.

         In the past, securities class action litigation has often been brought
against a company following periods of volatility in the market price of its
securities. We may in the future be the target of similar litigation. Securities
litigation could result in substantial costs and divert management's attention
and resources.

                                       15
<PAGE>

We do not expect to distribute cash dividends.

         We do not anticipate paying cash dividends in the foreseeable future.
According to the Israeli Companies Law, a company may distribute dividends out
of its profits (within the meaning of the Israeli Companies Law), so long as the
company reasonably believes that such dividend distribution will not prevent the
company from paying all its current and future debts. The declaration of
dividends is subject to the discretion of our Board of Directors and will depend
on various factors, including our operating results, financial condition, future
prospects and any other factors deemed relevant by our board of directors. You
should not rely on an investment in our company if you require dividend income
from your investment in our company. The success of your investment will likely
depend entirely upon any future appreciation of the market price of our ordinary
shares, which is uncertain and unpredictable. There is no guarantee that our
ordinary shares will appreciate in value or even maintain the price at which you
purchased your ordinary shares.

Compliance with corporate governance regulations could increase the cost of our
operations.

         As a result of certain corporate governance scandals and the
legislative and litigation environment resulting from those scandals, the costs
of being a public company in general have increased in recent years. The
Sarbanes-Oxley Act of 2002 requires changes in some of our corporate governance
and securities disclosure or compliance practices. We expect that the on-going
implementation of these regulations will further increase our legal compliance
costs and will make some activities more time consuming. We are presently
evaluating and monitoring regulatory developments and cannot estimate the
magnitude of additional costs we may incur as a result of such developments. If
we are required to implement Section 404 of the Sarbanes-Oxley Act of 2002,
which governs internal controls and procedures for financial reporting, we will
need to expend significant management time and financial resources to comply
with the applicable requirements. This and other proposed legislation may
increase the fees of our professional advisors and our insurance premiums.

Risks Relating to Operations in Israel

Conducting business in Israel entails special risks.

         We are incorporated under the laws of, and our executive offices and
research and development facilities are located in, the State of Israel.
Although most of our sales are made to customers outside Israel, we are directly
influenced by the political, economic and military conditions affecting Israel.
Specifically, we could be adversely affected by any major hostilities involving
Israel, a full or partial mobilization of the reserve forces of the Israeli
army, the interruption or curtailment of trade between Israel and its present
trading partners, or a significant downturn in the economic or financial
condition of Israel.

         Since the establishment of the State of Israel in 1948, a number of
armed conflicts have taken place between Israel and its Arab neighbors, and a
state of hostility, varying from time to time in intensity and degree, has led
to security and economic problems for Israel. Since September 2000, there has
been a marked increase in violence, civil unrest and hostility, including armed
clashes, between the State of Israel and the Palestinians, and acts of terror
have been committed inside Israel and against Israeli targets in the West Bank
and Gaza. These

                                       16
<PAGE>

developments have adversely affected the regional peace process, placed the
Israeli economy under significant stress, and have negatively influenced
Israel's relationship with several Arab countries. In August 2005, Israel
evacuated all Israeli settlements in the Gaza Strip and four settlements in the
West Bank. In January 2006, Hamas won the elections in the Palestinian Authority
and on March 28, 2006, elections to the Israeli parliament were held in Israel.
The implications of these developments cannot at this time be foreseen. Any
future armed conflict, political instability or violence in the region may have
a negative effect on our business condition, harm our results of operations and
adversely affect our share price.

Political trade relations could limit our ability to sell or buy
internationally.

         We could be adversely affected by the interruption or reduction of
trade between Israel and its trading partners. Some countries, companies and
organizations continue to participate in a boycott of Israeli firms and others
doing business with Israel or with Israeli companies. To date, these measures
have not had a material adverse affect on our business. However, restrictive
laws, policies or practices towards Israel or Israeli businesses may have an
adverse impact on our business.

Our results of operations may be negatively affected by the obligation of our
personnel to perform military service.

         Many of our directors, officers and employees in Israel are obligated
to perform annual reserve duty in the Israeli Defense Forces and may be called
for active duty under emergency circumstances at any time. If a military
conflict or war arises, these individuals could be required to serve in the
military for extended periods of time. Our operations could be disrupted by the
absence for a significant period of one or more of our executive officers or key
employees or a significant number of other employees due to military service.
Any disruption in our operations could adversely affect our business.

The economic conditions in Israel have not been stable in recent years.

         In recent years Israel has been going through a period of recession in
economic activity, resulting in low growth rates and growing unemployment.
Although economic activity in Israel has improved recently, our operations could
be adversely affected if the economic conditions in Israel begin to deteriorate
once again.

Our financial results may be adversely affected by inflation and currency
fluctuations.

         Since we report our financial results in dollars, fluctuations in rates
of exchange between the dollar and non-dollar currencies may affect our results
of operations. A significant amount of our expenses are paid in NIS (primarily
salaries) and are influenced by the timing of, and the extent to which, any
increase in the rate of inflation in Israel over the rate of inflation in the
United States is not offset by the devaluation of the NIS in relation to the
dollar. Our dollar costs in Israel will increase if inflation in Israel exceeds
the devaluation of the NIS against the dollar or if the timing of such
devaluation lags behind inflation in Israel. Over time, the NIS has been
devalued against the dollar, generally reflecting inflation rate differentials.
We cannot predict any future trends in the rate of inflation in Israel or the
rate of devaluation of the NIS against the dollar. If the dollar cost of our
operations in Israel increases, our dollar measured results of operations will
be adversely affected. Likewise, our operations could be adversely affected if
we are unable to guard against currency fluctuations in the future.

                                       17
<PAGE>

The government programs and tax benefits we currently participate in or receive
require us to meet several conditions and may be terminated or reduced in the
future.

         We have benefited from certain Israeli Government grants, programs and
tax benefits. In late 2005 and early 2006, we applied to the Office of the Chief
Scientist of the Israeli Ministry of Industry and Trade for grants for our
research and development projects. We received an approval for the 2005
application and our two 2006 applications are currently pending. The 2006 grant
applications may not be approved by the Office of the Chief Scientist and we may
not be able to obtain any such grants in the future. To remain eligible for
these grants, programs and tax benefits, we must comply with certain conditions,
including making specified investments in fixed assets from our own equity and
paying royalties with respect to grants received. In addition, some of these
programs restrict our ability to manufacture particular products and to transfer
particular technology outside of Israel. If we do not meet these conditions in
the future, the benefits we received could be canceled and we may have to refund
payments previously received under these programs or pay increased taxes. The
Government of Israel has reduced the benefits available under these programs in
recent years and these programs and tax benefits may be discontinued or
curtailed in the future.

Service and enforcement of legal process on us and our directors and officers
may be difficult to obtain.

         Service of process upon our directors and officers and the Israeli
experts named herein, most of whom reside outside the United States, may be
difficult to obtain within the United States. Furthermore, since substantially
all of our assets, most of our directors and officers and the Israeli experts
named herein are located outside the United States, any judgment obtained in the
United States against us or these individuals or entities may not be collectible
within the United States.

         There is doubt as to the enforceability of civil liabilities under the
Securities Act and the Securities Exchange Act in original actions instituted in
Israel. However, subject to certain time limitations and other conditions,
Israeli courts may enforce final judgments of United States courts for
liquidated amounts in civil matters, including judgments based upon the civil
liability provisions of those Acts.

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

         Provisions of Israeli corporate and tax law may have the effect of
delaying, preventing or making more difficult a merger with, or other
acquisition of, us. This could cause our ordinary shares to trade at prices
below the price for which third parties might be willing to pay to gain control
of us. Third parties who are otherwise willing to pay a premium over prevailing
market prices to gain control of us may be unable or unwilling to do so because
of these provisions of Israeli law.

                                       18
<PAGE>

The rights and responsibilities of our shareholders are governed by Israeli law
and differ in some respects from the rights and responsibilities of shareholders
under U.S. law.

         We are incorporated under Israeli law. The rights and responsibilities
of holders of our ordinary shares are governed by our memorandum of association,
articles of association and by Israeli law. These rights and responsibilities
differ in some respects from the rights and responsibilities of shareholders in
typical U.S. corporations. In particular, each shareholder of an Israeli company
has a duty to act in good faith in exercising his or her rights and fulfilling
his or her obligations toward the company and other shareholders and to refrain
from abusing his power in the company, including, among other things, in voting
at the general meeting of shareholders on certain matters. Israeli law provides
that these duties are applicable in shareholder votes on, among other things,
amendments to a company's articles of association, increases in a company's
authorized share capital, mergers and interested party transactions requiring
shareholder approval. In addition, a controlling shareholder of an Israeli
company or a shareholder who knows that it possesses the power to determine the
outcome of a shareholder vote or who has the power to appoint or prevent the
appointment of a director or officer in the company has a duty of fairness
toward the company. However, Israeli law does not define the substance of this
duty of fairness. Because Israeli corporate law has undergone extensive revision
in recent years, there is little case law available to assist in understanding
the implications of these provisions that govern shareholder behavior.

As a foreign private issuer whose shares are listed on the NASDAQ Capital
Market, we may follow certain home country corporate governance practices
instead of certain NASDAQ requirements.

         As a foreign private issuer whose shares are listed on the NASDAQ
Capital Market, we are permitted to follow certain home country corporate
governance practices instead of certain requirements of the NASDAQ Marketplace
Rules, including the composition of our Board of Directors, director nomination
procedure, compensation of officers, distribution of annual reports to
shareholders and quorum at shareholders meetings. In addition, we may follow
Israeli law instead of the NASDAQ Marketplace Rules that require that we obtain
shareholder approval for certain dilutive events, such as for the establishment
or amendment of certain equity based compensation plans, an issuance that will
result in a change of control of our company, certain transactions other than a
public offering involving issuances of a 20% or more interest in our company and
certain acquisitions of the stock or assets of another company. Currently, we
follow Israeli law and practice instead of the NASDAQ requirements with respect
to the directors' nomination process.

ITEM 4.  INFORMATION ON THE COMPANY

A.       HISTORY AND DEVELOPMENT OF THE COMPANY

         Our company was incorporated under the laws of the State of Israel in
December 1995. We are a public limited liability company under the Israeli
Companies Law 5739-1999 and operate under such law and associated legislation.
Our registered offices and principal place of business are located at 22 Zarhin
Street, Ra'anana 43662, Israel, and our telephone number is +972-9-762-1777.
Our address on the Internet is www.mtsint.com. The information on our website is
not incorporated by reference into this annual report.

                                       19
<PAGE>

         We are a total solutions provider in the telecom expense and billing
arenas. We design, develop, market and support a comprehensive line of
telecommunication management, expense management and customer care and billing,
or CC&B, solutions that enable business organizations and other enterprises to
more effectively manage and optimize the use of their communication resources.
Our products include call accounting and management products, fault management
systems and Web-based management solutions for converged voice, voice over IP,
or VoIP, IP data and video and CC&B solutions. These products are designed to
provide telecommunication and information technology managers with tools to
reduce communication costs, recover charges payable by third parties, detect and
report the abuse and misuse of telephone networks, monitor and detect hardware
and software faults in telecommunications networks and generate
telecommunications usage information for use in the management of an enterprise.
We were among the first to offer PC-based call accounting systems when we
introduced our TABS product in 1985. To date, over 70,000 TABS call accounting
systems have been sold to end-users in more than 80 countries. In the service
provider and carrier market, our billing solutions provide for retail billing,
interconnect billing, and partners revenue management.

         Call accounting systems afford businesses easy access to complete
information on telephone usage, including the dialed number, calling extension,
call duration, time of day, destination, trunk line usage, cost of each call and
multi-carrier analysis. We started developing the TABS line of call accounting
products for the DOS operating system and have upgraded and re-written our call
accounting and management systems as the industry and technology advanced
providing full compatibility to support the Windows operating systems and most
versions of Windows NT. As our sales of TABS were worldwide, we needed to have a
flexible and easily updated set of pricing tables to accommodate the different
pricing schemes and modes used worldwide and with different carriers. As
enterprises expanded and required information from their remote sites, so TABS
has expanded to accommodate their needs by providing multi-site solutions and
supporting most business telephone switching systems currently available for
sale. The solutions are capable of monitoring up to 100,000 extensions. The
Application Suite provides for an unlimited number of extensions, subject to the
capabilities of the customer's hardware, as well as an unlimited number of
remote sites. The sites can be monitored from a browser at any point as the
application is web based. Various modules were developed to service the needs of
different vertical markets such as our PMSi module for the hotel industry and a
solution for performing tie-line reconciliation for organizations and utilities
having multiple PBXs. TRAK-View, our fault management system, provides an
enterprise with early warning problem detection and prevention for multi-site
and multi-vendor networks including PBXs. In 1998, we introduced IP.TRAK, a
Web-based call accounting and management system that was built on the original
model and principles of TABSweb(TM). IP.TRAK was designed to harness the power
of the Internet for the needs of Information Technology managers through its
ability to access reports using a standard Internet browser. We added additional
modules to IP TRAK that could collect the information from routers, firewalls
and gateways. These additional modules provided tools for a comprehensive
communications management system. We were able to collect additional data from
files, file transfer protocol (FTP) servers, VoIP, and external buffers. We
subsequently merged the functionality of PBX systems and IP networks to provide
a unified management solution for multiple communication platforms from
different vendors supporting voice, VoIP, video and data communications. The
functionality of IP TRAK was subsequently superseded by the enhanced Application
Suite.

                                       20
<PAGE>

         We operate in five geographical areas. Our operations in Israel include
research and development, sales, marketing and support. Our operations in the
United States, Brazil, Europe and Asia include sales, marketing and customer
service.

         On April 24, 2000, we acquired all of the assets and assumed certain
liabilities of IntegraTRAK Inc., a privately held Seattle-based company, engaged
in the development and sale of packaged computer software for tracking telephone
calls and costs.

         In 2001, we developed our Web Access module that provides access and
control to the communications usage database, under strict control and privacy,
from anywhere on the web. During the second quarter of 2002, we added
FaciliTRAK, which is a comprehensive software system that greatly simplifies the
day-to-day task of maintaining and managing the physical layer details for any
network. FaciliTRAK allows the user to record the equipment, cables, and
pathways for the cable plant and define the connectivity and circuit routes. A
user can utilize FaciliTRAK to plan and manage the moves and changes within his
or her organization with the aid of the self-documenting service desk functions.
The FaciliTRAK system is an essential tool for any enterprise that is thinking
of implementing a disaster recovery program.

         In December 2004, we completed the acquisition of certain assets and
liabilities of Teleknowledge Group Ltd., or Teleknowledge, a provider of carrier
class billing and related solutions. In connection with the acquisition, we paid
an initial consideration of $2.374 million in cash and agreed to pay additional
contingent consideration of up to $3.65 million over a period of three years
based on post acquisition revenue performance. The acquisition of the
Teleknowledge billing solution enables us to offer an end-to-end customer care
and billing solution, including pre/post paid billing, Web self-care, assets
management, partner management, help desk and order management modules.

         During 2005, we conducted extensive research and development so that
our products and solutions could operate in the high-end enterprise market. As a
result, an advanced telecommunications expense management module was developed,
based on our Application Suite infrastructure. The modular and scalable
architecture topology of our Application Suite lends itself easily to an open
platform where modules can be added and integrated seamlessly into the platform,
thus allowing customers to buy such modules as they require.

         In addition, in 2005 we strengthened our product offerings to the
service provider and carrier market as a result of our release of a new billing
solution module that we acquired from Teleknowledge and through significant
investment in research and development in order to provide a complete end-to-end
billing solution for the wholesale trade. As a result, we introduced an
interconnect billing solution and our retail billing solution was expanded to
accommodate legacy telephony that carriers can use to bill their subscribers.
Also, new value-added services (such as video-on-demand (VOD), multimedia
message service, short message service (SMS)) and content (such as news and
games) were added to our billing solutions package. We believe that an advantage
of our solutions is that they operate off a single data base. We also introduced
a partner revenue management module to our billing solutions product, which
complements our product line by enabling carriers to reconcile bills among one
another.

                                       21
<PAGE>

B.       BUSINESS OVERVIEW

Industry Background

         Technological advances and worldwide deregulation and privatization in
the telecommunications industry have resulted in the growth of alternative
telecommunication services providers, such as cellular companies, competitive
access providers, cable companies and data transmission companies. This growth,
in conjunction with dramatic improvements in computing and communications
technology, including the convergence of telephony systems and computers, or
computer telephony integration, has fostered the rapid expansion of
communication services and an increase in the volume of voice and data traffic
by business organizations. The diversification of services and providers using
varied pricing algorithms and the proliferation of domestic and international
networks using varied equipment and technologies for different services and
modes of transmission has placed new demands on telecommunication and
information technology managers and has created the need for sophisticated and
flexible telecommunication management solutions. This has created a demand for
telemanagement solutions that are capable of supporting multiple sites,
switching platforms, languages and currencies, as well as the generation of
telecommunications usage information vital to an enterprise's operations.

         Telemanagement solutions have evolved from the stand-alone PC-based
telephone call accounting and billing systems of the mid-1980's to local area
network or LAN-based systems operating in Windows 98/2000/XP and Windows NT
environments offering call accounting, fraud detection and fault management
solutions for users with complex voice and data networks. Today, the trend is
moving more and more to Web-based solutions, and to converged solutions where
all expenses associated with the usage of a person or device are shown in one
report or invoice.

         Call accounting products, a fundamental management tool, record,
retrieve and process data received from a PBX or other telephone switching
system, providing a telecommunications manager with information on telephone
usage. This information enables managers to optimize an enterprise's
telecommunications resources and reduce communication expenses, typically the
second or third highest administrative expense of a business, through
cost-tracking and management awareness.

         As the trend continues toward enterprises utilizing one infrastructure
for both voice and data services, more and more emphasis will be placed on
finding efficient solutions to cope with the increasing demand on network
resources and for reducing congestion. Enterprises have been required to buy
additional communications resources to meet this demand immediately rather than
optimizing their existing networks due to the time consuming nature of such
projects. IT managers are constantly trying to justify the ever increasing
expenses created by managing the enormous amount of data that is being
transmitted through the Internet.

         The abuse and misuse of telephone and data networks, either by
employees making unauthorized telephone calls or by outside "hackers" who tap
into an organization's long distance service has become a major problem for
organizations resulting in great losses. Likewise, employees surfing the web for
private use during working hours overloads the network, preventing critical
tasks from getting through as well as reducing the overall productivity of the
enterprise. These losses have led to the development of intelligent toll fraud
detection systems that immediately alert or initiate preventive measures upon
detecting a suspicious occurrence in network usage traffic.

                                       22
<PAGE>

         Organizations with multiple PBXs and providers of maintenance services
require systems that are capable of alerting telecommunications managers of
impending or actual problems in a communications network. Financial and
operational benefits of a fault management system can be immediate and
significant, as down time of the system is reduced due to early problem
detection and real information on remote site events. Maintenance costs are
significantly lowered through better use of human resources and more efficient
inventory management.

         In addition, other executives and operational managers are now seeking
telemanagement solutions which permit them to assess how efficiently employees
are using their time, monitor customer service calls, analyze the effectiveness
of marketing expenditures, utilize toll-free responses to determine demographics
of callers through the use of Caller ID information, know who is using the
network and when they are using it, and obtain additional data that aid them in
management of the business.

         IP telephony and video conferencing are reaching technological maturity
and are being adopted by an increasing number of organizations. Enterprises have
begun to use the IP platform as a single common telecommunication infrastructure
for all services. The convergence of voice, data and video has become
commonplace, and there is a trend of data equipment manufacturers and PBX system
manufacturers offering platforms that support all services. These developments
as well as customer demands will require future management systems to be
upgraded to support the convergence of voice, data and video and provide a
unified management system that will provide information technology managers with
knowledge about the usage of their resources, the ability to ensure the optimal
use of these resources and centralized control over their networks.

         With today's greater mobility, the need to keep track of moves and
changes in an organization requires the use of tools to control, manage and
document these changes more effectively. The useful life of a standard cabling
structure should be fifteen years. This means that existing cables should be
able to support an average of three upgrades of communication equipment during
its lifetime, plus an average of five changes to all outlets. It is virtually
impossible to achieve this performance level without maintaining accurate
records reflecting all details of cabling installations.

         The continuing increase in use of cellular phones for business, during
and outside working hours, has created the need to develop products that will
enable an enterprise to generate a true and full record of all the calls made by
its employees, including cellular calls and calls made by calling cards and
other charge plans. In 2005, we filed an international patent application (PCT
application), which is currently pending, relating to a mobile verification
technique that verifies mobile phone usage against the bill received from the
service provider.

         Telephony over the Internet, which provides voice communications using
the Internet, is now becoming more prevalent. Although the cost of these calls
is insignificant, as most companies or enterprises already have the
infrastructure in place, it is important to keep track of the calls for
marketing purposes, security, or even just to increase worker productivity.
Skypes is an example of one of these services using computer to computer
communications. Others such

                                       23
<PAGE>

as Cisco, Mera, AirSpan and RADVision use gateways, while other PBX
manufacturers use special line cards in the PBX to connect to the Internet and
provide this service, which is known as Voice over Internet protocol (VoIP). We
provide telemanagement and billing solutions for these new services. Another
area used in conjunction with these new services is "pre-paid," which allows a
customer to buy a certain amount of time (expressed as a function of money)
either from the web or through the purchase of a "scratch" card (which contains
an account or personal identification number (PIN) and units of time) and debits
the account with each usage.

         Another new area for which we have already prepared billing solutions
is WiFi or "hot-spots," which are being installed in public places, such as
airports, hotels, universities and coffee houses. This enables the user's
account to be charged for any usage of the service by the user while connected
to these devices.

Products and Services

         We offer a range of call accounting and converged voice/data management
solutions, based on our standard platform which can be adjusted to specific
customers' needs and requests, as well as fault management systems for networks
and PBXs, and facilities management for cabling and equipment. Additionally,
some of our products are geared for communications resellers and as such enable
them to issue regular bills for the communications services rendered. Today
these products and services, starting with the original TABS line, constitute
the basic building blocks for adding modules to cater to the new advanced
communications infrastructures and services.

Background History

         We were the first company to offer a PC-based non-dedicated call
accounting system when we introduced the first version of TABS in 1985. To date,
over 70,000 TABS accounting systems have been sold to end-users located in over
80 countries. TABS supports worldwide charging methods (pulse and duration),
call pricing tables and currencies and is available in different languages. Our
PBX interface database includes default formats for the major PBX manufacturers
and business phone systems, including those manufactured by Ericsson, Philips,
Siemens, Lucent, Nortel, Alcatel, ECI/Tadiran, Harris, NEC, Avaya, Mitel,
Damovo, LG and Panasonic, making TABS compatible with substantially all
currently available PBX and business phone systems. Our flexible format allows
some of the newer equipment such as VoIP PBXs and routers/gateways to be
inputted to and reported on TABS. This includes the RADVision and Cisco gateways
and gatekeepers.

Call Accounting and Management Solutions for Enterprises

TABS.IT

         TABS.IT is a solution for small offices, medium sized businesses, and
Fortune 500 enterprises that want to take full control over their communications
network. Specific applications enable hotels, shared tenant environments,
hospitals, universities and service bureaus to resell communications services to
users employing simple, yet efficient mark-up formulas.

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<PAGE>

         TABS.IT tracks the details of all voice communications usage (dialed
numbers, call duration, destination, cost of each call, trunk line usage, etc.)
and produces accurately priced individual customer bills. In addition, TABS.IT
tracks the details of all data communications (IP address, name, number of
bytes, bandwidth usage, nodes, etc.) and can produce a relative cost figure.
TABS.IT products are able to:

         o     Register and track incoming and outgoing, trunk-to-trunk and
               internal calls, including response time, ring time and Caller
               ID.

         o     Add billing details and cost of calls according to applicable
               pricing tables, including mark-up calculations by extension
               and other user-defined categories and rate updates.

         o     Perform multi-carrier analysis, providing carrier comparison
               "what if" reports.

         o     Support authorization and account codes.

         o     Identify inactive and defective trunks and extensions.

         o     Operate in a LAN environment, permitting multi-user and
               multi-tasking functionality.

         o     Generate and electronically distribute billing documents,
               management and verification reports and 3-D color graphs for
               easy data analysis.

         With additional modules, the following optional features are available:

         o     Reporting on e-mails (eTABS).

         o     Reporting on VoIP (VoIPTABS).

         o     Reporting on web browsing (wTABS).

         o     Accessing the information over the Internet (Web Access).

         These additional modules were developed especially for Internet usage
and provide enterprises with the scalability necessary to permit growing
enterprise organizations to further extend their ability to monitor and optimize
their local networks. With the introduction of Web Access, multiple users now
have the ability to access the TABS database and easily generate reports and
graphs from any PC that has access to the Internet. With this new module, each
authorized user anywhere in the world can browse and review reports containing
restricted data, according to his authorization. These reports are created from
the TABS database by using a web browser at a remote station. In addition,
powerful graphs give the manager an immediate overview of the situation. Both
the graphs and reports can be exported to other applications, such as PowerPoint
for the graphs or Excel for the reports.

         The powerful TABS.IT report generator provides a wide variety of usage
reports that are easy to read and understand, yet provide all the information
necessary to identify how communications network resources are being utilized.
These reports can be generated either as a summary of the call data or complete
with all the details necessary to make informed management decisions. Their
structural flexibility allows the user to quickly zero in on the

                                       25
<PAGE>

specific data of greatest interest. Historical reports may be maintained for an
unlimited period of time and can become useful tools for assessing budget needs
for the coming months or years. Specific report categories include ring time
reports, call breakdown reports, hit parade reports, directory reports,
exception reports and trunk reports. In addition, a robust custom reporting
feature offers the user an effective means of generating reports that can go far
beyond the standard categories. With this feature, the user is able to create
reports that can be tailored to meet even the most specific of reporting
requirements, and they can be scheduled to run automatically at a prescribed
time.

         Version 7 of TABS.IT is fully web-based allowing users to see their own
call usage on-line from anywhere, and incorporates most of the features that
were offered as separate modules in previous versions. This version is easily
adapted to companies that have multiple sites, and would want to view the
activity from a central site. The administrative functions can also be performed
remotely using Internet Explorer. Full security and privacy is assured by use of
various levels of password protection.

Application Suite

         The Application Suite is an integrated, customized solution to manage
and control the entire communications network, from internal IT operations to
complete IT service management and CC&B solutions. The Application Suite
implements and monitors real time performance and usage defined by the
organization to maintain budget control, usage performance and system health,
and utilized by service providers for converged pre and post paid billing. The
system's flexible architecture enables organizations, service providers,
Internet service providers and operators to effectively manage their entire
billing process, adding on capabilities as their business grows, in accordance
with customer's requests, special projects or market trends. Utilizing its
web-based user centric capabilities, the platform provides its users, including
administrators, employees, and customers, with a single easy-to-use interface
self provisioning customer care, while guaranteeing corporate security via the
different authentication levels.

         The main functions of the TABS.IT and WinTRAK family of products were
incorporated into the Application Suite solution, which supersedes these
solutions. In addition, budget control monitoring modules were added to the
Application Suite solution to verify that the extensions, departments, cost
centers operate within budget, and a credit limit may be assigned.

          In 2005, we enhanced and expanded our Application Suite to include an
invoice management module. This new module checks the rates billed by the
service provider against the contracted rates and also reconciles an
organization's telecom bills reflecting the usage reported by the service
provider with the actual usage recorded by the Application Suite. Additionally,
the new module checks that the services provider has charged only for
communication equipment actually used by the organization, as opposed to
equipment that is no longer serviceable or not under current service contracts.
An organization's internal procedures for payment of bills can be entered into
the Application Suite and it will track the bills and insure that there are no
delays in payments, and in the case of discrepancies between the usage and
bills, it will provide an analysis of the discrepancies.

                                       26
<PAGE>

Facilities Management System

         With today's greater mobility, the need to keep track of moves and
changes in an organization requires the use of tools to control, manage and
document these changes more effectively. In March 2002, we acquired a software
product from Total Wire Software Company, Inc., a privately held Florida-based
company. That product, which was superseded by new software during 2002 and is
marketed as FaciliTRAK, enables us to offer a product that provides tracking of
inventory such as telephones, computers and ancillary equipment associated with
a user and develop a complete composite report of an enterprise's resources.
Additionally, it gives us the ability to provide a full "total information"
system to enterprises for controlling and managing the entire physical layer of
an organization's voice and data system. The "top of the line" FaciliTRAK
product is a full featured, graphic-oriented cable and asset management system,
that comes complete with Visio Technical, a CAD interface, and is available in
both a single workstation and a multi-user network version. Its unique
flexibility allows users to "mirror" complex networks commonly found in large
companies, while its enhanced ability allows it to document and design cable
plant projects of all sizes.

         FaciliTRAK documents and controls the management of the physical layer,
device configuration and circuit connectivity for a wide range of network
topologies including ethernet, token ring, voice, fiber distributed data
interface, etc. that range in size, from just a few hundred nodes to many
thousand, and with its universal functionality can be extended to interface with
logical network management systems, cable testing and labeling systems, help
desk, call accounting, and other facility management tools. Using a flexible and
multipurpose database, FaciliTRAK documents the physical characteristics for any
network, recording the network, asset, user, device configuration, and exact
connections between equipment and cabling. The results are then presented in
either a database view, dynamic schematic, or Visio Technical drawing. The
schematics generated by those modules are used to show the physical connectivity
and logical path of the equipment and cabling connections in the database.

         As a multi site system, FaciliTRAK can store information for multiple
buildings or campuses and show views by floor, closet and zones. Specific
information such as port or pair assignment, network addresses, and circuit
connections are easily entered to match the level of detail required.

         The FaciliTRAK help desk feature provides both an administrative
process and audit trail for recording, scheduling and maintenance changes that
need to be made to items and connections in a site. There are three options
within service desk: (i) service requests, (ii) trouble tickets, and (iii) work
orders. Each provides its own choices and reference numbering for easy tracking
and assignment. Both service requests and trouble tickets provide the option of
being used globally for the entire organization, regardless of whether the item
in service has been recorded in the site database, or used for items within the
current site. The main features of the FaciliTRAK, which are inventory control,
help desk, and cable management, have been incorporated into the Application
Suite solution.

Billing Solutions

         In 2002, we introduced the TABSBill module for vertical enterprises,
such as hospitals, universities, medical clinics and tenant sharing facilities,
enabling the enterprises to rapidly

                                       27
<PAGE>

generate bills based on usage. TABSBill, which is geared to resellers of billing
services, provides for the scheduled reporting and automatic distribution of
customer communications bills based on tracking phone calls, e-mail and network
usage, as well as for one time or recurring charges. The bills can be generated
directly from the data collected by TABS, from CDs from the service provider, or
from downloaded files of call data. All kinds of communications usage data may
be billed. The user can view his bills on-line as TABSBill is web based. The
bills can be displayed, printed out or sent by e-mail. There is even provision
for the secure payment of the bill on-line. Our billing solutions have been
enhanced as a result of the acquisition of the Teleknowledge billing solution,
which enables us to offer a comprehensive end-to-end customer care and billing
solution, including data collection, verification and validation, mediation,
guiding, rating, processing, reporting and issuing of invoices. The solutions
also track usage of some of the new value-added services (such as Video on
Demand and information) as well as for content (such as games, music, downloads
and ring tones). The billing solutions provide a converged user centric
solution, enabling the user to view all telecommunications expenditures on one
bill, including mobile phones, calling cards, pre-paid billing and landlines.
The billing solutions cover a full range of billing applications, from simple
customer bills, VoIP billing and WiFi billing, to full Interconnect (or
wholesale) billing. In addition to the main billing solution, our billing
solution provides customer Web self-care, Help Desk, and Order Management
modules.

Other Modules

         An add-on module, Tie Line Reconciliation, or TLR, provides for the
accurate costing of calls in a private PBX network by calculating the actual
cost of calls routed over private tie lines and assigning charges to the
originating extension. The call is resolved into an accurate
origination-destination configuration even though the call may pass many "nodes"
along the way, with each potentially discharging an independent call record.

         Another add-on module, Property Management System interface, or PMSi,
provides an interface protocol and format for telecommunication management
systems with hotel billing solutions (Front Office or PMS systems). Through the
use of this interface, which can also connect to PBXs, the hotel system is able
to control the opening and closing of guest extensions on check in or out.

         Another add-on module is our Budget Manager, which allows an
administrator to assign credit limits to extensions, departments, cost centers,
or any other organizational hierarchy, and monitor whether these limits have
been exceeded or the calls remain within their allocated budgets.

Customer Service and Installation

         We provide customer support to end-user customers in the United States,
Israel, Hong Kong, the Netherlands and Brazil on both a service contract and a
per-incident basis. Our technical support engineers answer support calls
directly and generally seek to provide same-day responses. We provide updated
telephone rate tables to customers on a periodic basis under annual service
contracts. The rate tables are obtained from third-party vendors who provide
this data for all major long-distance service providers. Our distributors
provide a full range of service and technical support functions for our
products, including rate tables, to their respective end-user customers.

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<PAGE>

         Our support staff installs products at end-user locations from offices
in Israel, the United States, Hong Kong, the Netherlands and Brazil. Customers
who maintain their own technical staffs are often able to install our products
themselves with minimal telephone support from us. We charge our customers a fee
for each installation performed by our employees. Our distributors are
responsible for the installation and support of our products with respect to
their end-user customers.

Sales and Marketing

         We market our products in over 80 countries worldwide through OEM
distribution channels and our own direct sales force in the United States,
Europe, Israel, Hong Kong and Brazil, and through a network of local
distributors in these and various other countries in Europe, Asia and Latin
America. We employed 18 persons in our sales and marketing force and 30 persons
in support as of December 31, 2005, as compared to 35 persons in sales and
marketing and 45 persons in support as of December 31, 2004.

         With the acquisition of IntegraTRAK in April 2000, our marketing
efforts in North America were significantly increased. This also enabled us to
acquire additional Fortune 500 companies as our customers. We also sell our
products to business telephone switching systems manufacturers and vendors,
distributors and PTTs. Since 1985, over 70,000 TABS call accounting products
have been sold, many of which have been sold to large organizations. In
addition, as customers move to consolidate the management of their multi-site
telecommunications activities, we intend to capitalize on our initial successes
with our customers and expand the use of our products by offering these
organizations the added capabilities of expanding and monitoring on the Web. By
acquiring the FaciliTRAK software in March 2002, we gained access to a whole new
realm of opportunities and we now are able to offer a complete solution to the
high-end market sector.

Managed Services

         Our managed services solution is an outsourcing solution geared to
multi-national companies that centrally manage their telecommunications usage
and is offered as an added value service. This solution has been offered in the
United States where our Seattle office acts as a service bureau.

         Switching Systems Manufacturers and Vendors. We believe that the most
efficient means of selling our telemanagement products is to enter into
relationships with major business telephone system manufacturers and vendors who
market our products on either an original equipment manufacturer, or OEM, basis,
or supplemental sales basis at the time they sell their switching systems. We
also utilize our distributors to market our products to local business telephone
switching systems manufacturers and distributors. We intend to establish
additional strategic relationships with business telephone switching systems
manufacturers and vendors and PTTs. These manufacturers have begun to consider
telemanagement capability as a competitive tool when selling their products and
have begun to offer end-users a complete, integrated solution. Among the
companies that sell our telemanagement products are Siemens, Philips,

                                       29
<PAGE>

Ericsson, Lucent, Nortel, Alcatel, ECI/Tadiran, Harris, NEC, Avaya, Mitel,
Cisco, Damovo, LG and Panasonic. We have also entered into an agreement with
Airspan and another major global manufacturer with respect to our billing
products. In addition, we work with gateway providers such as Cisco, Mera,
ArelNet and RADVision. The percentages of sales attributable to our three
largest OEM customers, Siemens, Philips and Ericsson, in each of the three years
ended December 31, 2005 are as follows:

                                               2003        2004        2005
                                               ----        ----        -----
         Siemens..........................     40.0%       38.0%       36.0%
         Philips..........................      7.0%        5.0%        4.0%
         Ericsson.........................      4.0%        4.0%        2.0%

         Distributors. In general, in those countries where we do not have a
marketing subsidiary, we distribute our products through a local distributor.
Marketing, sales, training, product and client support are provided by our local
distributors. A local distributor is typically a telecommunication products
marketing organization with the capability to add value with installation,
training, and support. Distributors are generally responsible for the
localization of our products into their native language. The distributor also
translates our standardized product marketing literature and technical
documentation. Prior to becoming an authorized distributor, the distributor's
employees must undergo sales and technical training. We are available for
second-tier support for the distributor and for end-users. In coordination with
the distributors, we also provide technical support for large and multinational
accounts. We have distributors worldwide and intend to expand our network of
distributors and resellers in selected markets.

         PTTs. We also market our products to PTTs who integrate our solutions
with the telephone systems they sell or lease to their customers. Among the PTTs
who sell our products are Telecom Italy, Cable and Wireless, Trinidad PTT and
Hong Kong Telecom.

         Strategic Relationships. As part of our marketing strategy, we attempt
to develop and establish new strategic relationships with manufacturers of voice
and data communication systems and IP based equipment as means of entering new
markets and channels. We are also continuing our relationship with RADVision, a
recognized IP technology leader. Together with RADVision, we offer solutions
consisting of RADVision's Gatekeeper and our advanced Web-based call management
solution. We also signed an agreement with Cisco, pursuant to which Cisco will
include our VoIP solution in their CallManager call processing software, a key
component of Cisco's AVVID (Architecture for Voice, Video and Integrated Data).
Our software provides validated reports on call records, start time, duration,
and origin and final destination. Additional features include the ability to
allocate usage-sensitive call costing and, using an integrated fraud module,
detect unauthorized or inappropriate system access.

         Other Marketing Activities. We are conducting a wide range of marketing
activities aimed at generating awareness and leads, including public relations,
attendance at trade shows and exhibitions, user conferences, direct mail,
response mail and seminars. We have joined alliances with strategic partners
such as Alcatel and Cisco. We regularly advertise our products in prominent
trade publications, and we also participate in major regional and international
technology and communications trade shows, forums, and fairs worldwide. These
activities are intended both to generate leads and maintain the general public
awareness of our products. We maintain our web site on-line, allowing for
correspondence and queries from new potential customers as well as promoting
support for our existing customer base.

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<PAGE>

Competition

         The market for telemanagement products and billing solutions is
fragmented and is intensely competitive. Competition in the industry is
generally based on product performance, depth of product line, technical support
and price. We compete both with international and local competitors (including
providers of telecommunications and billing services), many of whom have
significantly greater financial, technical and marketing resources than we do.
Our existing and potential customers, including business telephone switching
system manufacturers and vendors, may be able to develop telemanagement and
billing products and services that are as effective as, or more effective or
easier to use than, those offered by us. Such existing and potential competitors
may also enjoy substantial advantages over us in terms of research and
development expertise, manufacturing efficiency, name recognition, sales and
marketing expertise and distribution channels. Although we believe that the
quality of our products is equal to or better than the product quality of our
competitors with regard to performance and reliability, we have no quantitative
data other than the evaluations of our present customers from which to assess
our current ability to compete. There can be no assurance that we will be able
to compete successfully against current or future competitors or that
competition will not have a material adverse effect on our future revenues and,
consequently, on our business, operating results and financial condition.

Intellectual Property Rights

         We rely upon a combination of security devices, copyrights, trademarks,
trade secret laws, confidentiality procedures and contractual restrictions to
protect our rights in our products. In 2005, we filed an international patent
application (PCT application), which is currently pending, relating to a mobile
verification technique that verifies mobile phone usage against the bill
received from the service provider. Our policy has been to pursue copyright
protection for our software and related documentation and trademark registration
of our product names. Some of our products have the added protection afforded by
a hardware component which has embedded software that it is difficult to
misappropriate. In addition, our key employees and independent contractors are
required to sign non-disclosure and secrecy agreements. All of the intellectual
property rights with respect to our current products are held by Mer
Telemanagement Solutions Ltd.

         Our trademark rights include rights associated with the use of our
trademarks, and rights obtained by registration of our trademarks. We have
obtained trademark registrations in Israel and the United States. The use and
registration rights of our trademarks does not ensure that we have superior
rights over other third parties that may have registered or used identical
related marks on related goods or services.

         We believe that, because of the rapid pace of technological change in
the communication industry, the legal protections for our products are less
significant factors in our success than the knowledge, ability and experience of
our employees, the frequency of product enhancements and the timeliness and
quality of support services provided by us.

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<PAGE>

C.       ORGANIZATIONAL STRUCTURE

         Our wholly owned subsidiaries in the United States, Hong Kong, the
Netherlands and Brazil, MTS IntegraTRAK Inc., MTS Asia Ltd., JARAGA B.V. and
TABS Brazil Ltd., respectively, act as marketing and customer service
organizations in those countries. Our 50% owned affiliate in Spain, Jusan S.A.,
is engaged in the development, manufacture, assembly, sales, distribution and
maintenance of vocal server and call billing applications.

D.       PROPERTY, PLANTS AND EQUIPMENT

         Our executive offices and research and development facilities are
located at 22 Zarhin Street, Ra'anana, Israel, where we occupy approximately
14,600 feet. The lease, which expires on December 31, 2006, has an annual rental
charge of approximately $252,000.

         Our U.S. subsidiary occupies approximately 6,368 square feet of space
in Bellevue, Washington. The lease, which will expire in September 2006, has a
remaining obligation of approximately $100,000. We have subleased 1,900 square
feet of this space until September 2006 and are receiving rental income of
approximately $20,000 for the period leased in 2006.

         In addition, we have an office in New Jersey, where we occupy
approximately 1,852 square feet of space. The lease, which will expire in
September 2006, has a remaining obligation of approximately $27,000.

         The combined total annual rental cost for our Hong Kong and Sao Paulo
offices is approximately $25,000. The lease agreements for these premises will
expire in October 2007 and February 2008, respectively.

ITEM 4A. UNRESOLVED STAFF COMMENTS

         Not applicable.

ITEM 5.  OPERATING AND FINANCIAL REVIEW AND PROSPECTS

A.       OPERATING RESULTS

         The following discussion of our results of operations should be read
together with our consolidated financial statements and the related notes, which
appear elsewhere in this annual report. The following discussion contains
forward-looking statements that reflect our current plans, estimates and beliefs
and involve risks and uncertainties. Our actual results may differ materially
from those discussed in the forward-looking statements. Factors that could cause
or contribute to such differences include those discussed below and elsewhere in
this annual report.

Background

         We were incorporated under the laws of the State of Israel in December
1995, as a subsidiary of C.Mer Industries Ltd., an Israeli public company. Since
our initial public offering in May 1997, our ordinary shares have been listed on
the NASDAQ Stock Market. In June 1999, C.Mer Industries Ltd. distributed to its
shareholders all of its remaining shares in our company as a dividend.

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<PAGE>

         We have wholly owned subsidiaries in the United States, Hong Kong, the
Netherlands and Brazil, MTS IntegraTRAK Inc., MTS Asia Ltd., JARAGA B.V. and
TABS Brazil Ltd., respectively, which act as marketing and customer service
organizations in those countries. We also have a 50% owned affiliate in Spain,
Jusan S.A., which is engaged in the development, manufacture, assembly, sales,
distribution and maintenance of vocal server and call billing applications.

Overview

         We design, develop, market and support a comprehensive line of
telecommunication management and customer care and billing, or CC&B, solutions,
that enable business organizations and other enterprises to improve the
efficiency and performance of all IP operations, and to significantly reduce
associated costs. Our products include call accounting and management products,
fault management systems and Web-based management solutions for converged voice,
voice over IP, IP data and video and CC&B solutions. These products are designed
to provide telecommunication and information technology managers with tools to
reduce communication costs, recover charges payable by third parties, detect and
report the abuse and misuse of telephone networks, monitor and detect hardware
and software faults in telecommunications networks and generate
telecommunications usage information for use in the management of an enterprise.
We were among the first to offer PC-based call accounting systems when we
introduced our TABS product in 1985. To date, over 70,000 TABS call accounting
systems have been sold to end-users in more than 80 countries. In the service
provider and carrier market, our billing solutions provide for retail billing,
interconnect billing and partner revenue management.

General

         Our consolidated financial statements appearing in this annual report
are prepared in U.S. dollars and in accordance with generally accepted
accounting principles in the United States, or U.S. GAAP. Transactions and
balances originally denominated in dollars are presented at their original
amounts. Transactions and balances in other currencies are remeasured into
dollars in accordance with the principles set forth in Financial Accounting
Standards Board Statement No. 52. The majority of our sales are made outside
Israel in dollars. In addition, substantial portions of our costs are incurred
in dollars. Since the dollar is the primary currency of the economic environment
in which we and certain of our subsidiaries operate, the dollar is our
functional and reporting currency and, accordingly, monetary accounts maintained
in currencies other than the dollar are remeasured using the foreign exchange
rate at the balance sheet date. Operational accounts and non-monetary balance
sheet accounts are measured and recorded at the exchange rate in effect at the
date of the transaction. The financial statements of certain subsidiaries and an
affiliate whose functional currency is not the dollar, have been translated into
dollars. All balance sheet accounts have been translated using the exchange
rates in effect at the balance sheet date. Statement of operations amounts have
been translated using the average exchange rate for the period. The resulting
translation adjustments are reported as a component of shareholders' equity in
accumulated other comprehensive income (loss).

                                       33
<PAGE>

Discussion of Critical Accounting Policies and Estimations

         The preparation of financial statements in conformity with generally
accepted accounting principles requires us to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates and the use of different
assumptions would likely result in materially different results of operations.

         Critical accounting policies are those that are both most important to
the portrayal of a company's financial position and results of operations, and
require management's most difficult, subjective or complex judgments. Although
not all of our significant accounting policies require management to make
difficult, subjective or complex judgments or estimates, the following policies
and estimates are those that we deem most critical:

         Revenue Recognition

         We account for our revenue in accordance with the provisions of SOP No.
97-2, "Software Revenue Recognition," issued by the American Institute of
Certified Public Accountants and as amended by SOP No. 98-9 and related
interpretations. When an arrangement does not require significant production,
modification or customization of software or does not contain services
considered to be essential to the functionality of the software, revenue is
recognized when the following four criteria are met:

         o     Persuasive evidence of an arrangement exists. We require
               evidence of an agreement with a customer specifying the terms
               and conditions of the products or services to be delivered
               typically in the form of a purchase order;

         o     Delivery has occurred. For software licenses, delivery takes
               place when the software is installed on site or remotely or is
               shipped via mail on a compact disc or server. For services,
               delivery takes place as the services are provided;

         o     The fee is fixed or determinable. Fees are fixed or
               determinable if they are not subject to a refund or
               cancellation and do not have payment terms that exceed our
               standard payment terms.

         o     Collection is probable. We perform a credit review of all
               customers with significant transactions to determine whether a
               customer is credit worthy and collection is probable.

         In general, revenue for transactions that do not involve software
customization or services considered essential to the functionality of the
software is recognized as follows: (i) software license fees for sales through
OEMs are recognized upon receipt of license activity or royalty reports; (ii)
all other software license fees are recognized upon delivery of the software;
(iii) software maintenance and technical support are recognized ratably over the
contract term; and (iv) consulting, training and other similar services are
recognized as the services are performed.

                                       34
<PAGE>

         We exercise judgment and use estimates in connection with the
determination of the amount of product software license and services revenues to
be recognized in each accounting period. If the fee due from the customer is not
fixed or determinable, revenue is recognized as payments become due from the
customer. If collection is not considered probable, revenue is recognized when
the fee is collected. We record a provision to operating expenses for bad debts
resulting from customers' inability to pay for the products or services they
have received. These estimates are based on historical bad debt expense,
analyses of credit memo data, and other known factors, such as bankruptcy. If
the historical data we use to calculate these estimates do not accurately
reflect future returns or bad debts, adjustments to these reserves may be
required that would increase or decrease revenue or net income.

         Many of our software arrangements involve multiple elements. Such
elements typically include any or all of the following: software licenses,
software maintenance, technical support and training services. For
multiple-element arrangements that do not involve significant modification or
customization of the software and do not involve services that are considered
essential to the functionality of the software, we allocate value to each
undelivered element based on vendor specific objective evidence, or VSOE, of the
fair value of each undelivered element in the arrangement, in accordance with
the "residual method" prescribed by SOP No. 98-9, "Modification of SOP No. 97-2,
Software Revenue Recognition With Respect to Certain Transactions." The VSOE
used by us to allocate the sales price to support services and maintenance is
based on the renewal rate charged when these elements are sold separately.
License revenues are recorded based on the residual method. Under the residual
method, revenue is recognized for the delivered elements when (1) there is VSOE
of the fair values of all the undelivered elements, and (2) all revenue
recognition criteria of SOP No. 97-2, as amended, as described above, are
satisfied. Under the residual method any discount in the arrangement is
allocated to the delivered element.

         Revenues from billing products which involve significant customization
of our software to customer specific specifications are recognized in accordance
with SOP No. 81-1, "Accounting for Performance of Construction-Type and Certain
Production-Type Contracts," using contract accounting on a percentage of
completion method, over the period from signing of the license through to
customer acceptance in accordance with the "input method." The amount of revenue
recognized is based on the total license fees under the license agreement and
the percentage to completion achieved. The percentage to completion is measured
by monitoring progress using records of actual costs incurred to date in the
project compared with the total estimated project requirement. Estimates of
total project requirements are based on prior experience of customization,
delivery and acceptance of the same or similar technology and are reviewed and
updated regularly by management.

         Where arrangements recognized according to SOP No. 81-1 involve
maintenance and support services, revenues are recognized according to Emerging
Issues Task Force, or EITF, Issue No. 00-21, "Revenues Arrangements with
Multiply Deliveries," or EITF 00-21. According to EITF 00-21, a multiple-element
arrangement (an arrangement that involves the delivery or performance of
multiple products, services and/or rights to use assets) is separated into more
than one unit of accounting, if the functionality of the delivered element is
not dependent on the undelivered element, there is VSOE of fair value of the
undelivered element and delivery of the delivered element represents the
culmination of the earnings process for this element. We have established VSOE
for maintenance and support services based on the renewal rate charged when
these elements are sold separately and therefore the arrangement consideration
is allocated to maintenance and support services based on their relative VSOE.

                                       35
<PAGE>

         After delivery, if uncertainty exists about customer acceptance of the
software, license revenue is not recognized until acceptance. Provisions for
estimated losses on uncompleted contracts are made in the period in which such
losses are first determined, in the amount of the estimated loss on the entire
contract. As of December 31, 2005, no such estimated losses were identified.

         Estimated gross profit or loss from long-term contracts may change due
to changes in estimates resulting from differences between actual performance
and original forecasts. Such changes in estimated gross profit are recorded in
results of operations when they are reasonably determinable by management, on a
cumulative catch-up basis.

         We believe that the use of the percentage of completion method is
appropriate as we have the ability to make reasonably dependable estimates of
the extent of progress towards completion, contract revenues and contract costs.
In addition, contracts executed include provisions that clearly specify the
enforceable rights regarding services to be provided and received by the parties
to the contracts, the consideration to be exchanged and the manner and terms of
settlement. In all cases we expect to perform our contractual obligations and
our licensees are expected to satisfy their obligations under the contract.

         Allowances for Doubtful Accounts.

         We perform ongoing credit evaluations of our customers' financial
condition and we require collateral as deemed necessary. We maintain allowances
for doubtful accounts for estimated losses resulting from the inability of our
customers to make payments. In judging the adequacy of the allowance for
doubtful accounts, we consider multiple factors including the aging of our
receivables, historical bad debt experience and the general economic
environment. Management applies considerable judgment in assessing the
realization of receivables, including assessing the probability of collection
and the current credit worthiness of each customer. If the financial condition
of our customers were to deteriorate, resulting in an impairment of their
ability to make payments, additional allowances may be required.

         Income Taxes

         Estimates and judgments are required in the calculation of certain tax
liabilities and in the determination of the recoverability of certain of the
deferred tax assets, which arise from net operating losses tax carryforwards and
temporary differences between the tax and financial statement recognition of
revenue and expense. SFAS No. 109, "Accounting for Income Taxes," also requires
that the deferred tax assets be reduced by a valuation allowance, if based on
the weight of available evidence, it is more likely than not that some portion
or all of the recorded deferred tax assets will not be realized in future
periods.

         In evaluating our ability to recover our deferred tax assets, in full
or in part, we consider all available positive and negative evidence including
our past operating results, the existence of cumulative losses in the most
recent fiscal years and our forecast of future taxable income on a

                                       36
<PAGE>

jurisdiction by jurisdiction basis. In determining future taxable income, we are
responsible for assumptions utilized, including the amount of Israeli and
international pre-tax operating income, the reversal of temporary differences
and the implementation of feasible and prudent tax planning strategies. These
assumptions require significant judgment about the forecasts of future taxable
income and are consistent with the plans and estimates we use to manage the
underlying businesses.

         Based on estimates of future taxable profits and losses in certain
foreign tax jurisdictions, we determined that a valuation allowance of $2.0
million was required for tax loss carryforwards and other temporary differences
as of December 31, 2005. If these estimates prove inaccurate, a change in the
valuation allowance could be required in the future.

         Contingencies

         We are involved in legal proceedings and other claims from time to
time. We are required to assess the likelihood of any adverse judgments or
outcomes to these matters, as well as potential ranges of probable losses. A
determination of the amount of reserves required, if any, for any contingencies
are made after careful analysis of each individual claim. The required reserves
may change due to future developments in each matter or changes in approach,
such as a change in the settlement strategy in dealing with any contingencies,
which may result in higher net loss. If actual results are not consistent with
our assumptions and judgments, we may be exposed to gains or losses that could
be material. See "Item 8A. Financial Information - Consolidated Statements and
Other Financial Information - Legal Proceedings."

         Impairment of long-lived assets

         We review our long-lived assets and certain identifiable intangible
assets for impairment whenever events or changes in circumstances indicate that
the carrying value may not be recoverable. Factors that could indicate an
impairment include significant underperformance of the asset as compared to
historical or projected future operating results, significant changes in the
actual or intended use of the asset, or significant negative industry or
economic trends. When we determine that the carrying value of an asset may not
be recoverable, the related estimated future undiscounted cash flows expected to
result from the use and eventual disposition of the asset are compared to the
carrying value of the asset. If the sum of the estimated undiscounted future
cash flows is less than the carrying amount, we record an impairment charge
based on the difference between the carrying value of the asset and its fair
value, which we estimate based on discounted expected future cash flows. In
determining whether an asset is impaired, we must make assumptions regarding
recoverability of costs, estimated future cash flows from the asset, intended
use of the asset and other related factors. If these estimates or their related
assumptions change, we may be required to record impairment charges for these
assets. As of December 31, 2005, no impairment losses have been identified.

         Goodwill

         Goodwill represents excess of the costs over the net assets of business
acquired. Goodwill from acquisitions made prior to July 1, 2001 was amortized
until December 31, 2001 by the straight-line method over 10 years. Goodwill
acquired in a business combination on or after July 1, 2001 is not amortized.

                                       37
<PAGE>

         Effective January 1, 2002, we adopted SFAS No. 142. SFAS No. 142
requires goodwill to be tested for impairment on adoption and at least annually
thereafter, and written down when impaired, rather than being amortized as
previous accounting standards required. Goodwill attributable to each of our
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. 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. We have
selected September 30 as the date we will perform our annual goodwill impairment
tests. The annual goodwill impairment test for 2005 was prepared for us by an
independent consulting firm. As of December 31, 2005, no impairment was
required. Any changes in our key assumptions could result in an impairment
charge and such a change could have a material adverse affect on our financial
position and results of operations.

Recently Issued Accounting Standards

         On December 16, 2004, the Financial Accounting Standards Board, or
FASB, issued Statement of Financial Accounting Standards, or SFAS, No. 123
(revised 2004), "Share-Based Payment," or SFAS 123(R), which is a revision of
SFAS No. 123, "Accounting for Stock Based Compensation," or SFAS 123. Generally,
the approach in SFAS 123(R) is similar to the approach described in SFAS 123.
However, SFAS 123 permitted, but did not require, share-based payments to
employees to be recognized based on their fair values, while SFAS 123(R)
requires all share-based payments to employees to be recognized based on their
fair values on the date of grant. SFAS 123(R) also revises, clarifies and
expands guidance in several areas, including measuring fair value, classifying
an award as equity or as a liability and attributing compensation cost to
reporting periods. The new standard became effective for us commencing January
1, 2006.

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

         A "modified prospective" method in which compensation cost is
recognized beginning with the effective date (a) based on the requirements of
SFAS 123(R) for all share-based payments granted after the effective date and
(b) based on the requirements of SFAS 123 for all awards granted to employees
prior to the effective date of SFAS 123(R) that remain unvested on the effective
date.

         A "modified retrospective" method which includes the requirements of
the modified prospective method described above, but also permits entities to
restate based on the amounts previously recognized under SFAS 123 for purposes
of pro forma disclosures either (a) all prior periods presented or (b) prior
interim periods of the year of adoption.

         We have adopted the modified prospective method of SFAS 123(R).

         Prior to January 1, 2006, as permitted by SFAS 123, we accounted for
share-based payments to employees using Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees," the intrinsic value method. Had
we adopted SFAS 123(R) in 2005, the impact of that standard would have increased
our net losses by approximately $198,000, as described in the disclosure of pro
forma net income (loss) and earnings (losses) per share in our consolidated
financial statements.

                                       38
<PAGE>

         In March 2005, the Securities and Exchange Commission, or the SEC,
released SEC Staff Accounting Bulletin No. 107, "Share Based Payment," or "SAB
107." SAB 107 provides the SEC's staff position regarding the application of
Statement 123(R) and contains interpretive guidance relating to the interaction
between Statement 123(R) and certain SEC rules and regulations, and also
provides the SEC staff's view 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. We are currently reviewing the effect of SAB 107, however we do
not believe that SAB 107 will have a material effect on our financial position,
results of operations or cash flows.

         In May 2005, the FASB issued Statement of Financial Accounting Standard
No. 154, or SFAS No. 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 No. 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
change the cumulative effect of changing to the new accounting principle. SFAS
No. 154 requires retroactive application to prior periods' financial statements
of a voluntary change in accounting principles unless it is impracticable. SFAS
No. 154 is effective for accounting changes and corrections of errors made in
fiscal years beginning after December 15, 2005.

         In November 2005, the FASB released FASB Staff Position Nos. FAS 115-1
and FAS 124-1, "The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments," or FSP 115-1, which effectively replaces
EITF Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments." FSP 115-1 contains a three-step model for
evaluating impairments and carries forward the disclosure requirements under
EITF Issue No. 03-1 with respect to securities in an unrealized loss position.
Under the model, any security in an unrealized loss position is considered
impaired; an evaluation is made to determine whether the impairment is
other-than-temporary; and, if an impairment is considered other-than-temporary,
a realized loss is recognized to write the security's cost or amortized cost
basis down to fair value. FSP 115-1 references existing other-than-temporary
impairment guidance for determining when an impairment is other-than-temporary
and clarifies that subsequent to the recognition of an other-than-temporary
impairment loss for debt securities, an investor shall account for the security
using the constant effective yield method. FSP 115-1 is effective for reporting
periods beginning after December 15, 2005, with earlier application permitted.
We adopted FSP 115-1 upon issuance. The adoption of FSP 115-1 did not have a
material effect on our consolidated financial condition or results of
operations.

                                       39
<PAGE>

Results of Operations

         The following table presents certain financial data expressed as a
percentage of total revenues for the periods indicated:

<TABLE>
<CAPTION>
                                                                             Year Ended December 31,
                                                                            ------------------------
                                                                             2003      2004     2005
                                                                            ------    ------   ------
       Revenues
<S>                                                                          <C>       <C>      <C>
       Product sales...................................................      75.2%     75.1%    66.0%
       Services                                                              24.8      24.9     34.0
                                                                            ------    ------   ------
       Total revenues..................................................     100.0%    100.0%   100.0%
       Cost of revenues
       Product sales...................................................      16.5      25.6     25.7
       Services........................................................       3.5       4.3      7.2
       Total cost of revenues..........................................      20.0      29.9     32.9
       Gross profit....................................................      80.0      70.1     67.1
       Selling and marketing...........................................      42.5      66.9     41.5
       Research and development, net...................................      19.8      25.1     38.0
       General and administrative......................................      19.8      22.3     24.5
                                                                            ------    ------   ------
       Operating loss..................................................      (2.1)    (44.2)   (36.9)
       Financial income, net...........................................       1.4       0.8      0.5
                                                                            ------    ------   ------
       Loss before taxes on income.....................................      (0.7)    (43.4)   (36.4)
       Taxes on income.................................................       2.1       2.8      0.1
                                                                            ------    ------   ------
       Net loss before equity in earnings of affiliate.................      (2.8)    (46.2)   (36.5)
       Equity in earnings of affiliate.................................       3.7       2.4      0.0
                                                                            ------    ------   ------
       Net income (loss)...............................................       0.9%    (43.8)%  (36.5)
                                                                            ======    ======   ======
</TABLE>

Years Ended December 31, 2005 and 2004

         Revenues from Products and Services. Revenues consist primarily of
software license fees sales, hardware sales and revenues from services,
including service bureau, maintenance, training, professional services and
support. Revenues increased by 22.8% to $11.56 million in 2005 from $9.41
million in 2004. In 2005, the revenues from our wholly owned U.S. subsidiary,
MTS IntegraTRAK, increased by 22% from 2004 and accounted for 52.3% of our total
revenues. The increase in revenues in 2005 is primarily attributable to revenues
from billing solutions that were based on the technology that we acquired from
Teleknowledge and revenues from sales of our new telemanagement solutions. We
anticipate that our revenues will slightly increase in 2006.

         Cost of Revenues from Products and Services . Cost of revenues consists
primarily of (i) production costs (including hardware, media, packaging, freight
and documentation); (ii) certain royalties and licenses payable to third parties
(including the Office of the Chief Scientist of the Ministry of Industry and
Trade of the State of Israel), (iii) professional services costs; and (iv)
warranty and support costs for up to one year for end-users and up to 15 months
for our OEM distributors. Cost of revenues increased by 35.1% to $3.80 million
in 2005 from $2.81 million in 2004. This increase in cost of revenues in 2005
corresponds with the increase in revenues and is primarily a result of the
change in our product mix from "shelf products" to customized telecommunications
equipment manufacturer products and billing solutions.

                                       40
<PAGE>

         Research and Development, net. Research and development expenses
consist primarily of salaries of employees engaged in on-going research and
development activities, outsourcing subcontractor development and other related
costs, net of grants that were approved by the Office of the Chief Scientist.
Research and development costs increased by 86.1% to $4.40 million in 2005 (net
of the grant from the Office of the Chief Scientist in the amount of $130,000)
from $2.36 million in 2004 (after the capitalization of $386,000 of software
development costs). Total research and development expenses increased in 2005
primarily due to the continued integration of Teleknowledge's research and
development group, as well as to our continuing investment in product
development. We expect that our research and development expenses will remain at
the same level in 2006.

         Selling and Marketing. Selling and marketing expenses consist primarily
of costs relating to sales representatives and their travel expenses, trade
shows and marketing exhibitions, advertising and presales support. Selling and
marketing expenses decreased by 23.9% to $4.80 million in 2005 from $6.30
million in 2004. This decrease in selling and marketing expenses in 2005 is
primarily attributable to our focus on investing in growth markets and targeted
geographic areas, as well as our ability to form partnerships with leading OEMs
and vendors for various initiatives.

         General and Administrative. General and administrative expenses consist
primarily of compensation costs for administration, finance and general
management personnel, professional fees and office maintenance and
administrative costs. General and administrative expenses increased by 34.7% to
$2.83 million in 2005 from $2.10 million in 2004. This increase in general and
administrative expenses in 2005 is primarily attributable to the increase in our
overall activity.

         Financial Income, net. Financial income, net consists primarily gains
on marketable securities, interest income on bank deposits, bank commissions,
bank interest and foreign currency translation adjustments. Financial income,
net decreased by 32.1% to $53,000 in 2005 from $78,000 in 2004. In 2005, our
interest income was negatively affected by the decrease in our holdings of cash
and cash equivalents and by foreign currency translation adjustments expenses.
These expenses were offset in part by gains on marketable securities, net in the
amount of $81,000.

         Taxes on Income. In 2005, our taxes on income were $10,000 as compared
to $266,000 in 2004. Most of our taxes in 2004 were the result of our provision
for the Israeli tax authorities' demand for tax payment for the 1997-1999
period. We have made a provision in our financial statements for this tax demand
for the amount deemed probable.

         Equity in Results of Affiliate. We recognize income and loss from the
operations of our 50%-owned affiliate, Jusan S.A. In 2005 and 2004, we
recognized income of $2,000 and $225,000, respectively.

                                       41
<PAGE>

Years Ended December 31, 2004 and 2003

         Revenues. Revenues increased by 2.0% to $9.41 million in 2004 from
$9.23 million in 2003. In 2004, the revenues from our wholly owned U.S.
subsidiary, MTS IntegraTRAK, increased by 0.7% from 2003 and accounted for 52.6%
of our total revenues.

         Cost of Revenues. Cost of revenues increased by 52.2% to $2.81 million
in 2004 from $1.85 million in 2003. The increase in cost of revenues in 2004 is
principally as a result of the significant number of new employees recruitments
in professional services and technical support departments and their travel
expenditures.

         Research and Development. Research and development costs increased by
29% to $2.36 million (after the capitalization of $0.4 million of software
development costs) from $1.83 million in 2003. Total research and development
expenses increased in 2004 primarily due to the increase of our research and
development activity including the recruitment of new employees in that
department and outsourcing additional subcontractors for development.

         Selling and Marketing. Selling and marketing expenses were $6.30
million in 2004, an increase of approximately 60.9% from $3.92 million in 2003.
The increase in selling and marketing expenses in 2004 is primarily attributable
to the increase in our personnel globally across our sales division.

         General and Administrative. General and administrative expenses
increased by 14.8% to $2.10 million in 2004 from $1.83 million in 2003 as we
increased our overall activity.

         Financial Income, Net. Financial income decreased by 37% to $78,000 in
2004 from $130,000 in 2003. During the four years ended December 31, 2004 our
interest income was negatively affected by the prevailing low interest rates in
both the United States and in Israel and the decrease in the total cash and cash
equivalents held by us.

         Taxes on Income. In 2004, our taxes on income were $266,000 as compared
to $198,000 in 2003. Most of our taxes in 2004 were the result of our provision
for the Israeli tax authorities' demand for tax payment for the 1997-1999
period. Most of our taxes in 2003 were the result of our realization of a
deferred tax assets according to our accounting policy. During 2003, we realized
a tax benefit of $80,000 from a tax return received from the Spanish tax
authorities.

         Equity in Results of Affiliate. We recognize income and loss from the
operations of our 50%-owned affiliate, Jusan S.A. In 2004 and 2003, we
recognized income of $225,000 and $345,000, respectively.

Quarterly Results of Operations

         The following tables set forth certain unaudited quarterly financial
information for the two years ended December 31, 2005. The data has been
prepared on a basis consistent with our audited consolidated financial
statements included elsewhere in this annual report and include all necessary
adjustments, consisting only of normal recurring adjustments, that we consider
necessary for a fair presentation. The operating results for any quarter are not
necessarily indicative of results for any future periods.

                                       42
<PAGE>

<TABLE>
<CAPTION>
                                                                             Three months ended
                                         -----------------------------------------------------------------------------------------
                                                              2004                                          2005
                                         -------------------------------------------    ------------------------------------------
                                         Mar. 31,    Jun. 30,   Sept. 30,   Dec. 31,    Mar. 31,   Jun. 30,   Sept. 30,   Dec. 31,
                                         --------    --------   ---------   --------    --------   --------   ---------   --------
<S>                                    <C>         <C>        <C>         <C>         <C>        <C>         <C>         <C>
Revenues.............................. $   2,359   $   1,992  $   2,485   $   2,577   $   2,726  $   2,812   $   3,013   $  3,012
Cost of revenues......................       541         506        674       1,093         887      1,006       1,061        848
                                         --------    --------   ---------   --------    --------   --------   ---------   --------
Gross profit..........................     1,818       1,486      1,811       1,484       1,839      1,806       1,952      2,164
                                         --------    --------   ---------   --------    --------   --------   ---------   --------
Selling and marketing.................     1,125       1,397      1,762       2,016       1,527      1,370         984        916
Research and development, net.........       534         569        414         845       1,294      1,030       1,118        953
General and administrative............       397         489        533         682       1,045        677         588        520
Operating expenses....................     2,056       2,455      2,709       3,543       3,866      3,077       2,690      2,389
                                         --------    --------   ---------   --------    --------   --------   ---------   --------
Operating loss........................      (238)       (969)      (898)     (2,059)     (2,027)    (1,271)       (738)      (225)
Financial income (expense), net.......        (4)         (7)        42          47          21         83          (6)       (45)
Other income (loss), net..............         -           -          -           -           -          -          (2)         2
                                         --------    --------   ---------   --------    --------   --------   ---------   --------
Loss before taxes on income...........      (242)       (976)      (856)     (2,012)     (2,006)    (1,188)       (746)      (268)
Taxes on income.......................         -           2          1         263           -          -           -         10
                                         --------    --------   ---------   --------    --------   --------   ---------   --------
Net loss before equity in results of
   affiliate..........................      (242)       (978)      (857)     (2,275)     (2,006)    (1,188)       (746)      (278)
Equity in results of affiliate........        46          49        140         (10)        (28)        39          48        (57)
                                         --------    --------   ---------   --------    --------   --------   ---------   --------
Net loss.............................. $    (196)      $(929)     $(717)  $  (2,285)  $  (2,034) $  (1,149)  $    (698)  $   (335)
                                         ========    ========   =========   ========    ========   ========   =========   ========
Basic and diluted net loss per share.. $   (0.04)     $(0.20)    $(0.15)  $   (0.50)  $   (0.44) $   (0.24)  $   (0.13)  $  (0.06)
Weighted average number of ordinary
   shares used in computing basic and
   diluted net loss per share......... 4,624,804   4,633,471  4,638,004   4,638,004   4,638,004  4,712,561   5,306,565   5,724,504

Revenues..............................     100.0%      100.0%     100.0%      100.0%      100.0%     100.0%      100.0%      100.0%
Cost of revenues......................      22.9        25.4       27.1        42.4        32.5       35.8        35.2        28.2
                                         --------    --------   ---------   --------    --------   --------   ---------   --------
Gross profit..........................      77.1        74.6       72.9        57.6        67.5       64.2        64.8        71.8
                                         --------    --------   ---------   --------    --------   --------   ---------   --------
Selling and marketing.................      47.7        70.1       70.9        78.2        56.0       48.7        32.7        30.4
Research and development, net.........      22.6        28.6       16.7        32.8        47.5       36.6        37.1        31.6
General and administrative............      16.8        24.5       21.4        26.5        38.3       24.1        19.5        17.3
Operating expenses....................      87.2       123.2      109.0       137.5       141.8      109.4        89.3        79.3
                                         --------    --------   ---------   --------    --------   --------   ---------   --------
Operating loss........................     (10.1)      (48.6)     (36.1)      (79.9)      (74.3)     (45.2)      (24.5)       (7.5)
Financial income (expense), net.......      (0.2)       (0.4)       1.7         1.8         0.8        3.0        (0.2)       (1.5)
Other income (loss), net..............       -           -          -           -           -          -          (0.1)        0.1
                                         --------    --------   ---------   --------    --------   --------   ---------   --------
Loss before taxes on income...........     (10.3)      (49.0)     (34.4)      (78.1)      (73.5)     (42.2)      (24.8)       (8.9)
Taxes on income.......................       -           0.1        -          10.2         -          -           -           0.3
                                         --------    --------   ---------   --------    --------   --------   ---------   --------
Net loss before equity in results of
   affiliate..........................     (10.3)      (49.1)     (34.4)      (88.3)      (73.5)     (42.2)      (24.8)       (9.2)
Equity in results of affiliate........       1.9         2.5        5.5        (0.4)       (1.0)       1.4         1.6        (1.9)
                                         --------    --------   ---------   --------    --------   --------   ---------   --------
Net loss..............................      (8.3)%     (46.6)%    (28.9)%     (88.7)%     (74.6)%    (40.8)%     (23.2)%     (11.1)%
                                         ========    ========   =========   ========    ========   ========   =========   ========
</TABLE>

Seasonality

         Our operating results are generally not characterized by a seasonal
pattern except that our volume of sales in Europe are generally lower in the
summer months.

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

         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 a devaluation of the NIS in relation to the
dollar. When the rate of inflation in Israel exceeds the rate of devaluation of
the NIS against the dollar, companies experience increases in the dollar cost of
their operations in Israel. Unless offset by a devaluation of the NIS, inflation
in Israel will have a negative effect on our profitability, as we receive
payments in dollars for most of our sales, while we incur a portion of our
expenses in NIS.

                                       43
<PAGE>

         In addition, since part of our sales are quoted in NIS and a portion of
our expenses are incurred in NIS, our results have in the past been and would in
the future be adversely affected by a change in the rate of inflation in Israel
when the amount of our revenues in NIS is less than the amount of our expenses
in NIS or if such change in the rate of inflation is not offset, or is offset on
a lagging basis, by a corresponding devaluation of the NIS against the dollar
and other foreign currencies.

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

                                                              Israeli inflation
       Year ended     Israeli inflation    NIS devaluation      adjusted for
      December 31,         rate %              rate %           devaluation %
      ------------    -----------------    ---------------    -----------------
          2001              1.4                 9.3                (7.2)
          2002              6.5                 7.3                (0.7)
          2003             (1.9)               (7.6)                6.2
          2004              1.2                (1.6)                2.8
          2005              2.4                 6.8                (4.1)

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

         Because exchange rates between the NIS and the dollar fluctuate
continuously, with a historically declining trend in the value of the NIS,
exchange rate fluctuations, particularly larger periodic devaluations, may have
an impact on our profitability and period-to-period comparisons of our results.
We cannot assure you that in the future our results of operations may not be
materially adversely affected by currency fluctuations.

Conditions in Israel

         We are incorporated under the laws of, and our principal executive
offices and manufacturing and research and development facilities are located
in, the State of Israel. Accordingly, our operations in Israel are directly
influenced by political, economic and military conditions affecting Israel.
Specifically, we could be adversely affected by any major hostilities involving
Israel, a full or partial mobilization of the reserve forces of the Israeli
army, the interruption or curtailment of trade between Israel and its present
trading partners, and a significant downturn in the economic or financial
condition of Israel.

                                       44
<PAGE>

Political Conditions

         Since the establishment of the State of Israel in 1948, a number of
armed conflicts have taken place between Israel and its Arab neighbors, and a
state of hostility, varying from time to time in intensity, has led to security
and economic problems for Israel. Since September 2000, there has been a marked
increase in violence, civil unrest and hostility, including armed clashes,
between the State of Israel and the Palestinians, and acts of terror have been
committed inside Israel and against Israeli targets in the West Bank and Gaza.
These developments have adversely affected the regional peace process, placed
the Israeli economy under significant stress, and have negatively influenced
Israel's relationship with several Arab countries. In August 2005, Israel
evacuated all Israeli settlements in the Gaza Strip and four settlements in the
West Bank. In January 2006, Hamas won the elections in the Palestinian Authority
and on March 28, 2006, elections to the Israeli parliament were held in Israel.
The implications of these developments cannot at this time be foreseen. Any
future armed conflict, political instability or violence in the region may have
a negative effect on our business condition, harm our results of operations and
adversely affect our share price.

         Furthermore, there are a number of countries that restrict business
with Israel and with Israeli companies. Restrictive laws or policies of those
countries directed towards Israel or Israeli businesses had, and may in the
future continue to have, an adverse impact on our operations, our financial
results or the expansion of our business. No predictions can be made as to
whether or when a final resolution of the area's problems will be achieved or
the nature thereof and to what extent the situation will impact Israel's
economic development or our operations.

         In addition, some of our executive officers and employees in Israel are
obligated to perform annual reserve duty in the Israeli Defense Forces and may
be called for active duty under emergency circumstances at any time. If a
military conflict or war arises, these individuals could be required to serve in
the military for extended periods of time. Our operations could be disrupted by
the absence for a significant period of one or more of our executive officers or
key employees or a significant number of other employees due to military
service. Any disruption in our operations could adversely affect our business.

         To date, no executive officer or key employee has been recruited for
military service for any significant time period. Any further deterioration of
the hostilities between Israel and the Palestinian Authority into a full-scale
conflict might require more significant military reserve service by some of our
employees, which may have a material adverse effect on our business.

Economic Conditions

         In recent years Israel has been going through a period of recession in
economic activity, resulting in low growth rates and growing unemployment.
Although economic activity in Israel has improved recently, our operations could
be adversely affected if the economic conditions in Israel begin to deteriorate
again.

                                       45
<PAGE>

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 a member of the World Trade
Organization and is a signatory to the General Agreement on Tariffs and Trade,
which provides for reciprocal lowering of trade barriers among its members. 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 products covered by such programs either
duty-free or at reduced tariffs.

         Israel and the European Union Community concluded a Free Trade
Agreement in July 1975, which confers certain advantages with respect to Israeli
exports to most European countries and obligates Israel to lower its tariffs
with respect to 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 specified non-tariff
barriers on most trade between the two countries. On January 1, 1993, an
agreement between Israel and the European Free Trade Association, known as EFTA,
established a free-trade zone between Israel and the EFTA nations. In November
1995, Israel entered into a new agreement with the European Union, which
includes redefinement of rules of origin and other improvements, including
providing for Israel to become a member of the research and technology programs
of the European Union. In recent years, Israel has established commercial and
trade relations with a number of other nations, including China, India, Russia,
Turkey and other nations in Eastern Europe and Asia.

Effective Corporate Tax Rate

         Israeli companies are generally subject to income tax on their taxable
income. The applicable rate for 2005 was 34%, which was reduced to 31% in 2006,
and will be further reduced to 29% in 2007, 27% in 2008, 26% in 2009 and 25% in
2010 and thereafter.

         However, certain of our manufacturing facilities have been granted
"Approved Enterprise" status under the Law for the Encouragement of Capital
Investments, 1959, as amended, commonly referred to as the Investment Law, and,
consequently, are eligible, subject to compliance with specified requirements,
for tax benefits beginning when such facilities first generate taxable income.
Subject to certain restrictions, we are entitled to a tax exemption in respect
of income derived from our approved facilities for a period of two years,
commencing in the first year in which such income is earned, and will be
entitled to a reduced tax rate of 10%-25% for an additional five to eight years
if we qualify as a foreign investors' company. If we do not qualify as a foreign
investors' company, we will instead be entitled to a reduced rate of 25% for an
additional five, rather than eight, years.

         Our taxes outside Israel are dependent on our operations in each
jurisdiction as well as relevant laws and treaties. Under Israeli tax law, the
results of our foreign consolidated subsidiaries, which have generally been
unprofitable, cannot be consolidated for tax purposes with the results of
operations of the parent company.

                                       46
<PAGE>

B.       LIQUIDITY AND CAPITAL RESOURCES

         On December 31, 2005, we had $3.2 million in cash and cash equivalents,
$132,000 in marketable securities and working capital of $2.1 million as
compared to $3.8 million in cash and cash equivalents, $1.1 million in
marketable securities and working capital of $2.8 million on December 31, 2004.
The decrease in working capital in 2005 is primarily due to our cash decrease
during the year as a result of losses and research and development expenses
associated with the integration of the Teleknowledge activity.

         On August 10, 2005, we raised $2.8 million (before issuance costs) in a
private placement of 937,500 ordinary shares to institutional and private
investors, including our President, Mr. Eytan Bar. The investors, other than Mr.
Bar, paid $3.00 per share for the ordinary shares purchased in the private
placement. Mr. Bar purchased 14,000 shares at $3.88 per share, the closing price
of our ordinary shares on the day prior to the closing of the private placement.
The private placement also involved the acquisition by the investors of warrants
to purchase an aggregate of 375,000 ordinary shares at an exercise price of
$4.00 per share (subject to anti-dilution adjustments), exercisable from
February 10, 2006 until August 10, 2009. Each investor, including Mr. Eytan Bar,
received warrants to purchase two ordinary shares for each five ordinary shares
purchased. To date, no warrants have been exercised.

         One of the principal factors affecting our working capital is the
payment cycle on our sales. Any material change in the current aging of our
accounts receivable could have an adverse effect on our working capital.

         Our operations used $4.4 million during the year ended December 31,
2005, compared to $2.6 million that was used during the year ended December 31,
2004. The use of our funds in 2005 was primarily due to our research and
development expenses associated with the integration of the Teleknowledge
activity, as well as to our continuing investment in product development.

         In December 2000, we publicly announced our stock repurchase program,
under which our officers were authorized to repurchase up to 300,000 of our
ordinary shares. In May 2003, our Board of Directors increased the number of
shares to be repurchased to 600,000 ordinary shares. Through December 31, 2004,
we repurchased an aggregate 395,410 ordinary shares, at a total cost of
$486,000. We did not continue this program during 2005 and based on our current
financial situation, we do not expect to repurchase any shares during 2006. We
cancelled 384,610 of the repurchased ordinary shares.

         We currently do not have significant capital spending or purchase
commitments, but we expect to continue to engage in capital spending consistent
with the level of our operations. We anticipate that our cash on hand and cash
flow from operations will be sufficient to meet our working capital and capital
expenditure requirements for at least 12 months. However, if we do not generate
sufficient cash from operations, we may be required to obtain additional
financing or to reduce level of expenditure. There can be no assurance that such
financing will be available in the future, or, if available, will be on terms
satisfactory to us.

                                       47
<PAGE>

C.       RESEARCH AND DEVELOPMENT

         Our product development plans are market-driven and address the major,
fast-moving trends that are influencing the telecommunications industry. We
intend to expand upon our existing family of telemanagement solutions by adding
new features and functions to address evolving market needs. We work closely
with our customers and prospective customers to determine their requirements and
design enhancements and new releases to meet their needs. Research and
development activities take place in our facilities in Israel. Our quality
management system has been ISO 9001:2000 certified since the beginning of 2006,
and prior thereto was ISO 9001:1994 certified.

         We are evaluating approaches to solutions which will permit an
information technology manager to effectively measure the quality of the
services received from their service providers and to ensure that the users
within the organization received such services according to their needs and the
overall policy and priorities of the organization.

         On December 31, 2005, we employed 58 persons in research and
development. As part of our product development team, we employ a technical
writer who prepares user documentation for our products.

         We have committed substantial financial resources to research and
development for our telemanagement and CC&B activities. During 2003, 2004 and
2005, our net research and development expenditures were $1.8 million, $2.4
million and $4.4 million, respectively. In the past, we received funding from
the Israeli Ministry of Industry and Trade's Office of the Chief Scientist for
selected research and development projects, but we stopped seeking funding for a
number of years. In late 2005 and early 2006, we applied to the Office of the
Chief Scientist for new grants for our research and development projects. We
received an approval for the 2005 application and our two 2006 applications are
currently pending.

         Under the terms of research and development grants that we have
received from the Office of the Chief Scientist, we are required to pay
royalties on the revenues derived from products incorporating know-how developed
with such grants and ancillary services in connection therewith, up to 100% to
150% of the dollar-linked value of the total grants, plus interest. We are
required to pay royalties at a rate of 3%-5%. The obligation to pay these
royalties is contingent on actual sales of the products and in the absence of
such sales, no payment is required. Since June 1997, we have paid the Office of
the Chief Scientist royalties on all call accounting product sales at the
applicable rates at the time of payment. See Item 10E. "Additional Information -
Taxation - Grants under the Law for the Encouragement of Industrial Research and
Development, 1984."

         We have expensed royalties relating to the repayment of the Office of
the Chief Scientist grants in the amounts of $146,000, $181,000, and $198,000
for the years ended December 31, 2003, 2004 and 2005, respectively.

         As of December 31, 2005, we had a contingent obligation to pay
royalties in the amount of approximately $9.1 million (including a contingent
obligation in the amount of $1.7 million relating to royalties from revenues
derived from products that we acquired from Teleknowledge that were funded by
the Office of the Chief Scientist). The $5.3 million of grants received after
January 1999 are subject to interest at a rate equal to the 12 month LIBOR rate.

                                       48
<PAGE>

D.       TREND INFORMATION

         As a result of a less predictable business environment and the decline
in worldwide sales of PBX systems, we are unable to provide any guidance as to
current sales and profitability trends. We expect that our results will continue
to be impacted by a shift to a new line of products and increased marketing and
research and development expenditures.

E.       OFF-BALANCE SHEET ARRANGEMENTS

         We are not a party to any material off-balance sheet arrangements. In
addition, we have no unconsolidated special purpose financing or partnership
entities that are likely to create material contingent obligations.

F.       TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS

         The following table summarizes our minimum contractual obligations and
commercial commitments, including obligations of discontinued operations, as of
December 31, 2005 and the effect we expect them to have on our liquidity and
cash flow in future periods.

<TABLE>
<CAPTION>
           Contractual Obligations                                       Payments due by Period
----------------------------------------           ---------------------------------------------------------------------
                                                                 less than                                    more than
                                                    Total          1 year        1-3 years      3-5 years      5 years
                                                   ------        -----------     ---------      ---------    -----------
<S>                                                <C>            <C>             <C>           <C>         <C>
Operating lease obligations.............           $  402         $  384          $  18            --              --
Accrued severance pay*..................           $  713            --              --            --          $  713
Total...................................           $1,115         $  384          $  18            --          $  713
</TABLE>

----------

* See Item 6D. "Directors, Senior Management and Employees - Employees."

ITEM 6.  DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

A.       DIRECTORS AND SENIOR MANAGEMENT

         Set forth below are the name, age, principal position and a
biographical description of each of our directors and executive officers:

<TABLE>
<CAPTION>
    Name                                      Age    Position with the Company
    ----                                      ---    ----------------------------------
<S>                                            <C>
    Chaim Mer..........................        58    Chairman of the Board
    Eytan Bar..........................        40    President and Chief Executive Officer
    Shlomi Hagai.......................        35    Corporate Chief Operating Officer and Chief Financial Officer
    Hanoch Magid.......................        50    Vice President Sales and Marketing - Europe, Middle East and
                                                     Africa
    Alon Aginsky.......................        43    Director
    Isaac Ben-Bassat...................        52    Director
    Dr. Orna Berry.....................        56    Outside Director
    Dr. Yehoshua Gleitman..............        56    Outside Director
    Steven J. Glusband.................        59    Director
    Yaacov Goldman.....................        51    Director
</TABLE>

                                       49
<PAGE>

         Messrs. Mer, Aginsky, Ben-Bassat, Glusband and Goldman will serve as
directors until our 2006 Annual General Meeting of Shareholders. Dr. Gleitman
and Dr. Berry will serve as outside directors pursuant to the provisions of the
Israeli Companies Law for a three-year term until our 2007 annual general
meeting of shareholders and January 28, 2008, respectively, following which the
service of Dr. Gleitman as an outside director may not be extended and the
service of Dr. Berry as an outside director may be renewed for only one
additional three-year term.

         Chaim Mer has served as Chairman of our Board of Directors and a
director since our inception in December 1995. Mr. Mer has been the Chairman of
the Board of Directors of C. Mer Industries Ltd., or C. Mer, a publicly traded
company, since 1988 and served as its President and Chief Executive Officer from
1988 until January 2005. Mr. Mer holds a B.Sc. degree in Computer Sciences and
Mathematics from the Technion Israel Institute for Technology.

         Eytan Bar has served as our President and Chief Executive Officer since
December 2003. Prior to joining us, and between 2001 and 2003, Mr. Bar served as
General Manager of the CEM product division of NICE Systems Ltd. From 2000
through 2001, Mr. Bar served as Vice President of Professional Services at NICE
Systems Inc. From 1993 through 1999, Mr. Bar served as General Manager of STS
Software Systems Ltd., a company that developed a unique VoIP technology for
recording solutions.

         Shlomi Hagai has served as our Corporate Chief Operating Officer and
Chief Financial Officer-Israel since March 2005. Prior to that and since 2000,
Mr. Hagai served as our financial controller. Prior to joining our company and
since 1998, Mr. Hagai served as audit team manager in the Professional
Department of Ernst & Young Israel, supervising privately held and publicly
traded companies engaged in the hi-technology, industrial, services and
infrastructure sectors. Mr. Hagai is a certified public accountant since 1999
and holds a B.A. degree in Business (majoring in accounting) from the College of
Management and an LLM degree from Bar-Ilan University.

         Hanoch Magid has served as our Vice President Sales and Marketing -
Europe, Middle East and Africa since 2002. Prior to joining our company and
since 2001, Mr. Magid served as Vice President of Operating and Professional
Services of Xcitel Ltd., a start up company engaged in the field of mobile
communication. Prior to that and since 2000, Mr. Magid served as Chief Operating
Officer of Cellonet Interactive Mobile Commerce Ltd. From 1992 to 2000, Mr.
Magid served in various positions of sales, operating and customer support at
Scitex Corporation Ltd. Mr. Magid holds a B.Sc degree in Mechanical Engineering
from the Ben Gurion University, Be'er Sheva.

                                       50
<PAGE>

         Alon Aginsky has been a director since June 1996. Since July 2000, Mr.
Aginsky has served as President and Chief Executive Officer of cVidya Inc.,
which is engaged in the development of a service assurance platform for next
generation broadband service providers. Mr. Aginsky served as our Vice President
Marketing and Sales from October 1996 until April 1999. From April 1999 to July
2000, Mr. Aginsky served as sales manager of C. Mer, when he was appointed
Manager of C. Mer. From 1990 until September 1996, Mr. Aginsky served as
President of MTS Inc., our U.S.-based marketing subsidiary. Mr. Aginsky holds a
B.A. degree in Business Administration from the New York Technology Institute.

         Isaac Ben-Bassat has been a director since our inception in December
1995. Mr. Ben-Bassat has been Executive Vice President and a director of C. Mer
Industries Ltd. since 1988. Mr. Ben-Bassat holds a B.Sc. degree in Civil
Engineering from the Technion, Israel Institute for Technology.

         Dr. Orna Berry has served as an outside director since January 2005.
Dr. Berry is a Venture Partner in Gemini Israel Funds Ltd. and since 2000 has
served as Chairperson of Lambda Crossing, Ltd. and Riverhead Networks, Inc.,
which was sold to Cisco in March 2004. Dr. Berry served as the Chief Scientist
of the Ministry of Industry and Trade of the Government of Israel from 1997 to
2000 and Co-President of Ornet Data Communications Technologies Ltd., a provider
of high-speed switches, which was acquired by Siemens AG, from 1993 to 1997.
From 1992 to 1993, Dr. Berry served as a consultant to Intel Communications
Division and Elbit Systems, Ltd. Dr. Berry holds a B.A. in statistics and
mathematics from Haifa University, an M.A. in statistics and mathematics from
Tel Aviv University and a Ph.D. in computer science from the University of
Southern California.

         Dr. Yehoshua Gleitman has served as an outside director since July
2001. Since March 2000, Dr. Gleitman has been Chief Executive Officer of SFKT, a
company whose activities include: venture capital management, finance and
investments in high-tech and telecommunications. Mr. Gleitman was Chief
Executive Officer of Ampal-American Israel Corporation, or Ampal, from May 1997
and Managing Director of Ampal's Israeli wholly owned subsidiaries and head of
Ampal's Israeli operations from April 1, 1997 until his resignation in July
1999. From August 1996 until February 1997, Mr. Gleitman was Director General of
the Israeli Ministry of Industry and Trade and was Chief Scientist at the
Ministry of Industry and Trade of the Government of Israel from January 1993
through February 1997. From 1991 through 1992, Mr. Gleitman was the general
manager of AIMS Ltd., and between 1990-1991, he was an advisor in charge of
marketing and business for Ashtrom Ltd. Dr. Gleitman holds a Ph.D. and a M.Sc.
in Physical Chemistry and a B.Sc. from the Hebrew University of Jerusalem.

         Steven J. Glusband has served as a director since August 1, 1996. Mr.
Glusband has been a partner with Carter Ledyard & Milburn LLP, our U.S. counsel,
since March 1987. Mr. Glusband holds a B.B.A. degree from the City College of
the City University of New York, a J.D. degree from Fordham University School of
Law and an L.L.M. degree from the New York University School of Law.

         Yaacov Goldman has served as a director since May 2004. Mr. Goldman
provides consulting services to companies in strategic-financial areas, through
his wholly owned company, Maanit-Goldman Management & Investments (2002) Ltd.
Mr. Goldman serves as a director of Bank Leumi Le-Israel Ltd., Elron Electronic
Industries Ltd and Golden House Ltd.

                                       51
<PAGE>

Mr. Goldman serves as the Professional Secretary of the Peer Review Institute of
the Certified Public accountants Institute in Israel. From March 2002 until
October 2002, Mr. Goldman served as consultant for Poalim Capital Markets and
Investments Ltd. From September 2000 until November 2001, Mr. Goldman served as
Managing Director of Argoquest Holdings, LLC, a U.S. based investment company
focused on early stage high-tech companies. From November 1981 until August
2000, Mr. Goldman was associated with Kessleman & Kessleman, the Israeli member
firm of PricewaterhouseCoopers, and was a Partner and Senior Partner at such
firm from January 1991 through August 2000. Mr. Goldman is a Certified Public
Accountant (Israel) since 1981 and holds a B.A. degree in Economics and
Accounting from Tel Aviv University.

B.       COMPENSATION


         The following table sets forth all compensation we paid with respect to
all of our directors and executive officers as a group for the year ended
December 31, 2005.

<TABLE>
<CAPTION>
                                                                                         Pension,
                                                              Salaries, fees,         retirement and
                                                          commissions and bonuses    similar benefits
                                                          -----------------------    ----------------
<S>                                                      <C>                     <C>
         All directors and executive officers as a group .....   $1,073,308              $178, 504
</TABLE>

         All our executive officers work full time for us. Mr. Chaim Mer, the
Chairman of our Board of Directors, devotes approximately 20% of his time to the
management of our company in consideration of which we pay him a monthly salary
of $7,000 per month (as approved by our Audit Committee and Board of Directors
on November 8, 1999). We provide automobiles to our executive officers at our
expense.

         During the year ended December 31, 2005, we paid to each of our
directors an annual fee of approximately $8,400 and a per meeting attendance fee
of $300, except for Mr. Yaacov Goldman, an independent director and our
financial expert, to whom we paid an annual fee of approximately $16,800 and a
per meeting attendance fee of $400.

         As of December 31, 2005, our directors and executive officers as a
group, then consisting of sixteen persons, held options to purchase an aggregate
169,375 ordinary shares, having exercise prices ranging from $0.93 to $3.49 The
options vest over a four-year period. Of such options, options to purchase
159,375 ordinary shares were granted under our 2003 Israeli Share Option Plan
(of which, options to purchase 10,000 ordinary shares will expire in September
2006, options to purchase 141,875 ordinary shares will expire in December 2008,
options to purchase 3,750 ordinary shares will expire in August 2009, options to
purchase 1,250 ordinary shares will expire in February 2010, options to purchase
1,250 ordinary shares will expire in May 2010 and options to purchase 1,250
ordinary shares will expire in September 2010) and options to purchase 10,000
ordinary shares were granted under our 1996 Stock Option Plan (all of which will
expire in December 2008). See Item 6.E., "Directors, Senior Management and
Employees - Share Ownership - Stock Option Plans."

                                       52
<PAGE>

C.       BOARD PRACTICES

Election of Directors

         Our Articles of Association provide for a Board of Directors consisting
of up to ten members or such other number as may be determined from time to time
at a general meeting of shareholders. Our Board of Directors is currently
composed of seven directors.

         Pursuant to our articles of association, all of our directors (except
the outside directors) are elected at our annual general meeting of shareholders
by a vote of the holders of a majority of the voting power represented and
voting at such meeting and hold office until the next annual general meeting of
shareholders and until their successors have been elected. All the members of
our Board of Directors (except the outside directors) may be reelected upon
completion of their term of office. All of our current directors (except our
outside directors) were elected by our shareholders at our annual general
meeting of shareholders of July 2005.

         We do not follow the requirements of the NASDAQ Marketplace Rules with
regard to the nomination process of directors, and instead, we follow Israeli
law and practice, in accordance with which our directors are recommended by our
board of directors for election by our shareholders. See below in this Item 6C.
"Directors, Senior Management and Employees - Board Practices - NASDAQ
Marketplace Rules and Home Country Practices."

Outside and Independent Directors

         The Israeli Companies Law requires Israeli companies with shares that
have been offered to the public in or outside of Israel to appoint at least two
outside directors. Outside directors must be Israeli residents, unless the
company's shares have been offered to the public outside of Israel or have been
listed on a stock exchange outside of Israel. No person may be appointed as an
outside 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 outside director, any
affiliation with the company or any entity controlling, controlled by or under
common control with the company. The term affiliation includes:

         o     an employment relationship;

         o     a business or professional relationship maintained on a
               regular basis;

         o     control; and

         o     service as an officer holder, excluding service as an outside
               director of a company that is offering its shares to the
               public for the first time.

         No person may serve as an outside director if the person's position or
other activities create, or may create, a conflict of interest with the person's
responsibilities as an outside director or may otherwise interfere with the
person's ability to serve as an outside director. If, at the time an outside
director is to be appointed, all current members of the board of directors are
of the same gender, then the outside director must be of the other gender.

                                       53
<PAGE>

         According to a March 2005 amendment to the Israeli Companies Law,
effective as of January 2006, at least one of the outside directors must be an
accounting and financial expert and the other outside directors must be
professional experts, as such terms are defined by regulations promulgated under
the Israeli Companies Law. This requirement does not apply to outside directors
appointed prior to the March 2005 amendment, however a company can not renew the
appointment of any such outside director for an additional term unless the
outside director is (i) an accounting and financial expert or (ii) a
professional expert and at the time the appointment is to be renewed, an outside
director who is an accounting and financial expert serves on the board of
directors and such other number of directors who are accounting and financial
experts serve on the board of directors as determined by the board of directors
of the company.

         Outside directors are elected by shareholders. The shareholders voting
in favor of their election must include at least one-third of the shares of the
non-controlling shareholders of the company who voted on the matter. This
minority approval requirement need not be met if the total shareholdings of
those non-controlling shareholders who vote against their election represent 1%
or less of all of the voting rights in the company.

         Outside directors serve for a three-year term, which may be renewed for
only one additional three-year term. Outside directors can be removed from
office only by the same special percentage of shareholders as can elect them, or
by a court, and then only if the outside directors cease to meet the statutory
qualifications with respect to their appointment or if they violate their duty
of loyalty to the company.

         Any committee of the board of directors must include at least one
outside director and the audit committee must include all of the outside
directors. An outside 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 such service.

         In addition, the NASDAQ Marketplace Rules require that a majority of
our board of directors qualify as independent directors within the meaning of
the NASDAQ Marketplace Rules and our audit committee must have at least three
members and be comprised only of independent directors each of whom satisfies
the respective "independence" requirements of the Securities and Exchange
Commission and NASDAQ.

         Our Board of Directors has determined that Dr. Yehoshua Gleitman and
Dr. Orna Berry both qualify as independent directors under the Securities and
Exchange Commission and NASDAQ requirements and as outside directors under the
Israeli Companies Law requirements. Our Board of Directors has further
determined that Messrs. Alon Aginsky and Yaacov Goldman both qualify as
independent directors under the Securities and Exchange Commission and NASDAQ
Stock Market requirements

Audit Committee

         Our audit committee, which was established in accordance with Section
114 of the Israeli Companies Law and Section 3(a)(58)(A) of the Securities
Exchange Act of 1934, assists our board of directors in overseeing the
accounting and financial reporting processes of our company and audits of our
financial statements, including the integrity of our financial statements,

                                       54
<PAGE>

compliance with legal and regulatory requirements, our independent public
accountants' qualifications and independence, the performance of our internal
audit function and independent public accountants, finding any defects in the
business management of our company for which purpose the audit committee may
consult with our independent auditors and internal auditor, proposing to the
board of directors ways to correct such defects, approving related-party
transactions as required by Israeli law, and such other duties as may be
directed by our board of directors.

         The responsibilities of the audit committee also include approving
related-party transactions as required by law. Under Israeli law an audit
committee may not approve an action or a transaction with a controlling
shareholder, or with an office holder, unless at the time of approval two
outside directors are serving as members of the audit committee and at least one
of the outside directors was present at the meeting in which an approval was
granted.

         Our audit committee consists of four members of our Board of Directors
who satisfy the respective "independence" requirements of the Securities and
Exchange Commission, NASDAQ and Israeli Law for audit committee members. Our
audit committee is currently composed of Dr. Yehoshua Gleitman, Dr. Orna Berry
and Messrs. Alon Aginsky and Yaacov Goldman. Our Board of Directors has
determined that Mr. Goldman qualifies as a financial expert. The audit committee
meets at least once each quarter.

Internal Audit

         The Israeli Companies Law also requires the board of directors of a
public company to appoint an internal auditor nominated by the audit committee.
A person who does not satisfy the Israeli Companies Law's independence
requirements may not be appointed as an internal auditor. The role of the
internal auditor is to examine, among other things, the compliance of the
company's conduct with applicable law and orderly business practice. Mr. Shaul
Sofer, Certified Public Accountant (Israel), serves as our internal auditor.

Directors' Service Contracts

         We do not have any service contracts with our directors. Our directors
are not entitled to any benefits upon termination of their service as our
directors.

Approval of Related Party Transactions Under Israeli Law

         The Israeli Companies Law codifies the fiduciary duties that "office
holders," including directors and executive officers, owe to a company. An
office holder's fiduciary duties consist of a duty of care and a duty of
loyalty. The duty of care requires an office holder to act at a level of care
that a reasonable office holder in the same position would employ under the same
circumstances. The duty of loyalty includes avoiding any conflict of interest
between the office holder's position in the company and any other position or
his personal affairs, avoiding any competition with the company, avoiding
exploiting any business opportunity of the company in order to receive personal
gain for the office holder or others, and disclosing 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. Each person listed
as a director or executive officer in the table under Item 6A. "Directors,
Senior Management and Employees -- Directors and Senior Management" is an office
holder.

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<PAGE>

         Under the Israeli Companies Law, all arrangements as to compensation of
office holders who are not directors require approval of our board of directors,
and the compensation of office holders who are directors must be approved by our
audit committee, board of directors and shareholders, in that order.

         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 us. In addition, if the transaction is an extraordinary
transaction, that is, a transaction other than in the ordinary course of
business, other than on market terms, or likely to have a material impact on the
company's profitability, assets or liabilities, the office holder must also
disclose any personal interest held by the office holder's spouse, siblings,
parents, grandparents, descendants, spouse's descendants and the spouses of any
of the foregoing, or by any corporation in which the office holder or a relative
is a 5% or greater shareholder, director or general manager or in which he or
she has the right to appoint at least one director or the general manager. Some
transactions, actions and arrangements involving an office holder (or a third
party in which an office holder has an interest) must be approved by the board
of directors or as otherwise provided for in a company's articles of
association, as not being adverse to the company's interest. In some cases,
including in the case of an extraordinary transaction, such a transaction,
action and arrangement must be approved by the audit committee and by the board
of directors itself, and further shareholder approval is required to approve the
terms of compensation of an office holder who is a director. An office holder
who has a personal interest in a matter, which is considered at a meeting of the
board of directors or the audit committee, may not be present during the board
of directors or audit committee discussions and may not vote on this matter,
unless the majority of the members of the board or the audit committee have a
personal interest, as the case may be.

         The Israeli Companies Law also provides that an extraordinary
transaction with a controlling shareholder or in which a controlling shareholder
of the company has a personal interest (including private offerings in which a
controlling shareholder has a personal interest) and a transaction with a
controlling shareholder or his relative regarding terms of service and
employment, must be approved by the audit committee, the board of directors and
shareholders. The shareholder approval for an extraordinary transaction must
include at least one-third of the shareholders who have no personal interest in
the transaction who voted on the matter. The transaction can be approved by
shareholders without this one-third approval, if the total shareholdings of
those shareholders who have no personal interest and voted against the
transaction do not represent more than one percent of the voting rights in the
company.

         However, under the Companies Regulations (Relief from Related Party
Transactions), 5760-2000, promulgated under the Israeli Companies Law and
amended in January 2002, certain transactions between a company and its
controlling shareholder(s) and certain transaction with its director(s)
regarding terms of compensation do not require shareholder approval.

         In addition, directors' compensation and employment arrangements do not
require the approval of the shareholders if both the audit committee and the
board of directors agree that such arrangements are for the benefit of the
company. If the director or the office holder is a controlling shareholder of
the company, then the employment and compensation arrangements of such director
or office holder do not require the approval of the shareholders provided that
certain criteria are met.

                                       56
<PAGE>

         The above exemptions will not apply if one or more shareholders,
holding at least 1% of the issued and outstanding share capital of the company
or of the company's voting rights, objects to the grant of such relief, provided
that such objection is submitted to the company in writing not later than seven
(7) days from the date of the filing of a report regarding the adoption of such
resolution by the company pursuant to the requirements of the Israeli Securities
Law. If such objection is duly and timely submitted, then the compensation
arrangement of the directors will require shareholders' approval as detailed
above.

         The Israeli Companies Law provides that an acquisition of shares in a
public company must be made by means of a tender offer if as a result of the
acquisition the purchaser would become a 25% or greater shareholder of the
company. This rule does not apply if there is already another 25% or greater
shareholder of the company. Similarly, the Israeli Companies Law provides that
an acquisition of shares in a public company must be made by means of a tender
offer if as a result of the acquisition the purchaser would hold greater than a
45% shareholder of the company, unless there is another shareholder holding more
than a 45% interest in the company. These requirements do not apply if, in
general, the acquisition (1) was made in a private placement that received
shareholder approval, (2) was from a 25% or greater shareholder of the company
which resulted in the acquiror becoming a 25% or greater shareholder of the
company, or (3) was from a shareholder holding more than a 45% interest in the
company which resulted in the acquiror becoming a holder of more than a 45%
interest in the company.

         If, as a result of an acquisition of shares, the acquiror will hold
more than 90% of a company's outstanding shares, the acquisition must be made by
means of a tender offer for all of the outstanding shares. If less than 5% of
the outstanding shares are not tendered in the tender offer, all the shares that
the acquirer offered to purchase will be transferred to the acquirer. The
Israeli Companies Law provides for appraisal rights if any shareholder files a
request in court within three months following the consummation of a full tender
offer. If more than 5% of the outstanding shares are not tendered in the tender
offer, then the acquiror may not acquire shares in the tender offer that will
cause his shareholding to exceed 90% of the outstanding shares

         Regulations under the Israeli Companies Law provide that the Israeli
Companies Law's tender offer rules do not apply to a company whose shares are
publicly traded outside of Israel, if pursuant to the applicable foreign
securities laws and stock exchange rules there is a restriction on the
acquisition of any level of control of the company, or if the acquisition of any
level of control of the company requires the purchaser to make a tender offer to
the public shareholders.

Exculpation, Indemnification and Insurance of Directors and Officers

         Exculpation of Office Holders. Israeli law allows a company, if
permitted by its articles of association, to exculpate an office holder in
advance, in whole or in part, from liability for damages sustained by a breach
of duty of care to the company, except with respect to a breach of his or her
duty of care in the event of distributions.

                                       57
<PAGE>

         Office Holders' Insurance. Israeli law provides that a company may, if
permitted by its articles of association, enter into a contract to insure its
office holders for liabilities incurred by the office holder with a respect to
an act performed in his or her capacity as an office holder, as a result of: (i)
the breach of his or her duty of care to the company or another person; (ii) a
breach of his or her duty of loyalty to the company, provided that the office
holder acted in good faith and had reasonable cause to assume that the act would
not prejudice the company's interests; and (iii) a financial liability imposed
upon the office in favor of another person.

         Indemnification of Office Holders. Under Israeli law a company may, if
permitted by its articles of association, indemnify an office holder for acts
performed by the office holder in such capacity for (a) monetary liability
imposed upon the office holder in favor of another person pursuant to a court
judgment, including a settlement or an arbitration award approved by a court;
(b) reasonable litigation expenses, including attorney's fees, actually incurred
by the office holder as a result of an investigation or proceeding instituted
against him by a competent authority, provided that such investigation or
proceeding concluded without the filing of an indictment against the office
holder or the imposition of any financial liability in lieu of criminal
proceedings, or concluded without the filing of an indictment against the office
holder and a financial liability was imposed on him or her in lieu of criminal
proceedings with respect to a criminal offense that does not require proof of
criminal intent; and (c) reasonable litigation expenses, including attorneys'
fees, actually incurred by the office holder or imposed upon the office holder
by a court: (i) in an action, suit or proceeding brought against the office
holder by or on behalf of the company or another person, (ii) in connection with
a criminal action in which the office holder was acquitted, or (iii) in
connection with a criminal action in which the office holder was convicted of a
crime that does not require proof of criminal intent.

         Israeli law provides that a company's articles of association may
permit the company to (a) indemnify an office holder retroactively, following a
determination to this effect made by the company after the occurrence of the
event in respect of which the office holder will be indemnified; and (b)
undertake in advance to indemnify an office holder, except that with respect to
a financial liability imposed on the office holder by any judgment, settlement
or court-approved arbitration award, the undertaking must be limited to types of
occurrences, which, in the opinion of the company's board of directors, are, at
the time of the undertaking, foreseeable due to the company's activities and to
an amount or standard that the board of directors has determined is reasonable
under the circumstances.

         Limitations on Exculpation, Insurance and Indemnification. These
provisions are specifically limited in their scope by Israeli law, which
provides that a company may not indemnify an office holder, nor exculpate an
office holder, nor enter into an insurance contract which would provide coverage
for any monetary liability, incurred as a result of certain improper actions.

         The term "office holder" of a company includes a director, general
manager or chief executive officer, a vice president or any officer who reports
directly to the general manager or chief executive officer of a company and any
other person assuming the responsibilities of any of the foregoing positions
without regard to such person's title.

         Pursuant to the Israeli Companies Law, exculpation of, procurement of
insurance coverage for, and an undertaking to indemnify or indemnification of,
our office holders must be approved by our audit committee and our board of
directors and, if the office holder is a director, also by our shareholders.

                                       58
<PAGE>

         Our Articles of Association allow us to insure, indemnify and exempt
our office holders, subject to the provisions of the Israeli Companies Law. We
maintain a directors' and officers' liability insurance policy with a per claim
and aggregate coverage limit of $5 million, including legal costs incurred in
Israel. In addition, our Audit Committee, Board of Directors and shareholders
resolved to indemnify our office holders, pursuant to a standard indemnification
agreement that provides for indemnification of an office holder in an amount up
to $3 million.

NASDAQ Marketplace Rules and Home Country Practices

         Under NASDAQ Marketplace Rule 4350, or Rule 4350, foreign private
issuers, such as our company, are permitted to follow certain home country
corporate governance practices instead of certain provisions of Rule 4350,
without the need to seek individual exemptions from NASDAQ. A foreign private
issuer that elects to follow a home country practice instead of any of such
provisions of Rule 4350, must submit to NASDAQ, in advance, a written statement
from an independent counsel in such issuer's home country certifying that the
issuer's practices are not prohibited by the home country's laws.

         On June 21, 2005, we provided NASDAQ with a notice of non-compliance
with Rule 4350 with respect to the requirements regarding the directors
nominations process. Instead, we follow Israeli law and practice in accordance
with which our directors are recommended by our board of directors for election
by our shareholders. See above in this Item 6C. "Directors, Senior Management
and Employees - Board Practices - Election of Directors."

D.       EMPLOYEES

         On December 31, 2005, we and our consolidated subsidiaries employed 124
persons, of which 58 persons were employed in research and development, 30 in
training and technical support, 18 in marketing and sales and 18 in operations
and administration. As of December 31, 2005, 85 of our employees were located in
Israel, 23 of our employees were located in the United States, 5 of our
employees were located in Hong Kong, 1 of our employees was located in Holland
and 10 of our employees were located in Brazil.

         On December 31, 2004, we and our consolidated subsidiaries employed 153
persons, of which 47 persons were employed in research and development, 45 in
training and technical support, 35 in marketing and sales and 26 in operations
and administration. As of December 31, 2004, 86 of our employees were located in
Israel, 39 of our employees were located in the United States, 9 of our
employees were located in Hong Kong, 2 of our employees were located in Holland
and 17 of our employees were located in Brazil.

         On December 31, 2003, we and our consolidated subsidiaries employed 86
persons, of which 23 persons were employed in research and development, 31 in
training and technical support, 15 in marketing and sales and 17 in operations
and administration. As of December 31, 2003, 40 of our employees were located in
Israel, 31 of our employees were located in the United States, 8 of our
employees were located in Hong Kong, 2 of our employees were located in Holland
and 5 of our employees were located in Brazil.

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<PAGE>

         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 Association) are applicable
to our employees by order of the Israeli Ministry of Labor. These provisions
concern mainly the length of the workday, minimum daily wages for professional
workers, contributions to a pension fund, 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.

         Cost of living adjustments of employees' wages are determined on a
nationwide basis and are legally binding. Under the current inflation rates,
these adjustments compensate employees for approximately 40% of the change in
the cost of living, with certain lag factors in implementation. Israeli
employers and employees are required to pay predetermined amounts to the
National Insurance Institute, which is similar to the United States Social
Security Administration. In 2005, payments to the National Insurance Institute
amounted to approximately 14.5% of wages, of which approximately two-thirds was
contributed by employees with the balance contributed by the employer.

         Pursuant to Israeli law, we are legally required to pay severance
benefits upon certain circumstances, including the retirement or death of an
employee or the termination of employment of an employee without due cause. We
partly satisfy this obligation by contributing approximately 8.3% of between
80%-100% of the employee's annual gross salary to a fund known as "Managers'
Insurance" or to pension fund. 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 part of this obligation is
presented in our balance sheet as the difference between the "accrued severance
pay" and "severance pay fund."

E.       SHARE OWNERSHIP

         The following table sets forth certain information as of March 28, 2006
regarding the beneficial ownership of our ordinary shares by each of our
directors and executive officers.

                                       Number of           Percentage of
                                    Ordinary Shares         Outstanding
    Name                         Beneficially Owned(1)   Ordinary Shares(2)
    ----                         ---------------------   -----------------
Chaim Mer.................          2,009,954   (3)            34.87%
Eytan Bar ................            160,225   (4)             2.50%
Shlomi Hagai..............              2,500   (4)              *
Hanoch Magid..............             10,000   (4)              *
Alon Aginsky..............             16,918                    *
Isaac Ben-Bassat..........            689,214   (5)            11.96%
Dr. Orna Berry............                 --                    --
Dr. Yehoshua Gleitman.....                 --                    --
Steven J. Glusband........             11,000   (6)              *
Yaacov Goldman............               --                      --

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<PAGE>

----------
* Less than 1%.

(1)   Beneficial ownership is determined in accordance with the rules of the
      Securities and Exchange Commission and generally includes voting or
      investment power with respect to securities. Ordinary shares relating to
      options currently exercisable or exercisable within 60 days of the date of
      this table are deemed outstanding for computing the percentage of the
      person holding such securities but are not deemed outstanding for
      computing the percentage of any other person. Except as indicated by
      footnote, and subject to community property laws where applicable, the
      persons named in the table above have sole voting and investment power
      with respect to all shares shown as beneficially owned by them.

(2)   The percentages shown are based on 5,763,845 ordinary shares (excluding
      10,800 ordinary shares held in treasury) issued and outstanding as of
      March 28, 2006.

(3)   Mr. Chaim Mer and his wife, Mrs. Dora Mer, are the holders of 253,821
      ordinary shares, and are the beneficial owners of 1,744,453 ordinary
      shares through their controlling interest in Mer Ofekim Ltd., 11,539
      ordinary shares through their controlling interest in Mer Services Ltd.,
      95 ordinary shares through their controlling interest in Mer & Co. (1982)
      Ltd. and 46 ordinary shares through their controlling interest in C. Mer
      Industries Ltd.

(4)   Subject to currently exercisable stock options.

(5)   Includes 630,045 ordinary shares held by Ron Dan Investments Ltd., a
      corporation controlled by Mr. Ben-Bassat.

(6)   Includes 10,000 ordinary shares subject to currently exercisable stock
      options.

Stock Option Plans

1996 Stock Option Plan

         Under our 1996 Stock Option Plan, as amended, or the 1996 Plan, options
to purchase up to 400,000 ordinary shares may be granted to our employees,
management, officers and directors or those of our subsidiaries. Any options
which are canceled or forfeited within the option period will become available
for future grants. The 1996 Plan will terminate on May 31, 2006, unless earlier
terminated by the Board of Directors.

         The 1996 Plan is administered by the Board of Directors or an Option
Committee which may be appointed by the Board of Directors, which has the
authority, subject to applicable law, to determine the persons to whom options
will be granted, the number of ordinary shares to be covered by each option the
time or times at which options will be granted or exercised, and the

                                       61
<PAGE>

terms and conditions of the options. The exercise price of options granted under
the 1996 Plan may not be less than 100% of the fair market value of our ordinary
shares on the date of the grant of incentive stock options and 75% in the case
of options not designated as incentive stock options. Fair market value is the
mean between the highest and lowest quoted selling prices on the date of grant
of our shares traded on NASDAQ or a stock exchange on which such shares are
principally traded. According to the 1996 Plan, we may provide loans to
employees to assist them in purchasing the shares upon exercise of an option on
terms and conditions approved by the Board of Directors and subject to
applicable law. Such loans have never been granted.

         Options granted under the 1996 Plan will generally be exercisable under
such circumstances as the Board or Option Committee determines. Such options
will not be transferable by an optionee other than by will or by laws of descent
and distribution, and during an option holder's lifetime will be exercisable
only by such option holder or by his or her legal representative. Options
granted under the 1996 Plan will terminate at such time and under such
circumstances as the Board or Option Committee determines.

         During 2005, options to purchase 55,000 ordinary shares were granted
under our 1996 Plan, with an average exercise price of $3.55, and options to
purchase 3,000 ordinary shares were exercised into ordinary shares. At December
31, 2005, options to purchase 58,500 ordinary shares were outstanding under the
1996 Plan, exercisable at an average exercise price of $3.44 per share.

1996 Section 102 Stock Option Plan

         In 1996, we adopted a Section 102 Stock Option Plan, as amended, or the
1996 102 Plan, providing for the grant of options to our Israeli employees,
management, officers and directors or those of our subsidiaries. The 1996 102
Plan was adopted pursuant to Section 102 of the Israeli Income Tax Ordinance
[New Version] - 1961, or Section 102, and provided recipients with tax
advantages under the Israeli Income Tax Ordinance. As of January 1, 2003,
Section 102 was amended, pursuant to which certain new tax advantages are
afforded with respect to option grants to employees and directors. In order to
enable employees and directors to benefit from such tax advantages with respect
to future grants of options and issuance of shares upon exercise thereof, such
grants have to be performed under a share option plan that is adjusted to the
amended Section 102, and therefore we adopted our 2003 Israeli Share Option
Plan. We do not intend to grant any more options under the 1996 102 Plan and the
ordinary shares that remained available for grant under the 1996 102 Plan were
rolled-over into our 2003 Israeli Share Option Plan for issuance thereunder.

         Options granted under our 1996 102 Plan are exercisable under such
circumstances as the Board of Directors or Option Committee determined.
According to the 1996 102 Plan, we may provide loans to employees to assist them
in purchasing the shares upon exercise of an option on terms and conditions
approved by the Board of Directors and subject to applicable law. Such loans
have never been granted. Options granted under the this plan are not
transferable by an optionee other than by will or by laws of descent and
distribution, and during an option holder's lifetime will be exercisable only by
such option holder or by his or her legal representative.

         During 2005, no options were granted under the 1996 102 Plan and
options to purchase 145,000 ordinary shares were exercised. At December 31,
2005, options to purchase 30,000 ordinary shares were outstanding under the 1996
102 Plan, exercisable at an average exercise price of $1.18 per share.

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<PAGE>

2003 Israeli Share Option Plan

         Under our 2003 Israeli Share Option Plan, or the 2003 Plan, options to
purchase up to 893,915 ordinary shares may be granted to directors, employees,
consultants, advisors, service providers, controlling shareholders and other
persons not employed by us or by our affiliates. Any options which are canceled
or forfeited within the option period will become available for future grants.
The 2003 Plan will terminate in 2013, unless earlier terminated by the Board of
Directors.

         Options to Israeli employees, directors and officers, other than
controlling shareholders (as such term is defined in the Israeli Income Tax
Ordinance), under the 2003 Plan may only be granted under Section 102. Under
amended Section 102, options granted pursuant to Section 102 may be designated
as "Approved 102 Options" or "Unapproved 102 Options." An Approved 102 Option
may either be classified as a capital gains option or an ordinary income option.
We elected to initially grant our options pursuant to Section 102 as capitals
gain options. Such election is effective as of the first date of grant of such
capital gains options under the 2003 Plan and shall remain in effect at least
until the lapse of one year following the end of the tax year during which we
first granted capital gains options. All Approved 102 Options (or the ordinary
shares issued upon exercise thereof) must be held in trust by a trustee for the
requisite holding period under Section 102 in order to benefit from the certain
tax advantages. We may also grant Unapproved 102 Options, which do not have any
tax benefit and are not held by a trustee. Options granted under Section 102 are
taxed on the date of sale of the exercised ordinary shares and/or the date of
the release of the options or such exercised ordinary shares from the trust.

         The 2003 Plan is administered by the Board of Directors or a committee
of the Board of Directors, if appointed, which has the authority, subject to
applicable law, to determine, the persons to whom options will be granted, the
terms and conditions of the respective options, including the time and the
extent to which the options may be exercised, may designate the type of options,
make an election as to the type of Approved 102 Option. The exercise price of
options granted under the 2003 Plan will be based on the fair market value of
our ordinary shares and are determined by the Board of Directors or the
committee at the time of the grant.

         Options granted under the 2003 Plan are not assignable or transferable
by an optionee, other than by will or by laws of descent and distribution, and
during the lifetime of an optionee may be exercised only by the optionee or by
the optionee's legal representative. Such options may be exercised as long as
the optionee is employed by, or providing services to us or any of our
affiliates, to the extent the options have vested.

         During 2005, options to purchase an aggregate of 390,000 ordinary
shares were granted under the 2003 Plan at an average exercise price of $3.50
per share and 10,000 options were exercised into ordinary shares. At December
31, 2005, options to purchase 717,000 ordinary shares were outstanding under the
2003 Plan, exercisable at an average exercise price of $2.72 per share.

                                       63
<PAGE>

Warrants

         On February 7, 2001, we issued a five-year warrant to purchase 25,000
of our ordinary shares to Investec Bank (Mauritius) Ltd. in connection with
certain financial services performed on our behalf. The warrant had an exercise
price of $4.95 per ordinary share for shares purchased until February 2004, and
from thereafter until February 2006, the exercise price is $5.625 per ordinary
share. Such warrant expired in February 2006.

         On August 3, 2005, we issued a warrant to purchase 37,000 ordinary
shares to Mr. Avraham Ziv in connection with financial services that he provided
to our company. The warrant has an exercise price of $4.00 per share, subject to
anti-dilution adjustments, and is exercisable from February 3, 2006 until August
3, 2009. Mr. Ziv has provided financial services to us from to time during the
last five years.

         In connection with our August 2005 private placement to institutional
and private investors, we issued to the investors warrants to purchase an
aggregate 375,000 ordinary shares at an exercise price of $4.00 per share
(subject to anti-dilution adjustments), exercisable from February 10, 2006 until
August 10, 2009.

         On December 7, 2005, we issued a one-year warrant to purchase 100,000
ordinary shares to one of our consultants in connection with certain business
development services performed on our behalf. The warrant has an exercise price
of $3.12 per share (subject to anti-dilution adjustments) and is exercisable
from the date of grant until December 7, 2006.

ITEM 7.  MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

A.       MAJOR SHAREHOLDERS

         The following table sets forth certain information as of March 28, 2006
regarding the beneficial ownership by all shareholders known to us to own
beneficially 5.0% or more of our ordinary shares:

                                        Number of               Percentage of
                              Ordinary Shares Beneficially       Outstanding
Name                                    Owned(1)              Ordinary Shares(2)
----                          ----------------------------    ------------------

Chaim Mer and Dora Mer.....             2,009,954 (3)               34.87%
Isaac Ben-Bassat...........               689,214 (4)               11.96%

-----------
(1)   Beneficial ownership is determined in accordance with the rules of the
      Securities and Exchange Commission and generally includes voting or
      investment power with respect to securities. Ordinary shares relating to
      options currently exercisable or exercisable within 60 days of the date of
      this table are deemed outstanding for computing the percentage of the
      person holding such securities but are not deemed outstanding for
      computing the percentage of any other person. Except as indicated by
      footnote, and subject to community property laws where applicable, the
      persons named in the table above have sole voting and investment power
      with respect to all shares shown as beneficially owned by them.

                                       64
<PAGE>

(2)   The percentages shown are based on 5,763,845 ordinary shares (excluding
      10,800 ordinary shares held in treasury) issued and outstanding as of
      March 28, 2005.

(3)   Mr. Chaim Mer and his wife, Mrs. Dora Mer, are the holders of 253,821
      ordinary shares, and are the beneficial owners of 1,744,453 ordinary
      shares through their controlling interest in Mer Ofekim Ltd., 11,539
      ordinary shares through their controlling interest in Mer Services Ltd.,
      95 ordinary shares through their controlling interest in Mer & Co. (1982)
      Ltd. and 46ordinary shares through their controlling interest in C. Mer
      Industries Ltd.

(4)   Includes 630,045 ordinary shares held by Ron Dan Investments Ltd., a
      corporation controlled by Mr. Ben-Bassat.

Major Shareholders Voting Rights

         Our major shareholders do not have different voting rights.

Record Holders

         Based on a review of the information provided to us by our transfer
agent, as of March 29, 2006, there were 47 holders of record of our ordinary
shares, of which seven record holders holding approximately 39.77% of our
ordinary shares had registered addresses in the United States and 40 record
holders holding approximately 60.23% of our ordinary shares had registered
addresses in Israel. These numbers are not representative of the number of
beneficial holders of our shares nor are they representative of where such
beneficial holders reside, since many of these ordinary shares were held of
record by brokers or other nominees (including one U.S. nominee company, CEDE &
Co., which held approximately 39.72% of our outstanding ordinary shares as of
such date).

B.       RELATED PARTY TRANSACTIONS

         Ms. Dora Mer, the wife of Chaim Mer, provides legal services to us and
receives a monthly retainer of $5,000. The conditions of retaining the services
of Ms. Mer were approved by our Board of Directors and Audit Committee.

         Our subsidiaries, MTS Asia Ltd. and MTS IntegraTRAK, entered into an
agreement with C. Mer Industries Ltd., or C. Mer, pursuant to which they
distribute and support certain of C. Mer's products and provide certain services
on behalf of C. Mer. Generally, C. Mer compensates MTS Asia Ltd. for these
activities at cost plus 10% and compensates MTS IntegraTRAK at cost plus 5%. C.
Mer is a publicly traded company controlled by Mr. Chaim Mer, and Mr. Mer has
been the Chairman of its Board of Directors since 1988 and served as its
President and Chief Executive Officer from 1988 until January 2005.

         Presently, the only service provided to us by C. Mer is our
participation in its umbrella liability insurance coverage. We believe that the
terms under which C. Mer provides such participation to us is on a basis no less
favorable than could be obtained from an unaffiliated third party.

                                       65
<PAGE>

         On August 10, 2005, we entered into definitive agreements with
institutional and private investors, including our President, Mr. Eytan Bar, for
a private placement of ordinary shares and warrants to purchase ordinary shares
that raised $2.8 million. Pursuant to the agreements, the investors, other than
our President, Mr. Eytan Bar, paid $3.00 per share for the aggregate 937,500
ordinary shares issued in the private placement. Mr. Bar purchased 14,000 shares
at $3.88 per share, the closing price of our ordinary shares on the day prior to
the closing of the private placement. The private placement also involved the
acquisition by the investors of warrants to purchase an aggregate 375,000
additional ordinary shares at an exercise price of $4.00 per share (subject to
anti-dilution adjustments), exercisable from February 10, 2006 until August 10,
2009. Each investor, including Mr. Eytan Bar, received warrants to purchase two
ordinary shares for each five ordinary shares purchased.

         Mr. Isaac Ben-Bassat, a director and one of our major shareholders,
receives an annual fee of approximately $8,400 and a per meeting attendance fee
of $300 in connection with his service as a director of our company. See Item.
6B. "Directors and Senior Management - Compensation."

C.       INTERESTS OF EXPERTS AND COUNSEL

         Not applicable.

ITEM 8.  FINANCIAL INFORMATION

A.       CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION

Financial Statements

         See the consolidated financial statements, including the notes thereto,
and the exhibits listed in Item 19 hereof and incorporated herein by this
reference.

Export Sales

         See Note 16 of our Consolidated Financial Statements.

Legal Proceedings

         On April 18, 2005, Amdocs (Israel) Ltd. and Amdocs Ltd. filed a
complaint in the Tel Aviv District Court naming our company, our chief executive
officer and others as defendants (Civil File No. 32419-05/05). The complaint
alleges, among other things, that professional and commercial information
belonging to the plaintiffs was transferred to the defendants for use in our
company's activity. The plaintiffs are seeking an injunction prohibiting the
defendants from making any use of the information and trade secrets that were
allegedly transferred, and mandatory injunctions requiring the return of any
such information and the payment of estimated damages of NIS 14,775,000
(approximately US$3.2 million). On June 27, 2005, we and the other defendants
filed a statement of defense, claiming that the factual and legal allegations
made by the plaintiffs have no basis and the causes of action and relief
requested are without merit. Since such time, there have been no further
developments in connection with this claim. Due to the preliminary stage of this
litigation proceeding, we and our legal advisors cannot currently assess the
outcome or possible adverse effect on our financial position or results of
operations.

                                       66
<PAGE>

         In April 2000, the tax authorities in Israel issued to us a demand for
a tax payment in the amount of approximately NIS 6.0 million (approximately $1.3
million) for the 1997-1999 period. We have appealed to the Israeli district
court in respect of this tax demand. We believe that certain defenses can be
raised against the demand of the tax authorities. We have made a provision in
our financial statements for this tax demand for the amount deemed probable,
based on the current evidence, which we believe is adequate. We believe that the
outcome of this matter will not have a material adverse effect on our financial
position or results of operations.

         On November 22, 2005, we received a letter from one of our customer's
legal counsel alleging, among other things, that we materially breached an
agreement relating to our billing solutions that we entered into with the
customer on March 9, 2005, as subsequently amended on June 6, 2005. The customer
is seeking full repayment of the amounts that were paid by him under the
agreement in the amount of approximately $100,000, plus interest and
indemnification for damages that he claims to have suffered as a result of our
alleged breach. On February 19, 2006, we submitted a response letter to the
customer in which we denied these allegations and claimed that the customer's
refusal to fulfill his contractual undertakings constitute a breach of the
agreement and entitles us to remedies under applicable law.

         Other than the above, we are not involved in any legal proceedings nor
are we subject to any threatened litigation that are material to our business or
financial condition.

Dividend Distribution Policy

         We have never paid cash dividends to our shareholders. We intend to
retain future earnings for use in our business and do not anticipate paying cash
dividends on our ordinary shares in the foreseeable future. Any future dividend
policy will be determined by our Board of Directors and will be based upon
conditions then existing, including our results of operations, financial
condition, current and anticipated cash needs, contractual restrictions and
other conditions as the Board of Directors may deem relevant.

         According to the Israeli Companies Law, a company may distribute
dividends out of its profits (as such term is defined in the Israeli Companies
Law), provided that there is no reasonable concern that payment of the dividend
will prevent the company from satisfying all its current and foreseeable
obligations, as they become due. Notwithstanding the foregoing, dividends may be
paid with the approval of a court, at the company's request, provided that there
is no reasonable concern that payment of the dividend will prevent the company
from satisfying its current and foreseeable obligations, as they become due. In
the event cash dividends are declared, such dividends will be paid in NIS.

B.       SIGNIFICANT CHANGES

         Except as otherwise disclosed in this Annual Report, no significant
change has occurred since December 31, 2005.

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<PAGE>

ITEM 9.  THE OFFER AND LISTING

A.       OFFER AND LISTING DETAILS

Annual Stock Information

         The following table sets forth, for each of the years indicated, the
range of high ask and low bid prices of our ordinary shares on the NASDAQ
Capital Market.

            Year                             High          Low
            ----                             ----          ---
            2005........................    $4. 23       $3. 01
            2004........................    $4. 00       $1. 90
            2003........................    $3. 56       $0. 87
            2002........................    $1. 65       $0. 75
            2001........................    $4. 50       $0. 99

Quarterly Stock Information

         The following table sets forth, for each of the full financial quarters
in the years indicated, the range of high ask and low bid prices of our ordinary
shares on the NASDAQ Capital Market.

                                             High          Low
                                            -----          ---
            2004
            ----
            First Quarter................   $4. 00       $2. 99
            Second Quarter...............   $3. 62       $2. 61
            Third Quarter................   $2. 71       $1. 90
            Fourth Quarter...............   $3. 33       $2. 08

            2005
            ----
            First Quarter................   $4. 00       $3. 15
            Second Quarter...............   $3. 83       $3. 10
            Third Quarter................   $4. 23       $3. 01
            Fourth Quarter...............   $3. 98       $3. 05

Monthly Stock Information

         The following table sets forth, for each of the most recent six months,
the range of high ask and low bid prices of our ordinary shares on the NASDAQ
Capital Market.

            Month                            High             Low
            -----                            ----             ---
            September 2005...............   $3. 89          $3. 75
            October 2005.................   $3. 98          $3. 05
            November 2005................   $3. 40          $3. 08
            December 2005................   $3. 50          $3. 07
            January 2006.................   $3. 50          $3. 19
            February 2006................   $3. 50          $3. 12
            March 2006 (until 29)........   $3. 45          $3. 12

                                       68

<PAGE>

B.       PLAN OF DISTRIBUTION

         Not applicable.

C.       MARKETS

         Our ordinary shares were listed on the NASDAQ National Market in
connection with our initial public offering on May 21, 1997. On December 23,
1998, the listing of our ordinary shares was transferred to the NASDAQ Capital
Market (symbol: MTSL).

D.       SELLING SHAREHOLDERS

         Not applicable.

E.       DILUTION

         Not applicable.

F.       EXPENSE OF THE ISSUE

         Not applicable.

ITEM 10. ADDITIONAL INFORMATION

A.       SHARE CAPITAL

         Not applicable.

B.       MEMORANDUM AND ARTICLES OF ASSOCIATION

         Set out below is a description of certain provisions of our Articles of
Association and of the Israeli Companies Law related to such provisions. This
description is only a summary and does not purport to be complete and is
qualified by reference to the full text of the Articles of Association, which
are incorporated by reference as exhibits to this Annual Report, and to Israeli
law.

Purposes and Objects of the Company

         We are a public company registered under the Israel Companies Law,
1999-5759, or the Israeli Companies Law, as MER Telemanagement Solutions Ltd.,
registration number 520042904. Our objects and purposes, as provided by our
Articles of Association, are to carry on any lawful activity.

         On February 1, 2000, the Israeli Companies Law came into effect and
superseded most of the provisions of the Israeli Companies Ordinance (New
Version), 5743-1983, except for certain provisions which relate to bankruptcy,
dissolution and liquidation of companies. Under the Israeli Companies Law,
various provisions, some of which are detailed below, overrule the current
provisions of our Articles of Association.

                                       69
<PAGE>

The Powers of the Directors

         Under the provisions of the Israeli Companies Law and our Articles of
Association, a director cannot participate in a meeting nor vote on a proposal,
arrangement or contract in which he or she is materially interested. In
addition, our directors cannot vote compensation to themselves or any members of
their body without the approval of our audit committee and our shareholders at a
general meeting. See Item 6C. "Directors, Senior Management and Employees -
Board Practices - Approval of Related Party Transactions Under Israeli Law."

         The authority of our directors to enter into borrowing arrangements on
our behalf is not limited, except in the same manner as any other transaction by
us.

         Under our articles of association, retirement of directors from office
is not subject to any age limitation and our directors are not required to own
shares in our company in order to qualify to serve as directors.

Rights Attached to Shares

         Our authorized share capital consists of 12,000,000 ordinary shares of
a nominal value of NIS 0.01 each. All outstanding ordinary shares are validly
issued, fully paid and non-assessable.

         The rights attached to the ordinary shares are as follows:

         Dividend rights. Holders of our ordinary shares are entitled to the
full amount of any cash or share dividend subsequently declared. The board of
directors may declare interim dividends and propose the final dividend with
respect to any fiscal year only out of the retained earnings, in accordance with
the provisions of the Israeli Companies Law. Our Articles of Association provide
that the declaration of a dividend requires approval by an ordinary resolution
of the shareholders, which may decrease but not increase the amount proposed by
the board of directors. See Item 8A. "Financial Information - Consolidated and
Other Financial Information - Dividend Distribution Policy." If after one year a
dividend has been declared and it is still unclaimed, the board of directors is
entitled to invest or utilize the unclaimed amount of dividend in any manner to
our benefit until it is claimed. We are not obligated to pay interest or linkage
differentials on an unclaimed dividend.

         Voting rights. Holders of ordinary shares have one vote for each
ordinary share held on all matters submitted to a vote of shareholders. Such
voting rights may be affected by the grant of any special voting rights to the
holders of a class of shares with preferential rights that may be authorized in
the future.

         The quorum required for an ordinary meeting of shareholders consists of
at least two shareholders present in person or represented by proxy who hold or
represent, in the aggregate, at least one third of the voting rights of the
issued share capital. A meeting adjourned for lack of a quorum generally is
adjourned to the same day in the following week at the same time and place or
any time and place as the directors designate in a notice to the shareholders.
At the reconvened meeting, the required quorum consists of any two members
present in person or by proxy.

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<PAGE>

         An ordinary resolution, such as a resolution for the declaration of
dividends, requires approval by the holders of a majority of the voting rights
represented at the meeting, in person, by proxy or by written ballot, and voting
thereon. Under our Articles of Association, a special resolution, such as
amending our memorandum of association or articles of association, approving any
change in capitalization, winding-up, authorization of a class of shares with
special rights, or other changes as specified in our Articles of Association,
requires approval of a special majority, representing the holders of no less
than 65% of the voting rights represented at the meeting in person, by proxy or
by written ballot, and voting thereon.

         Pursuant to our articles of association, our directors (other than
outside directors) are elected at our annual general meeting of shareholders by
a vote of the holders of a majority of the voting power represented and voting
at such meeting. For information regarding the election of outside directors,
see Item 6C. "Directors, Senior Management and Employees - Board Practices -
Election of Directors."

         Rights to share in our company's profits. Our shareholders have the
right to share in our profits distributed as a dividend and any other permitted
distribution. See this Item 10B. "Additional Information - Memorandum and
Articles of Association - Rights Attached to Shares - Dividend Rights."

         Rights to share in surplus in the event of liquidation. In the event of
our liquidation, after satisfaction of liabilities to creditors, our assets will
be distributed to the holders of ordinary shares in proportion to the nominal
value of their holdings. This right may be affected by the grant of preferential
dividend or distribution rights to the holders of a class of shares with
preferential rights that may be authorized in the future.

         Liability to capital calls by our company. Under our memorandum of
association and the Israeli Companies Law, the liability of our shareholders is
limited to the par value of the shares held by them.

         Limitations on any existing or prospective major shareholder. See Item
6C. "Directors and Senior Management -Board Practices - Approval of Related
Party Transactions Under Israeli Law."

Changing Rights Attached to Shares

         According to our Articles of Association, in order to change the rights
attached to any class of shares, unless otherwise provided by the terms of the
class, such change must be adopted by a general meeting of the shareholders and
by a separate general meeting of the holders of the affected class with a
majority of 75% of the voting power participating in such meeting.

Annual and Extraordinary Meetings

         The Board of Directors must convene an annual meeting of shareholders
at least once every calendar year, within fifteen months of the last annual
meeting. Notice of at least twenty-one days prior to the date of the meeting is
required. An extraordinary meeting may be convened by the board of directors, as
it decides or upon a demand of any two directors or 25% of the directors,
whichever is less, or of one or more shareholders holding in the aggregate at
least 5% of our issued capital. An extraordinary meeting must be held not more
than thirty-five days from the publication date of the announcement of the
meeting. See Item 10B. "Additional Information -- Memorandum and Articles of
Association -- Rights Attached to Shares--Voting Rights."

                                       71
<PAGE>

Limitations on the Rights to Own Securities in Our Company

         Neither our memorandum of association or our articles of association
nor the laws of the State of Israel restrict in any way the ownership or voting
of shares by non-residents, except with respect to subjects of countries, which
are in a state of war with Israel.

Provisions Restricting Change in Control of Our Company

         The Israeli Companies Law requires that mergers between Israeli
companies be approved by the board of directors and general meeting of
shareholders of both parties to the transaction. The approval of the board of
directors of both companies is subject to such boards' confirmations that there
is no reasonable doubt that after the merger the surviving company will be able
to fulfill its obligations towards its creditors. Each company must notify its
creditors about the contemplated merger. Under the Israeli Companies Law, our
Articles of Association are deemed to include a requirement that such merger be
approved by an extraordinary resolution of the shareholders, as explained above.
The approval of the merger by the general meetings of shareholders of the
companies is also subject to additional approval requirements as specified in
the Israeli Companies Law and regulations promulgated thereunder. See also Item
6C. "Directors, Senior Management and Employees - Board Practices - Approval of
Related Party Transactions Under Israeli Law."

Disclosure of Shareholders Ownership

         The Israeli Securities Law and regulations promulgated thereunder do
not require a company whose shares are publicly traded solely on a stock
exchange outside of Israel, as in the case of our company, to disclose its share
ownership.

Changes in Our Capital

         Changes in our capital are subject to the approval of the shareholders
at a general meeting by a special majority of 65% of the votes of shareholders
participating and voting in the general meeting.

C.       MATERIAL CONTRACTS

         On August 10, 2005, we entered into definitive agreements with
institutional and private investors, including our President, Mr. Eytan Bar, for
a private placement of ordinary shares and warrants to purchase ordinary shares
that raised $2.8 million. Pursuant to the agreements, the investors, other than
Mr. Bar, paid $3.00 per share for the aggregate 937,500 ordinary shares issued
in the private placement. Mr. Bar purchased 14,000 shares at $3.88 per share,
the closing price of our ordinary shares on the day prior to the closing of the
private placement. The private placement also involved the acquisition by the
investors of warrants to purchase an aggregate 375,000 additional ordinary
shares at an exercise price of $4.00 per share (subject to anti-dilution
adjustments), exercisable from February 10, 2006 until August 10, 2009. Each
investor, including Mr. Eytan Bar, received warrants to purchase two ordinary
shares for each five ordinary shares purchased. To date, no warrants have been
exercised.

                                       72
<PAGE>

D.       EXCHANGE CONTROLS

         Israeli law and regulations do not impose any material foreign exchange
restrictions on non-Israeli holders of our ordinary shares. In May 1998, a new
"general permit" was issued under the Israeli Currency Control Law, 1978, which
removed most of the restrictions that previously existed under such law, and
enabled Israeli citizens to freely invest outside of Israel and freely convert
Israeli currency into non-Israeli currencies.

         Non-residents of Israel who purchase our ordinary shares will be able
to convert dividends, if any, thereon, and any amounts payable upon our
dissolution, liquidation or winding up, as well as the proceeds of any sale in
Israel of our ordinary shares to an Israeli resident, into freely repatriable
dollars, at the exchange rate prevailing at the time of conversion, provided
that the Israeli income tax has been withheld (or paid) with respect to such
amounts or an exemption has been obtained.

E.       TAXATION

         The following is a discussion of Israeli and United States tax
consequences material to our shareholders. To the extent that the discussion is
based on new tax legislation which has not been subject to judicial or
administrative interpretation, the views expressed in the discussion might not
be accepted by the tax authorities in question. The discussion is not intended,
and should not be construed, as legal or professional tax advice and does not
exhaust all possible tax considerations.

         Holders of our ordinary shares should consult their own tax advisors as
to the United States, Israeli or other tax consequences of the purchase,
ownership and disposition of ordinary shares, including, in particular, the
effect of any foreign, state or local taxes.

ISRAELI TAX CONSIDERATIONS

         The following is a summary of the current tax structure applicable to
companies in Israel, with special reference to its effect on us. The following
also contains a discussion of the material Israeli tax consequences to
purchasers of our ordinary shares and Israeli government programs benefiting us.
This summary does not discuss all the aspects of Israeli tax law that may be
relevant to a particular investor in light of his or her personal investment
circumstances or to some types of investors subject to special treatment under
Israeli law.

General Corporate Tax Structure

         Israeli companies are subject to "Company Tax" on their worldwide
income. The applicable rate for 2005 was 34%. The rate was reduced to 31% in
2006, and will be further reduced to 29% in 2007, 27% in 2008, 26% in 2009 and
25% in 2010 and thereafter. However, the effective tax rate payable by a
company, which derives income from an approved enterprise (as further discussed
below), may be considerably less.

                                       73
<PAGE>

Controlled Foreign Companies

         Under the controlled foreign companies rules an Israeli company may
become subject to Israeli taxes (as deemed dividends) on non-distributed profits
of a non-Israeli subsidiary if the subsidiary's primary source of income is
passive income (such as interest, dividends, royalties, rental income or capital
gains) and if the taxes imposed outside of Israel are no more than 20% of the
profits.

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

         The Law for the Encouragement of Capital Investments, 1959, commonly
referred to as the Investment Law, provides that a proposed capital investment
in eligible facilities may, upon application to the Investment Center of the
Ministry of Industry and Trade of the State of Israel, be designated as an
approved enterprise. Each certificate of approval for an approved enterprise
relates to a specific investment program delineated both by its financial scope,
including its capital sources, and by its physical characteristics, e.g., the
equipment to be purchased and utilized pursuant to the program. An approved
enterprise is entitled to benefits including Israeli Government cash grants and
tax benefits in specified development areas. The tax benefits derived from any
such certificate of approval relate only to taxable income attributable to the
specific approved enterprise. If a company has more than one approval or only a
portion of its capital investments is approved, its effective tax rate is the
result of a weighted average of the applicable rates.

         Taxable income of a company derived from an approved enterprise is
subject to corporate tax at the maximum rate of 25% (rather than the regular
corporate tax rate) for the benefit period. This period is ordinarily seven
years (or ten years if the company qualifies as a foreign investors' company as
described below) commencing with the year in which the approved enterprise first
generates taxable income, and is limited to twelve years from commencement of
production or 14 years from the date of approval, whichever is earlier. Tax
benefits under the Investments Law also apply to income generated from the grant
of a usage right with respect to know-how developed by the approved enterprise,
income generated from royalties, and income derived from a service which is
auxiliary to such usage right or royalties, provided that such income is
generated within the approved enterprise's ordinary course of business. The
Investment Law also provides that a company that has an approved enterprise
within Israel will be eligible for a reduced tax rate and is entitled to claim
accelerated depreciation on buildings, machinery and equipment used by the
approved enterprise during the first five years of use.

         A company owning an approved enterprise may elect to forego entitlement
to the grants otherwise available under the Investment Law and in lieu thereof
participate in an alternative track of benefits. Under the alternative track of
benefits, a company's undistributed income derived from an approved enterprise
will be exempt from company tax for a period of two years from the first year of
taxable income and such company will be eligible for a reduced tax rate for the
remainder, if any, of the otherwise applicable benefits period.

         A company that has an approved enterprise program is eligible for
further tax benefits if it qualifies as a foreign investors' company. A foreign
investors' company is a company that more than 25% of its share capital and
combined share and loan capital is owned by non-Israeli residents. A company,
which qualifies as a foreign investors' company and has an approved enterprise
program is eligible for tax benefits for a ten-year benefit period. The company
tax rate applicable to income from the approved enterprise earned in the benefit
period (distributed or not) is as follows:

                                       74
<PAGE>

                                                          The company
         For a company with foreign investment of         tax rate is
         -----------------------------------------        -----------
         over 25% but less than 49%                            25%
         49% or more but less than 74%..........               20%
         74% or more but less than 90%..........               15%
         90% or more............................               10%

         In addition, the dividend recipient is taxed at the reduced rate
applicable to dividends from approved enterprises income (15%), if the dividend,
deriving from the approved enterprises, is distributed during the tax benefit
period or within 12 years thereafter, yet, no time limit is applicable to
dividends from a foreign investment company. The company must withhold this tax
at source, regardless of whether the dividend is converted into foreign
currency. However, if retained tax-exempt income is distributed in a manner
other than upon the complete liquidation of the company, the company would be
taxed at the reduced corporate tax rate applicable to such profits (between
10%-25%). Our company is not obliged to distribute exempt retained profits under
the alternative track of benefits, and may generally decide from which source of
income to declare dividends. We intend to reinvest any income derived from our
approved enterprise programs and not to distribute such income as a dividend.

         We have been granted approved enterprise status with respect to several
investment programs and chose the alternative track with respect to each of
these programs. See Item 5A. "Operating and Financial Review and Prospects -
Operating Results - Effective Corporate Tax Rate."

         The benefits available to an approved enterprise are conditional upon
the fulfillment of conditions stipulated in the Investment Law and its
regulations and the criteria set forth in the specific certificate of approval,
as described above. In the event that a company does not meet these conditions,
its tax benefits could be canceled, in whole or in part, and it would be
required to refund the amount of tax benefits, with the addition of the Israeli
consumer price index linkage adjustment and interest.

         Recent Amendment of the Investments Law

         A recent amendment to the Investments Law, which came into effect on
April 1, 2005, has changed certain provisions of such law, including the
criteria for investments qualified to receive tax benefits under such law. An
eligible investment program under the amendment will qualify for benefits as a
"Privileged Enterprise" (rather than the previous terminology of Approved
Enterprise). As a result of the amendment, a company is no longer obliged to
acquire approved enterprise status in order to receive the tax benefits
previously available under the alternative benefits track, and therefore there
is no need to apply to the Investment Center for this purpose (however, approved
enterprise status remains mandatory for companies seeking grants). Rather, a
company may claim the tax benefits offered by the Investment Law directly in its
tax returns, provided that its facilities meet the criteria for tax benefits set
out by the amendment. Companies may also approach the Israeli Tax Authority for
a pre-ruling regarding its eligibility for benefits under the amendment. The
amendment does not apply to investment programs approved prior to December 31,
2004. The new tax regime will apply only to new investment programs.

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         Tax benefits are available under the April 2005 amendment to production
facilities (or other eligible facilities), which are generally required to
derive more than 25% of their business income from export. In order to receive
the tax benefits, a company must make an investment in the Privileged Enterprise
exceeding a minimum amount specified in the Investment Law. Such investment may
be made over a period of no more than three years ending at the end of the year
in which the company requested to have the tax benefits apply to the Privileged
Enterprise, referred to as the Year of Election. Where the company requests to
have the tax benefits apply to an expansion of existing facilities, only the
expansion will be considered a Privileged Enterprise and the company's effective
tax rate will be the result of a weighted combination of the applicable rates.
In such case, the minimum investment required in order to qualify as a
Privileged Enterprise is required to exceed a certain percentage of the
company's production assets before the expansion.

Tax Benefits for Research and Development

         Israeli tax law allows, under specified conditions, a tax deduction for
expenditures, including capital expenditures, in the year incurred relating to
scientific research and development projects, if the expenditures are approved
by the relevant Israeli Government ministry, determined by the field of
research, and the research and development is for the promotion of the company
and is carried out by or on behalf of the company seeking such deduction.
However, the amount of such deductible expenses shall be reduced by the sum of
any funds received through government grants for the finance of such scientific
research and development projects. Expenditures not so approved are deductible
over a three-year period.

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

         Under the Law for the Encouragement of Industry (Taxes), 1969, or the
Industry Encouragement Law, Industrial Companies are entitled to certain
corporate tax benefits, including, among others:

         o     deduction, under certain conditions, of purchases of know-how
               and patents over an eight-year period for tax purposes;

         o     right to elect, under specified conditions, to file a
               consolidated tax return with additional related Israeli
               Industrial Companies;

         o     accelerated depreciation rates on equipment and buildings; and

         o     deductions over a three-year period of expenses involved with
               the issuance and listing of shares on the Tel Aviv Stock
               Exchange or, on or after January 1, 2003, on a recognized
               stock market outside of Israel.

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<PAGE>

         Eligibility for benefits under the Industry Encouragement Law is not
subject to receipt of prior approval from any governmental authority. Under the
Industry Encouragement Law, an "Industrial Company" is defined as a company
resident in Israel, at least 90% of the income of which, in any tax year,
determined in Israeli currency, exclusive of income from government loans,
capital gains, interest and dividends, is derived from an "Industrial
Enterprise" owned by it. An "Industrial Enterprise" is defined as an enterprise
owned by an Industrial Company, whose major activity in a given tax year is
industrial production activity.

         We believe that we currently qualify as an Industrial Company within
the definition of the Industry Encouragement Law. No assurance can be given that
we will continue to qualify as an Industrial Company or that the benefits
described above will be available in the future.

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

         The Government of Israel encourages research and development projects
through the Office of Chief Scientist of the Israeli Ministry of Industry, Trade
and Labor, or the Office of the Chief Scientist, pursuant to the Law for the
Encouragement of Industrial Research and Development, 1984, and the regulations
promulgated thereunder, commonly referred to as the Research Law. Grants
received under such programs are repaid through a mandatory royalty based on
revenues from products incorporating know-how developed with the grants. This
government support is conditioned upon the ability of the participant to comply
with certain applicable requirements and conditions specified in the Office of
the Chief Scientist's programs and with the provisions of the Research Law.

         Under the Research Law, research and development programs which meet
specified criteria and are approved by a research committee of the Office of the
Chief Scientist are eligible for grants of up to 50% of certain of the project's
approved expenditure, as determined by the research committee.

         In exchange, the recipient of such grants is required to pay the Office
of the Chief Scientist royalties from the revenues derived from products
incorporating technology developed within the framework of the approved research
and development program or derived from such program (including ancillary
services in connection with such program), usually up to100% of the U.S.
dollar-linked value of the total grants received in respect of such program,
plus LIBOR interest.

         The terms of the Israeli Government participation generally requires
that the products developed with such grants be manufactured in Israel. However,
under regulations promulgated under the Research Law, upon the approval of the
Chief Scientist, some of the manufacturing volume may be performed outside
Israel, provided that the grant recipient pays royalties at an increased rate.
The Research Law also allows for the approval of grants in cases in which the
applicant declares that part or all of the manufacturing will be performed
outside of Israel or by non-Israeli residents and the research committee is
convinced that this is essential for the execution of the program. The Research
Law also provides that know-how developed under an approved research and
development program may not be transferred to third parties in Israel without
the prior approval of the research committee. The Research Law further provides
that the know-how developed under an approved research and development program
may not be transferred to any third parties outside Israel. No approval is
required for the sale or export of any products resulting from such research and
development.

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<PAGE>

         However, in June 2005, an amendment to the Research Law became
effective, which amendment was intended to make the Research Law more compatible
with the global business environment by, among other things, relaxing
restrictions on the transfer of manufacturing rights outside Israel and on the
transfer of Office of the Chief Scientist-funded know-how outside of Israel. The
amendment permits the Office of the Chief Scientist, among other things, to
approve the transfer of manufacturing rights outside Israel in exchange for an
import of different manufacturing into Israel as a substitute, in lieu of
demanding the recipient to pay increased royalties as described above. The
amendment further permits, under certain circumstances and subject to the Office
of the Chief Scientist's prior approval, the transfer outside Israel of know-how
that has been funded by Office of the Chief Scientist, generally in the
following cases: (a) the grant recipient pays to the Office of the Chief
Scientist a portion of the consideration paid for such funded know-how
(according to certain formulas), (b) the grant recipient receives know-how from
a third party in exchange for its funded know-how, or (c) such transfer of
funded know-how arises in connection with certain types of cooperation in
research and development activities.

         The Research Law imposes reporting requirements with respect to certain
changes in the ownership of a grant recipient. The law requires the grant
recipient and its controlling shareholders and interested parties to notify the
Office of the Chief Scientist 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 and
requires the new interested party to undertake to the Office of the Chief
Scientist to comply with the Research Law. In addition, the rules of the Office
of the Chief Scientist may require prior approval of the Office of the Chief
Scientist or additional information or representations in respect of certain of
such events. 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 or the right to appoint directors or the chief
executive officer. An "interested party" of a company includes a holder of 5% or
more of its outstanding share capital or voting rights, its chief executive
officer and directors, someone who has the right to appoint its chief executive
officer or at least one director, and a company with respect to which any of the
foregoing interested parties owns 25% or more of the outstanding share capital
or voting rights or has the right to appoint 25% or more of the directors.
Accordingly, any non-Israeli who acquires 5% or more of our ordinary shares will
be required to notify the Office of the Chief Scientist that it has become an
interested party and to sign an undertaking to comply with the Research Law.
Additionally, procedures regulated under the Research Law require the grant
recipient to obtain the approval of the Office of the Chief Scientist prior to a
change in the holdings of the recipient or change in the holdings of the means
of control of the recipient if the recipient's shares are being issued to a
non-Israeli person or entity and require the new non-Israeli party to undertake
to the Office of the Chief Scientist to comply with the Research Law.

         The funds available for grants from the Office of the Chief Scientist
were reduced in 1998, however the Israeli authorities have indicated in the past
that the government may increase grants from the Office of the Chief Scientist
in the future.

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<PAGE>

         In the past, we received funding from the Office of the Chief Scientist
for selected research and development projects, but we stopped seeking funding
for a number of years. In 2005, we received the approval of the Office of the
Chief Scientist for a new research and development grant in the amount of
$130,000 and in 2006, we submitted two additional grant applications that are
currently pending. See Item 5C. "Operating and Financial Review and Prospects -
Research and Development, Patents and Licenses" for additional details on the
grants that we have received and our contingent liability to the Office of the
Chief Scientist.

Special Provisions Relating to Taxation under Inflationary

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

         o     There is a special tax adjustment for the preservation of
               equity whereby some corporate assets are classified broadly
               into fixed assets and non-fixed assets. Where a company's
               equity, as defined in such law, exceeds the depreciated cost
               of fixed assets, a deduction from taxable income that takes
               into account the effect of the applicable annual rate of
               inflation on such excess is allowed up to a ceiling of 70% of
               taxable income in any single tax year, with the unused portion
               permitted to be carried forward on a linked basis. If the
               depreciated cost of fixed assets exceeds a company's equity,
               then such excess multiplied by the applicable annual rate of
               inflation is added to taxable income.

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

Capital Gains Tax on Sales of Our Ordinary Shares

         As of January 1, 2003, when the recent Israeli tax reform came into
effect, individuals and companies on which the provisions of the Income Tax Law
(Inflationary Adjustments), 1985 are not imposed, are subject to a 15% tax rate
on the real capital gains derived on or after January 1, 2003 from the sale of
shares in Israeli companies publicly traded on a recognized stock exchange
outside of Israel.

         Under a recent amendment to the Israeli Income Tax Ordinance, which is
retroactively effective as of January 1, 2003, individual shareholders are
subject to a 20% tax rate on the real capital gains derived on or after January
1, 2003 from the sale of shares made on or after January 1 2006. However,
substantial individual shareholders (who are defined as shareholders of 10% or
more of the shares of the company on the date of the sale of the shares or any
date during the 12 months before the sale of the shares) are subject to a 25%
tax rate on the real capital gains derived on or after January 1, 2003 from the
sale of shares made on or after January 1 2006. Companies on which the
provisions of the Income Tax Law (Inflationary Adjustments), 1985 were not
imposed before January 1, 2006 are subject to 25% tax rate on real capital gains
derived on or after January 1, 2003 from the sale of shares made on or after
January 1 2006. Companies on which the provisions of the Income Tax Law
(Inflationary Adjustments), 1985 were imposed before January 1, 2006 are subject
to regular corporate tax rate on real capital gains derived on the sale of
shares.

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<PAGE>

         This will be the case so long as our securities remain listed on NASDAQ
or traded on a stock exchange in Israel or another country.

         Under income tax regulations non-Israeli residents, who sell shares of
an Israeli company publicly traded on a recognized stock exchange outside of
Israel, will be exempt from tax subject to the satisfaction of both of the
following conditions:

         o     The capital gain is not attributable to a permanent
               establishment in Israel; and

         o     The shares were purchased after the first initial public
               offering on the recognized stock exchange outside of Israel.

         Pursuant to the convention between the governments of the United States
of America and Israel with respect to taxes on income, as amended, referred to
as the Treaty, the sale, exchange or disposition of ordinary shares by a person
who qualifies as a resident of the United States within the meaning of the
Treaty and who is entitled to claim the benefits afforded to such person by the
Treaty generally will not be subject to the Israeli capital gains tax unless
such U.S. resident holds, directly or indirectly, shares representing 10% or
more of our voting power during any part of the 12-month period preceding such
sale, exchange or disposition, subject to particular conditions. A sale,
exchange or disposition of ordinary shares by such a U.S. resident who holds,
directly or indirectly, shares representing 10% or more of our voting power at
any time during such preceding 12-month period would be subject to such Israeli
tax, to the extent applicable; however, under such U.S. resident would be
permitted to claim a credit for such taxes against the U.S. federal income tax
imposed with respect to such sale, exchange or disposition, subject to the
limitations under U.S. laws applicable to foreign tax credits. The Treaty does
not relate to U.S. state or local taxes.

Taxation of Non-Resident Holders of Shares

         Non-residents of Israel are subject to income tax on income accrued or
derived from sources in Israel. Such sources of income include passive income
such as dividends, royalties and interest, as well as non-passive income from
services rendered in Israel. On distributions of dividends after January 1, 2006
other than bonus shares or stock dividends, income tax at the rate of 20% will
be withheld on dividends distributed to Israeli individual shareholders or to a
Non-resident.

         However, under the Investment Law, dividends generated by an approved
enterprise are taxed at the rate of 15%.

         The foregoing tax rates are withheld at source, unless a different rate
is provided by a treaty between Israel and the shareholder's country of
residence. (For instance under the provisions of the treaty between Israel and
the United States 12.5% tax rate is imposed on dividends not generated by an
approved enterprise if the non-resident is a U.S. corporation that holds 10% of
a company's voting power, and 15% on dividends generated by an approved
enterprise. In addition under the Treaty, the maximum tax on dividends paid to a
holder of ordinary shares who is a U.S. resident within the meaning of the
Treaty will be 25%).

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Foreign Exchange Regulations

         Dividends (if any) paid to the holders of our ordinary shares, and any
amounts payable with respect to our ordinary shares upon dissolution,
liquidation or winding up, as well as the proceeds of any sale in Israel of the
ordinary shares to an Israeli resident, may be paid in non-Israeli currency or,
if paid in Israeli currency, may be converted into freely reparable U.S. dollars
at the rate of exchange prevailing at the time of conversion, however, Israeli
income tax is required to have been paid or withheld on these amounts.

Stamp Duty

         The Israeli Stamp Duty on Documents Law, 1961, or the Stamp Duty Law,
provides that any document (or part thereof) that is signed in Israel or that is
signed outside of Israel and refers to an asset or other item in Israel or to an
action that is executed or will be executed in Israel, is subject to a stamp
duty, generally at a rate of between 0.4% and 1% of the value of the subject
matter of such document. However, it has been common practice in Israel not to
pay such stamp duty unless a document is filed with a governmental authority. An
amendment to the Stamp Duty Law that came into effect on June 1, 2003 introduced
several exemptions together with transitional orders and determined, among other
things, that stamp duty on most agreements shall be paid by the parties that
signed such agreement, jointly or severally, or by the party that undertook
under such agreement to pay the stamp duty. Following this amendment, the
Israeli tax authorities have approached many companies in Israel and requested
disclosure of all agreements signed by such companies after June 1, 2003, with
the aim of collecting stamp duty on such agreements. The legitimacy of the
amendment to the Stamp Duty Law and of the subsequent actions by the Israeli tax
authorities are currently under the review of the Israeli Supreme Court of
Justice.

         During 2005, the acting Prime Minister and Israeli Minister of Finance
announced that payment of stamp duty on agreements signed after January 1, 2006
will not be required.

UNITED STATES FEDERAL INCOME TAX CONSEQUENCES

         The following is a summary of certain material U.S. federal income tax
consequences that apply to U.S. Holders who hold ordinary shares as capital
assets. This summary is based on the United States Internal Revenue Code of
1986, as amended, or the Code, Treasury regulations promulgated thereunder,
judicial and administrative interpretations thereof, and the U.S.-Israel Tax
Treaty, all as in effect on the date hereof and all of which are subject to
change either prospectively or retroactively. This summary does not address all
tax considerations that may be relevant with respect to an investment in
ordinary shares. This summary does not account for the specific circumstances of
any particular investor, such as:

         o     broker-dealers,

         o     financial institutions,

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         o     certain insurance companies,

         o     regulated investment companies,

         o     investors liable for alternative minimum tax,

         o     tax-exempt organizations,

         o     non-resident aliens of the U.S. or taxpayers whose functional
               currency is not the U.S. dollar,

         o     persons who hold the ordinary shares through partnerships or
               other pass-through entities,

         o     persons who acquired their ordinary shares through the
               exercise or cancellation of employee stock options or
               otherwise as compensation for services,

         o     certain expatriates or former long-term residents of the
               United States,

         o     investors that own or have owned, directly, indirectly or by
               attribution, 10 percent or more of our voting shares, and

         o     investors holding ordinary shares as part of a straddle or
               appreciated financial position or a hedging or conversion
               transaction.

         If a partnership or an entity treated as a partnership for U.S. federal
income tax purposes owns ordinary shares, the U.S. federal income tax treatment
of a partner in such a partnership will generally depend upon the status of the
partner and the activities of the partnership. A partnership that owns ordinary
shares and the partners in such partnership should consult their tax advisors
about the U.S. federal income tax consequences of holding and disposing of
ordinary shares.

         This summary does not address the effect of any U.S. federal taxation
other than U.S. federal income taxation. In addition, this summary does not
include any discussion of state, local or foreign taxation.

         You are urged to consult your tax advisors regarding the foreign and
United States federal, state and local tax considerations of an investment in
ordinary shares.

         For purposes of this summary, a U.S. Holder is any beneficial owner of
ordinary shares that is:

         o     an individual who is a citizen or, for U.S. federal income tax
               purposes, a resident of the United States;

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<PAGE>

         o     a corporation or other entity created or organized in or under
               the laws of the United States or any political subdivision
               thereof;

         o     an estate whose income is subject to U.S. federal income tax
               regardless of its source; or

         o     a trust that (a) is subject to the primary supervision of a
               court within the United States and the control of one or more
               U.S. persons or (b) has a valid election in effect under
               applicable U.S. Treasury regulations to be treated as a U.S.
               person.

Taxation of Dividends

         Subject to the discussion below under the heading "Passive Foreign
Investment Companies," the gross amount of any distributions received with
respect to ordinary shares, including the amount of any Israeli taxes withheld
therefrom, will constitute dividends for U.S. federal income tax purposes, to
the extent of our current and accumulated earnings and profits as determined for
U.S. federal income tax purposes. You will be required to include this amount of
dividends in gross income as ordinary income. Distributions in excess of our
earnings and profits will be treated as a non-taxable return of capital to the
extent of your tax basis in the ordinary shares, and any amount in excess of
your tax basis will be treated as gain from the sale of ordinary shares. See
"--Disposition of Ordinary Shares" below for the discussion on the taxation of
capital gains. Dividends will not qualify for the dividends-received deduction
generally available to corporations under Section 243 of the Code.

         Dividends that we pay in NIS, including the amount of any Israeli taxes
withheld therefrom, will be included in your income in a U.S. dollar amount
calculated by reference to the exchange rate in effect on the day such dividends
are received. A U.S. Holder who receives payment in NIS and converts NIS into
U.S. dollars at an exchange rate other than the rate in effect on the day of
receipt may have a foreign currency exchange gain or loss that would be treated
as ordinary income or loss. U.S. Holders should consult their own tax advisors
concerning the U.S. tax consequences of acquiring, holding and disposing of NIS.

         Subject to complex limitations, any Israeli withholding tax imposed on
such dividends will be a foreign income tax eligible for credit against a U.S.
Holder's U.S. federal income tax liability, subject to certain limitations set
out in the Code (or, alternatively, for deduction against income in determining
such tax liability). The limitations set out in the Code include computational
rules under which foreign tax credits allowable with respect to specific classes
of income cannot exceed the U.S. federal income taxes otherwise payable with
respect to each such class of income. Dividends generally will be treated as
foreign-source passive income or financial services income for United States
foreign tax credit purposes. U.S. Holders should note that recently enacted
legislation eliminates the "financial services income" category with respect to
taxable years beginning after December 31, 2006. Under this legislation, the
foreign tax credit limitation categories will be limited to "passive category
income" and "general category 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 31-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

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<PAGE>

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. Further, there are special rules for computing
the foreign tax credit limitation of a taxpayer who receives dividends subject
to a reduced tax rate. The rules relating to the determination of the foreign
tax credit are complex, and you should consult with your personal tax advisors
to determine whether and to what extent you would be entitled to this credit.

         Subject to certain limitations, "qualified dividend income" received by
a noncorporate U.S. Holder through 2008 will be subject to tax at a reduced
maximum tax rate of 15 percent. The rate reduction does not apply to dividends
received from passive foreign investment companies, see discussion below.
Distributions taxable as dividends paid on the ordinary shares should qualify
for the 15 percent rate provided that either: (i) we are entitled to benefits
under the income tax treaty between the United States and Israel (the "Treaty")
or (ii) the ordinary shares are readily tradable on an established securities
market in the United States and certain other requirements are met. We believe
that we are entitled to benefits under the Treaty and that the ordinary shares
currently are readily tradable on an established securities market in the United
States. However, no assurance can be given that the ordinary shares will remain
readily tradable. The rate reduction does not apply unless certain holding
period requirements are satisfied. With respect to the ordinary shares, the U.S.
Holder must have held such shares for at least 61 days during the 121-day period
beginning 60 days before the ex-dividend date. The rate reduction also does not
apply in respect of certain hedged positions or in certain other situations. The
legislation enacting the reduced tax rate contains special rules for computing
the foreign tax credit limitation of a taxpayer who receives dividends subject
to the reduced tax rate. U.S. Holders of ordinary shares should consult their
own tax advisors regarding the effect of these rules in their particular
circumstances.

Disposition of Ordinary Shares

         If you sell or otherwise dispose of ordinary shares, you will recognize
gain or loss for U.S. federal income tax purposes in an amount equal to the
difference between the amount realized on the sale or other disposition and the
adjusted tax basis in ordinary shares. Subject to the discussion below under the
heading "Passive Foreign Investment Companies," such gain or loss generally will
be capital gain or loss and will be long-term capital gain or loss if you have
held the ordinary shares for more than one year at the time of the sale or other
disposition. In general, any gain that you recognize on the sale or other
disposition of ordinary shares will be U.S.-source for purposes of the foreign
tax credit limitation; losses will generally be allocated against U.S. source
income. Deduction of capital losses is subject to certain limitations under the
Code.

         In the case of a cash basis U.S. Holder who receives NIS in connection
with the sale or disposition of ordinary shares, the amount realized will be
based on the U.S. dollar value of the NIS received with respect to the ordinary
shares as determined on the settlement date of such exchange. A U.S. Holder who
receives payment in NIS and converts NIS into United States dollars at a
conversion rate other than the rate in effect on the settlement date may have a
foreign currency exchange gain or loss that would be treated as ordinary income
or loss.

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         An accrual basis U.S. Holder may elect the same treatment required of
cash basis taxpayers with respect to a sale or disposition of ordinary shares,
provided that the election is applied consistently from year to year. Such
election may not be changed without the consent of the Internal Revenue Service.
In the event that an accrual basis U.S. Holder does not elect to be treated as a
cash basis taxpayer (pursuant to the Treasury regulations applicable to foreign
currency transactions), such U.S. Holder may have a foreign currency gain or
loss for U.S. federal income tax purposes because of differences between the
U.S. dollar value of the currency received prevailing on the trade date and the
settlement date. Any such currency gain or loss would be treated as ordinary
income or loss and would be in addition to gain or loss, if any, recognized by
such U.S. Holder on the sale or disposition of such ordinary shares. Passive
Foreign Investment Companies

         There is a substantial risk that we are a passive foreign investment
company, or PFIC, for U.S. federal income tax purposes. Our treatment as a PFIC
could result in a reduction in the after-tax return to the U.S. Holders of our
ordinary shares and may cause a reduction in the value of such shares.

         For U.S. federal income tax purposes, we will be classified as a PFIC
for any taxable year in which either (i) 75% or more of our gross income is
passive income, or (ii) at least 50% of the average value of all of our assets
for the taxable year produce or are held for the production of passive income.
For this purpose, cash is considered to be an asset which produces passive
income. Passive income generally includes dividends, interest, royalties, rents,
annuities and the excess of gains over losses from the disposition of assets
which produce passive income. As a result of our relatively substantial cash
position at the time, we believe that we were a PFIC in certain periods in the
past under a literal application of the asset test described above, which looks
solely to the market value. We do not believe that we were a PFIC in 2005.

         If we are a PFIC, dividends will not qualify for the reduced maximum
tax rate, applicable to qualified dividend income, discussed above, and, unless
you timely elect to "mark-to-market" your ordinary shares, as described below:

         o     you will be required to allocate income recognized upon
               receiving certain dividends or gain recognized upon the
               disposition of ordinary shares ratably over the holding period
               for such ordinary shares,

         o     the amount allocated to each year during which we are
               considered a PFIC other than the year of the dividend payment
               or disposition would be subject to tax at the highest
               individual or corporate tax rate, as the case may be, in
               effect for that year and an interest charge would be imposed
               with respect to the resulting tax liability allocated to each
               such year,

         o     the amount allocated to the current taxable year and any
               taxable year before we became a PFIC would be taxable as
               ordinary income in the current year, and

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         o     you will be required to make an annual return on IRS Form 8621
               regarding distributions received with respect to ordinary
               shares and any gain realized on your ordinary shares.

         The PFIC provisions discussed above apply to U.S. persons who directly
or indirectly hold stock in a PFIC. Generally, a U.S. person is considered an
indirect shareholder of a PFIC if it is:

         o     A direct or indirect owner of a pass-through entity, including
               a trust or estate, that is a direct or indirect shareholder of
               a PFIC,

         o     A shareholder of a PFIC that is a shareholder of another PFIC,
               or

         o     A 50%-or-more shareholder of a foreign corporation that is not
               a PFIC and that directly or indirectly owns stock of a PFIC.

An indirect shareholder may be taxed on a distribution paid to the direct owner
of the PFIC and on a disposition of the stock indirectly owned. Indirect
shareholders are strongly urged to consult their tax advisors regarding the
application of these rules.

         If we cease to be a PFIC in a future year, a U.S. Holder may avoid the
continued application of the tax treatment described above by electing to be
treated as if it sold its ordinary shares on the last day of the last taxable
year in which we were a PFIC. Any gain would be recognized and subject to tax
under the rules described above. Loss would not be recognized. A U.S. Holder's
basis in its ordinary shares would be increased by the amount of gain, if any,
recognized on the sale. A U.S. Holder would be required to treat its holding
period for its ordinary shares as beginning on the day following the last day of
the last taxable year in which we were a PFIC.

         If the ordinary shares are considered "marketable stock" and if you
elect to "mark-to-market" your ordinary shares, you would not be subject to the
rules described above. Instead, you will generally include in income any excess
of the fair market value of the ordinary shares at the close of each tax year
over your adjusted basis in the ordinary shares. If the fair market value of the
ordinary shares had depreciated below your adjusted basis at the close of the
tax year, you may generally deduct the excess of the adjusted basis of the
ordinary shares over its fair market value at that time. However, such
deductions generally would be limited to the net mark-to-market gains, if any,
that you included in income with respect to such ordinary shares in prior years.
Income recognized and deductions allowed under the mark-to-market provisions, as
well as any gain or loss (to the extent of net mark-to-market gains) on the
disposition of ordinary shares with respect to which the mark-to-market election
is made, is treated as ordinary income or loss. Loss on a disposition, to the
extent in excess of net mark-to-market gains, would be treated as capital loss.
Gain or loss from the disposition of ordinary shares (as to which a
"mark-to-market" election was made) in a year in which we are no longer a PFIC
will be capital gain or loss. Loss on a disposition, to the extent in excess of
net mark-to-market gains, would be treated as capital loss. Our ordinary shares
should be considered "marketable stock" if they traded at least 15 days during
each calendar quarter of the relevant calendar year in more than de minimis
quantities.

                                       86
<PAGE>

         A U.S. Holder of ordinary shares will not be able to avoid the tax
consequences described above by electing to treat us as a qualified electing
fund, or QEF, because we do not intend to prepare the information that U.S.
Holders would need to make a QEF election.

Backup Withholding and Information Reporting

         Payments in respect of ordinary shares may be subject to information
reporting to the U.S. Internal Revenue Service and to U.S. backup withholding
tax at a rate equal to the fourth lowest income tax rate applicable to
individuals which, under current law, is 28%. Backup withholding will not apply,
however, if you (i) are a corporation or come within certain exempt categories,
and demonstrate the fact when so required, or (ii) furnish a correct taxpayer
identification number and make any other required certification.

         Backup withholding is not an additional tax. Amounts withheld under the
backup withholding rules may be credited against a U.S. Holder's U.S. tax
liability, and a U.S. Holder may obtain a refund of any excess amounts withheld
under the backup withholding rules by filing the appropriate claim for refund
with the IRS.

         Any U.S. Holder who holds 10% or more in vote or value of our ordinary
shares will be subject to certain additional United States information reporting
requirements.

U.S. Gift and Estate Tax

         An individual U.S. Holder of ordinary shares will be subject to U.S.
gift and estate taxes with respect to ordinary shares in the same manner and to
the same extent as with respect to other types of personal property.

F.       DIVIDEND AND PAYING AGENTS

         Not applicable.

G.       STATEMENT BY EXPERTS

         Not applicable.

H.       DOCUMENTS ON DISPLAY

         We are subject to the reporting requirements of the United States
Securities Exchange Act of 1934, as amended, as applicable to "foreign private
issuers" as defined in Rule 3b-4 under the Exchange Act, and in accordance
therewith, we file annual and interim reports and other information with the
Securities and Exchange Commission.

         As a foreign private issuer, we are exempt from certain provisions of
the Exchange Act. Accordingly, our proxy solicitations are not subject to the
disclosure and procedural requirements of Regulation 14A under the Exchange Act,
transactions in our equity securities by our officers and directors are exempt
from reporting and the "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 as frequently or
as promptly as U.S. companies whose securities are registered under the Exchange
Act. However, we distribute

                                       87
<PAGE>

annually to our shareholders an annual report containing financial statements
that have been examined and reported on, with an opinion expressed by, an
independent public accounting firm, and we file reports with the Securities and
Exchange Commission on Form 6-K containing unaudited financial information for
the first three quarters of each fiscal year.

         This annual report and the exhibits thereto and any other document we
file pursuant to the Exchange Act may be inspected without charge and copied at
prescribed rates at the following Securities and Exchange Commission public
reference rooms: 100 F Street, N.E., Room 1580, Washington, D.C. 20549; and on
the Securities and Exchange Commission Internet site (http://www.sec.gov) and on
our website www.mtsint.com. You may obtain information on the operation of the
Securities and Exchange Commission's public reference room in Washington, D.C.
by calling the Securities and Exchange Commission at 1-800-SEC-0330 or by
visiting the Securities and Exchange Commission's website at http://www.sec.gov,
and may obtain copies of our filings from the public reference room by calling
(202) 551-8090. The Exchange Act file number for our Securities and Exchange
Commission filings is 0-28950.

         The documents concerning our company referred to in this annual report
may also be inspected at our offices located at 22 Zarhin Street, Ra<180>anana
43662, Israel.

I.       SUBSIDIARY INFORMATION

         Not applicable.

ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

Exposure To Market Risks

         We are exposed to a variety of risks, including changes in interest
rates affecting primarily the interest received on short-term deposits, and
foreign currency fluctuations. We do not use derivative financial instruments to
hedge against such exposure.

Interest Rate Risk

         Our exposure to market risk for changes in interest rates relates
primarily to our short term deposits. Our short term deposits are held in
dollars and bear annual interest of 3.5% to 4.5%, which is based upon the London
Inter Bank Offered Rate (LIBOR). We place our short term deposits with major
financial center U.S. banks. For purposes of specific risk analysis, we use
sensitivity analysis to determine the impact that market risk exposure may have
on the financial income derived from our short term deposits. The potential loss
to us over one year that would result from a hypothetical change of 10% in the
LIBOR rate would be approximately $20,000.

Foreign Currency Exchange Risk

         We have operations in several countries in connection with the sale of
our products. A substantial portion of our sales and expenditures are
denominated in dollars. We have mitigated, and expect to continue to mitigate, a
portion of our foreign currency exposure through salaries, marketing and support
operations in which all costs are local currency based. As a result, our

                                       88
<PAGE>

results of operations and cash flows can be affected by fluctuations in foreign
currency exchange rates (primarily the Euro and NIS). A hypothetical 10%
movement in foreign currency rates (primarily the Euro and NIS) against the
dollar, with all other variables held constant on the expected sales, would
result in a decrease or increase in expected 2006 sales revenues of $200,000.

ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

         Not applicable.

                                     PART II


ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

         None.

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

         Not applicable.

ITEM 15. CONTROLS AND PROCEDURES

         Our management, including our chief executive officer and chief
financial officer, evaluated the effectiveness of our disclosure controls and
procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934)
as of the end of the period covered by this annual report on Form 20-F. Based
upon that evaluation, our chief executive officer and chief financial officer
have concluded that, as of such date, our disclosure controls and procedures
were effective to ensure that information required to be disclosed by our
company in reports that we file or submit under the U.S. Securities Exchange Act
of 1934, as amended, is recorded, processed, summarized and reported within the
time periods specified in the Securities and Exchange Commission's rules and
forms and that such information was made known to them by others within the
company, as appropriate to allow timely decisions regarding required disclosure.

         All internal control systems no matter how well designed, have inherent
limitations. Therefore, even those systems determined to be effective may not
prevent or detect misstatements and can provide only reasonable assurance with
respect to financial statement preparation and presentation. Also, projections
of any evaluation of effectiveness to future periods are subject to the risk
that controls may become inadequate because of changes in conditions, or that
the degree of compliance with the policies or procedures may deteriorate.

ITEM 16. [RESERVED]

ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT

         Our board of directors has determined that Mr. Yaacov Goldman, an
independent director, meets the definition of an audit committee financial
expert, as defined in Item 401 of Regulation S-K.

                                       89
<PAGE>

ITEM 16B. CODE OF ETHICS

         We have adopted a code of ethics that applies to our chief executive
officer and all senior financial officers of our company, including the chief
financial officer, chief accounting officer or controller, or persons performing
similar functions. Our code of ethics has been filed as an exhibit to this
annual report. Written copies are available upon request. If we make any
substantive amendment to the code of ethics or grant any waivers, including any
implicit waiver, from a provision of the codes of ethics, we will disclose the
nature of such amendment or waiver on our website.

ITEM 16C. PRINCIPAL ACCOUNTING FEES AND SERVICES

Fees Paid to Independent Public Accountants

         The following table sets forth, for each of the years indicated, the
fees paid to our principal independent registered public accounting firm. All of
such fees were pre-approved in advance by our Audit Committee.

                                          Year Ended December 31,
                                         -------------------------
                                          2005              2004
                                         -------           -------
              Services Rendered           Fees              Fees
        ----------------------------     --------          -------
        Audit (1).................       $123,162          $60,195
        Audit-related(2)..........          7,500               --
        Tax (3)...................         19,537           11,000
        Other (4).................          1,734            7,841
                                         --------          -------
        Total ....................       $151,933          $79,036

--------------
(1)  Audit fees consist of services that would normally be provided in
     connection with statutory and regulatory filings or engagements, including
     services that generally only the independent registered public accounting
     firm can reasonably provide.

(2)  Audit-related fees relate to services provided in connection with the
     filing of an amendment to our Annual Report on Form 20-F, on Form 20-F/A,
     for the year ended December 31, 2004.

(3)  Tax fees relate to services performed by the tax division for tax
     compliance, planning, and advice.

(4)  Other fees relate to services provided by our principal independent
     registered public accounting firm other than services covered by above
     categories.

Pre-Approval Policies and Procedures

         Our audit committee has adopted a policy and procedures for the
pre-approval of audit and non-audit services rendered by our independent public
accountants, Kost Forer Gabbay & Kasierer, a member firm of Ernst & Young
Global. Pre-approval of an audit or non-audit service may be given as a general
pre-approval, as part of the audit committee's approval of the scope of the
engagement of our independent auditor, or on an individual basis. Any proposed
services exceeding general pre-approved levels also require specific
pre-approval by our audit committee. The policy prohibits retention of the
independent public accountants to perform the prohibited non-audit functions
defined in Section 201 of the Sarbanes-Oxley Act or the rules of the Securities
and Exchange Committee, and also requires the audit committee to consider
whether proposed services are compatible with the independence of the public
accountants.

                                       90
<PAGE>

ITEM 16D. EXEMPTIONS FROM THE LISTING REQUIREMENTS AND S
          TANDARDS FOR AUDIT COMMITTEE

         Not applicable.

ITEM 16E. PURCHASE OF EQUITY SECURITIES BY THE ISSUER AND
          AFFILIATES AND PURCHASERS

Issuer Purchase of Equity Securities

         None.

                                    PART III


ITEM 17. FINANCIAL STATEMENTS

         We have elected to furnish financial statements and related information
specified in Item 18.

ITEM 18. FINANCIAL STATEMENTS

Consolidated Financial Statements of Mer Telemanagement Solutions Ltd.

<TABLE>
<CAPTION>
Consolidated Financial Statements of Mer Telemanagement Solutions Ltd.

<S>                                                                                       <C>
         Index to Consolidated Financial Statements ........................................F-1

         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-40

Financial Statements of Jusan, S.A. as of December 31, 2004 and 2005 and for the three
years ended December 31, 2005

         Index to Financial Statements of Jusan, S.A........................................F-41

         Report of Independent Registered Public Accounting Firm............................F-42

         Balance Sheets.....................................................................F-43

         Statements of Income...............................................................F-44

         Statements of Changes in Shareholders' Equity......................................F-45

         Statements of Cash Flows...........................................................F-46

         Notes to Financial Statements......................................................F-47
</TABLE>

                                       91
<PAGE>

ITEM 19. EXHIBITS

         Index to Exhibits

         Exhibit  Description

         1.1      Memorandum of Association of the Registrant (1)

         1.2      Articles of Association of the Registrant (1)

         2.1      Specimen of Ordinary Share Certificate (1)

         4.1      1996 Employee Stock Option Plan (1)

         4.2      Section 102 Stock Option Plan (1)

         4.3      2003 Israeli Share Option Plan (2)

         4.4      Asset Purchase Agreement dated December 30, 2004 among the
                  Registrant and Teleknowledge Group Ltd.  (3)

         4.5      Securities Purchase Agreement dated August 10, 2005 among the
                  Registrant and the Investors therein (4)

         4.6      Form of Warrant (5)

         4.7      Registration Rights Agreement dated August 10, 2005 (6)

         4.8      Form of Warrant issued to Mr. Avi Ziv (7)

         8.1      List of Subsidiaries of the Registrant

         11.1     Code of Ethics (8)

         12.1     Certification of Chief Executive Officer pursuant to Rule
                  13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act,
                  as amended.

         12.2     Certification of Chief Financial Officer pursuant to Rule
                  13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act,
                  as amended.

         13.1     Certification of Chief Executive Officer pursuant to 18 U.S.C.
                  Section1350, as adopted pursuant to Section 906 of the
                  Sarbanes-Oxley Act of 2002.

                                       92
<PAGE>

         13.2     Certification of 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, a Member of
                  Ernst & Young Global

          15.2    Consent of BDO Audiberia Auditores, S.L.

          -----------------
          (1)     Filed as an exhibit to the Registrant's Registration Statement
                  on Form F-1, registration number 333-05814, filed with the
                  Securities and Exchange Commission, and incorporated herein by
                  reference.

          (2)     Filed as Exhibit 10.3 to the Registrant's Annual Report on
                  Form 20-F for the year ended December 31, 2003, and
                  incorporated herein by reference.

          (3)     Filed as Exhibit 4.1 to the Registrant's Annual Report on Form
                  20-F for the year ended December 31, 2004, and incorporated
                  herein by reference.

          (4)     Filed as Item 1 to the Registrant's Report on Form 6-K for the
                  month of August 2005 filed on August 19, 2005, and
                  incorporated herein by reference.

          (5)     Filed as Item 3 to the Registrant's Report on Form 6-K for the
                  month of August 2005 filed on August 19, 2005, and
                  incorporated herein by reference.

          (6)     Filed as Item 2 to the Registrant's Report on Form 6-K for the
                  month of August 2005 filed on August 19, 2005, and
                  incorporated herein by reference.

          (7)     Filed as Exhibit 4.6 to the Registrant's Registration
                  Statement on Form F-3, registration number 333-128225, and
                  incorporated herein by reference.

          (8)     Filed as Exhibit 14.1 to the Registrant's Annual Report on
                  Form 20-F for the year ended December 31, 2003, and
                  incorporated herein by reference.




                                       93


<PAGE>
             MER TELEMANAGEMENT SOLUTIONS 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-40




                               - - - - - - - - - -


                                      F-1
<PAGE>

[LOGO of ERNST & YOUNG]


                 |X| Kost Forer Gabbay & Kasierer   |X| Phone: 972-3-6232525
                     3 Aminadav St.                     Fax:   972-3-5622555
                     Tel-Aviv 67067, Israel




             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

                             To the Shareholders of

                        MER TELEMANAGEMENT SOLUTIONS LTD.


       We have audited the accompanying consolidated balance sheets of Mer
Telemanagement Solutions 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 the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits. We did not audit the
financial statements of Jusan SA, a 50% owned affiliate for the years ended
December 31, 2004 and 2005, in which the Company's investments totaled $ 2,119
thousand and $ 1,615 thousand as of December 31, 2004 and 2005, respectively and
the Company's equity in its revenues in 2004 and 2005 constitutes $ 225 thousand
and $ 2 thousand, respectively . Those statements were audited by other auditors
whose reports have been furnished to us and our opinion, insofar as it relates
to amounts emanating from the financial statements of such investee companies,
is based solely on the reports of the other auditors.


       We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. 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 and the reports of other auditors provide a reasonable basis for our
opinion.


        In our opinion, based on our audits and the reports of the other
auditors, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of the
Company and its subsidiaries as of December 31, 2004 and 2005, and the
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 accounting
principles generally accepted in the United States.



                                             /s/ KOST FORER GABBAY AND KASIERER
Tel-Aviv, Israel                                KOST FORER GABBAY & KASIERER
February 7, 2006                              A Member of Ernst & Young Global

                                      F-2

<PAGE>

                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
--------------------------------------------------------------------------------
U.S. dollars in thousands


<TABLE>
<CAPTION>
                                                                                    December 31,
                                                                                 -----------------
                                                                                  2004      2005
                                                                                 -------   -------
    ASSETS
                                CURRENT ASSETS:
<S>                                                                              <C>       <C>
  Cash and cash equivalents                                                      $ 3,814   $ 3,191
  Marketable securities (Note 3)                                                   1,057       132
  Trade receivables (net of allowance for doubtful accounts of $ 370 and $ 402
    at December 31, 2004 and 2005, respectively)                                   1,348     1,895
  Unbilled receivables                                                                --       104
  Other accounts receivable and prepaid expenses (Note 4)                            391       491
  Inventories (Note 5)                                                               178       181
                                                                                 -------   -------

Total current assets                                                               6,788     5,994
-----                                                                            -------   -------

LONG-TERM ASSETS:
  Investments in an affiliate (Note 6)                                             2,119     1,615
  Long-term loans, net of current maturities (Note 7)                                 45         3
  Severance pay fund                                                                 535       478
  Other investments (Note 8)                                                         373       347
                                                                                 -------   -------

Total long-term assets                                                             3,072     2,443
-----
                                                                                 -------   -------

PROPERTY AND EQUIPMENT, NET (Note 9)                                                 581       571
                                                                                 -------   -------

OTHER ASSETS:
  Goodwill (Note 10a)                                                              3,415     3,700
  Other intangible assets, net (Note 10b)                                          1,394       993
  Deferred income taxes (Note 13)                                                     73       115
                                                                                 -------   -------

Total other assets                                                                 4,882     4,808
-----                                                                            -------   -------

Total assets                                                                     $15,323   $13,816
-----                                                                            =======   =======
</TABLE>


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

                                      F-3

<PAGE>

                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)

<TABLE>
<CAPTION>
                                                                                   December 31,
                                                                               --------------------
                                                                                 2004        2005
                                                                               --------    --------
    LIABILITIES AND SHAREHOLDERS' EQUITY

CURRENT LIABILITIES:
<S>                                                                            <C>         <C>
  Trade payables                                                               $    719    $    735
  Accrued expenses and other liabilities (Note 11)                                2,042       2,306
  Deferred revenues                                                               1,254         888
                                                                               --------    --------

Total current liabilities                                                         4,015       3,929
-----                                                                          --------    --------

LONG-TERM LIABILITIES:
  Accrued severance pay                                                             651         713
                                                                               --------    --------

Total long-term liabilities                                                         651         713
-----                                                                          --------    --------

COMMITMENTS AND CONTINGENT LIABILITIES (Note 12)

SHAREHOLDERS' EQUITY (Note 15):
  Share capital -
    Ordinary shares of NIS 0.01 par value - Authorized: 12,000,000 shares at
      December 31, 2004 and 2005; Issued: 4,648,804 and 5,744,304 shares at
      December 31, 2004 and 2005, respectively; Outstanding: 4,638,004 and
      5,733,504 shares at December 31, 2004 and 2005, respectively                   14          17
  Additional paid-in capital                                                     12,879      15,966
  Treasury shares (10,800 Ordinary shares at December 31, 2004 and 2005)            (29)        (29)
  Deferred stock compensation                                                      (208)       (142)
  Accumulated other comprehensive income (loss)                                     348         (75)
  Accumulated deficit                                                            (2,347)     (6,563)
                                                                               --------    --------

Total shareholders' equity                                                       10,657       9,174
-----                                                                          --------    --------

Total liabilities and shareholders' equity                                     $ 15,323    $ 13,816
-----                                                                          ========    ========
</TABLE>

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

                                      F-4
<PAGE>


                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)



<TABLE>
<CAPTION>
                                                                        Year ended December 31,
                                                               -----------------------------------------
                                                                  2003           2004            2005
                                                               -----------    -----------    -----------
Revenues (Note 16):
<S>                                                            <C>            <C>            <C>
  Product sales                                                $     6,944    $     7,070    $     7,628
  Services                                                           2,286          2,343          3,935
                                                               -----------    -----------    -----------

Total revenues                                                       9,230          9,413         11,563
-----                                                          -----------    -----------    -----------

Cost of revenues:
  Product sales                                                      1,523          2,407          2,968
  Services                                                             326            407            834
                                                               -----------    -----------    -----------

Total cost of revenues                                               1,849          2,814          3,802
-----                                                          -----------    -----------    -----------

Gross profit                                                         7,381          6,599          7,761
                                                               -----------    -----------    -----------

Operating expenses:
  Research and development, net                                      1,825          2,362          4,395
  Selling and marketing                                              3,916          6,300          4,797
  General and administrative                                         1,830          2,101          2,830
                                                               -----------    -----------    -----------

Total operating expenses                                             7,571         10,763         12,022
-----                                                          -----------    -----------    -----------

Operating loss                                                        (190)        (4,164)        (4,261)
Financial income, net                                                  131             78             53
                                                               -----------    -----------    -----------

Loss before taxes on income                                            (60)        (4,086)        (4,208)
Taxes on income (Note 13)                                              198            266             10
                                                               -----------    -----------    -----------

Loss before equity in earnings of affiliate                           (258)        (4,352)        (4,218)
Equity in earnings of affiliate                                        345            225              2
                                                               -----------    -----------    -----------

Net income (loss)                                              $        87    $    (4,127)   $    (4,216)
                                                               ===========    ===========    ===========

Net earnings (loss) per share:

Basic and diluted net earnings (loss) per Ordinary share       $      0.02    $     (0.89)   $     (0.83)
                                                               ===========    ===========    ===========


Weighted average number of Ordinary shares used in computing
   basic net earnings (loss) per share                           4,617,099      4,634,413      5,092,117
                                                               ===========    ===========    ===========

Weighted average number of Ordinary shares used in computing
   diluted net earnings (loss) per share                         4,628,249      4,634,413      5,092,117
                                                               ===========    ===========    ===========
</TABLE>

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

                                      F-5

<PAGE>

<TABLE>
<CAPTION>
                                                                                  MER TELEMANAGEMENT SOLUTIONS LTD.
                                                                                               AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
-------------------------------------------------------------------------------------------------------------------
U.S. dollars in thousands


                                                      Share capital         Additional                  Deferred
                                               ---------------------------   paid-in      Treasury        stock
                                                   Number       Amount       capital       shares      compensation
                                               -------------  ------------  ----------  -----------  --------------
<S>                                           <C>            <C>          <C>          <C>           <C>
 Balance as of January 1, 2003                    4,621,648    $        15  $  12,846    $    (330)    $          -
   Exercise of options                              133,333         *)   -          -            -                -
   Employee stock based compensation                      -              -        223            -             (223)
   Amortization of deferred stock compensation            -              -          -            -              213
   Retirement of treasury shares                   (130,510)            (1)      (456)         457                -
   Purchase of treasury shares                            -              -          -         (147)               -
   Other comprehensive income:
     Unrealized gains on available-for-sale
       marketable securities, net                         -              -          -            -                -
     Foreign currency translation adjustments             -              -          -            -                -
     Loss from cash flows hedging transaction             -              -          -            -                -

   Total other comprehensive income
   Net income                                             -              -          -            -                -
                                               -------------  ------------  ----------  -----------  --------------
   Total comprehensive income

 Balance as of December 31, 2003                  4,624,471             14     12,613          (20)             (10)
   Exercise of options                               17,333         *)   -          2            -                -
   Employee stock based compensation                      -              -        264            -             (264)
   Amortization of deferred stock compensation            -              -          -            -               66
   Purchase of treasury shares                       (3,800)             -          -           (9)               -
   Other comprehensive loss:
     Unrealized gains on available-for-sale
       marketable securities, net                         -              -          -            -                -
     Foreign currency translation adjustments             -              -          -            -                -
     Gain from cash flows hedging transaction             -              -          -            -                -

   Total other comprehensive loss                         -
   Net loss                                               -              -          -            -                -
                                               -------------  ------------  ----------  -----------  --------------
   Total comprehensive loss

 Balance as of December 31, 2004                  4,638,004             14     12,879          (29)            (208)
   Issuance of shares, net                          937,500              2      2,623            -                -
   Exercise of options                              158,000              1        308            -                -
   Stock based compensation related to
   warrants issued to non employees                       -              -        156            -                -
   Amortization of deferred stock compensation            -              -          -            -               66
   Other comprehensive loss:
     Unrealized losses on available-for-sale
       marketable securities, net                         -              -          -            -                -
     Foreign currency translation adjustments             -              -          -            -                -

   Total other comprehensive loss
   Net loss                                               -              -          -            -                -
                                               -------------  ------------  ----------  -----------  --------------
   Total comprehensive loss

 Balance as of December 31, 2005                  5,733,504    $        17  $  15,966    $     (29)    $       (142)
                                               =============  ============  ==========  ===========  ==============

 Accumulated unrealized gains from available-for-sale
   marketable securities
 Accumulated foreign currency translation adjustments

</TABLE>

<TABLE>
<CAPTION>
                                                         Accumulated
                                                            other        Accumulated       Total           Total
                                                         comprehensive     earnings     comprehensive   shareholders'
                                                         income (loss)     deficit)     income (loss)     equity
                                                       ---------------  ------------   --------------   -------------
<S>                                                    <C>             <C>            <C>               <C>
 Balance as of January 1, 2003                           $        (211)  $     1,693                    $      14,013
   Exercise of options                                               -             -                           *)   -
   Employee stock based compensation                                 -             -                                -
   Amortization of deferred stock compensation                       -             -                              213
   Retirement of treasury shares                                     -             -                                -
   Purchase of treasury shares                                       -             -                             (147)
   Other comprehensive income:
     Unrealized gains on available-for-sale
       marketable securities, net                                  109             -    $        109              109
     Foreign currency translation adjustments                      196             -             196              196
     Loss from cash flows hedging transaction                       (7)            -              (7)              (7)
                                                                                        ------------
   Total other comprehensive income                                                              298
   Net income                                                        -            87              87               87
                                                        --------------  ------------   --------------   -------------
   Total comprehensive income                                                           $        385
                                                                                        ============
 Balance as of December 31, 2003                                    87         1,780                           14,464
   Exercise of options                                               -             -                                2
   Employee stock based compensation                                 -             -                                -
   Amortization of deferred stock compensation                       -             -                               66
   Purchase of treasury shares                                       -             -                               (9)
   Other comprehensive loss:
     Unrealized gains on available-for-sale
       marketable securities, net                                   83             -    $         83               83
     Foreign currency translation adjustments                      171             -             171              171
     Gain from cash flows hedging transaction                        7             -               7                7
                                                                                        ------------
   Total other comprehensive loss                                                                261
   Net loss                                                          -        (4,127)         (4,127)          (4,127)
                                                        --------------  ------------    -------------   -------------
   Total comprehensive loss                                                             $     (3,866)
                                                                                        ============
 Balance as of December 31, 2004                                   348        (2,347)                          10,657
   Issuance of shares, net                                           -             -                            2,625
   Exercise of options                                               -             -                              309
   Stock based compensation related to
   warrants issued to non employees                                  -             -                              156
   Amortization of deferred stock compensation                       -             -                              66
   Other comprehensive loss:
     Unrealized losses on available-for-sale
       marketable securities, net                                  (76)            -    $        (76)             (76)
     Foreign currency translation adjustments                     (347)            -            (347)            (347)
                                                                                        ------------
   Total other comprehensive loss                                                               (423)
   Net loss                                                          -        (4,216)         (4,216)          (4,216)
                                                        --------------  ------------    -------------   -------------
   Total comprehensive loss                                                             $     (4,639)
                                                                                        ============
 Balance as of December 31, 2005                         $         (75)  $    (6,563)                   $       9,174
                                                        ==============  ============                    =============

 Accumulated unrealized gains from available-for-sale    $          10
   marketable securities
 Accumulated foreign currency translation adjustments              (85)
                                                         -------------
                                                         $         (75)
                                                         =============
</TABLE>


*) Represents an amount lower than $ 1.

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

                                      F-6
<PAGE>

                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
--------------------------------------------------------------------------------
U.S. dollars in thousands


<TABLE>
<CAPTION>
                                                                              Year ended December 31,
                                                                           -----------------------------
                                                                            2003       2004       2005
                                                                           -------    -------    -------
Cash flows from operating activities:
-------------------------------------
<S>                                                                        <C>        <C>        <C>
  Net income (loss)                                                        $    87    $(4,127)   $(4,216)
  Adjustments required to reconcile net income (loss) to net cash
    provided by (used in) operating activities:
    Gains on sale of available-for-sale marketable securities                   (6)        --        (77)
    Loss on sale of property and equipment                                      39          1         --
    Impairment of other investments                                             --         --         27
    Equity in earnings of affiliate                                           (345)      (225)        (2)
    Depreciation and amortization                                              401        399        655
    Deferred income taxes, net                                                  23         33         10
    Employee stock-based compensation                                          213         66         66
    Stock based compensation related to warrants issued to non employees        --         --        156
    Accrued severance pay, net                                                 (47)         2        119
    Decrease (increase) in trade receivables and unbilled receivables         (132)       144       (672)
    Decrease (increase) in other accounts receivable and prepaid
      expenses                                                                 (89)       175        (99)
    Decrease (increase) in inventories                                          47         15         (3)
    Increase in trade payables                                                  43        326         16
    Increase (decrease) in accrued expenses and other liabilities              (99)       611        (46)
    Increase (decrease) in deferred revenues                                    35        (41)      (366)
    Increase in related parties, net                                            51         20         15
    Others                                                                      (7)        --         --
                                                                           -------    -------    -------

Net cash provided by (used in) operating activities                            163     (2,621)    (4,417)
                                                                           -------    -------    -------

Cash flows from investing activities:
-------------------------------------
  Proceeds from sale of property and equipment                                   5         22          7
  Purchase of property and equipment                                          (171)      (293)      (251)
  Capitalization of research and development costs                              --       (386)        --
  Investment in lease deposits                                                  --         (5)       (26)
  Investment in available-for-sale marketable securities                      (969)      (220)      (163)
  Proceeds from sale of available-for-sale marketable securities               318        891      1,089
  Proceeds from redemption of held-to-maturity marketable securities           275         --         --
  Acquisition of certain assets and liabilities of Teleknowledge (a)            --     (2,445)       (21)
  Dividend from an affiliate                                                   100        136        195
  Others                                                                        16         50         63
                                                                           -------    -------    -------

Net cash provided by (used in) investing activities                           (375)    (2,230)       893
                                                                           -------    -------    -------
</TABLE>

The accompanying notes are an integral part of the consolidated financial
statements.
                                      F-7

<PAGE>

                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
--------------------------------------------------------------------------------
U.S. dollars in thousands


<TABLE>
<CAPTION>
                                                                                   Year ended December 31,
                                                                                -----------------------------
                                                                                 2003       2004       2005
                                                                                -------    -------    -------
 Cash flows from financing activities:
 -------------------------------------
<S>                                                                           <C>        <C>          <C>
   Repayment of long-term loans                                                      (8)        (8)        --
   Proceeds from issuance of shares and warrants, net                                --         --      2,625
   Proceeds from exercise of options and warrants                                *)  --          2        281
   Purchase of treasury shares                                                     (147)        (9)        --
                                                                                -------    -------    -------

 Net cash provided by (used in) financing activities                               (155)       (15)     2,906
                                                                                -------    -------    -------

 Effect of exchange rate changes on cash and cash equivalents                       (11)        (4)        (5)
                                                                                -------    -------    -------

 Decrease in cash and cash equivalents                                             (378)    (4,870)      (623)
 Cash and cash equivalents at the beginning of the year                           9,062      8,684      3,814
                                                                                -------    -------    -------

 Cash and cash equivalents at the end of the year                               $ 8,684    $ 3,814    $ 3,191
                                                                                =======    =======    =======

 Supplemental disclosure of cash flows activities:
 -------------------------------------------------
   Cash paid during the year for:

     Interest                                                                   $     1    $     1    $     3
                                                                                =======    =======    =======

     Income taxes                                                               $    49    $    25    $    17
                                                                                =======    =======    =======

 (a)   In conjunction with the acquisition, the fair values of assets
          acquired and liabilities assumed at the date of acquisition were as
          follows (see Note 1c):
          -------------------------------------------------------------------
          Working capital (excluding cash and cash equivalents)                            $    24    $    --
          Estimated fair value of assets acquired and liabilities
            assumed at the acquisition date:
          Property and equipment                                                                40         --
          Goodwill                                                                           1,391         21
          Developed technology                                                                 690         --
          Customer relationship                                                                300         --
                                                                                           -------    -------

                                                                                           $ 2,445    $    21
                                                                                           =======    =======
 (b)   Supplemental disclosure of non-cash activities:
       -----------------------------------------------
          Earnout in respect of Teleknowledge acquisition                       $    --    $    --    $   264
                                                                                =======    =======    =======
</TABLE>

*) Represents an amount lower than $ 1.

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

                                      F-8
<PAGE>

                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands


NOTE 1:-    GENERAL

            a.    Mer Telemanagement Solutions Ltd. ("the Company" or "MTS") was
                  incorporated on December 27, 1995. MTS and its subsidiaries
                  ("the Group") design, develop, market and support a
                  comprehensive line of telecommunication management and
                  customer care & billing ("CC&B") solutions that enable
                  business organizations and other enterprises to improve the
                  efficiency and performance of all IP operations, and reduce
                  associated costs. The Group products include call accounting
                  and management products, fault management systems and web
                  based management solutions for converged voice, voice over
                  Internet Protocol, IP data and video and CC&B solutions. As
                  for MTS's subsidiaries, see Note 18.

            b.    MTS's products are designed to provide telecommunication and
                  information technology managers with tools to reduce
                  communication costs, recover charges payable by third parties,
                  and to detect and prevent abuse and misuse of telephone
                  networks including fault telecommunication usage.

                  The Group markets its products worldwide through distributors,
                  business telephone switching systems manufacturers and vendors
                  and its direct sales force. Several international private
                  automatic branch exchange ("PBX") manufacturers market the
                  Group's products as part of their PBX selling efforts or on an
                  Original Equipment Manufacturer ("OEM") basis. The Group is
                  highly dependent upon the active marketing and distribution of
                  its OEM's. If the Group is unable to effectively manage and
                  maintain a relationship with its OEM or any event negatively
                  affecting such dealer's financial condition, could cause a
                  material adverse effect on the Group's results of operations
                  and financial position. In 2003, 2004 and 2005, one major
                  customer generated 40%, 38% and 36% of the Group's revenues,
                  respectively.

                  Certain components and subassemblies included in the Group's
                  products are obtained from a single source or a limited group
                  of suppliers and subcontractors. If such supplier fails to
                  deliver the necessary components or subassemblies, the Company
                  may be required to seek alternative sources of supply. A
                  change in supplier could result in manufacturing delays, which
                  could cause a possible loss of sales and, consequently, could
                  adversely affect the Company's results of operations and
                  financial position.

                  MTS's shares are listed for trade on the Nasdaq Capital
                  Market.

            c.    On December 30, 2004, the Company and Teleknowledge Group Ltd.
                  ("Teleknowledge") consummated an Assets Purchase Agreement
                  ("the Agreement"). TeleKnowledge is a leading provider of
                  carrier-class billing and rating solutions. The integration of
                  Teleknowledge's billing solution enables MTS to offer an
                  end-to-end customer care and billing solution. Under the terms
                  of the Agreement, the Company acquired certain assets and
                  liabilities of Teleknowledge for the following consideration:

                  1. An initial consideration of $ 2,374 in cash.

                                       F-9
<PAGE>

                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands


NOTE 1:-    GENERAL (Cont.)

            2.    Additional contingent consideration of up to an amount of $
                  3,650, based on post acquisition revenue performance
                  (calculated as 10% of renewal maintenance fees and 20% of all
                  other revenues from sales which included Teleknowledge
                  products), over a period of three years. Such payments will be
                  recorded as additional goodwill, during the contingency
                  period, when actual revenue performance will be evaluated (see
                  Note 10a). In 2005, an additional consideration of $285K was
                  recorded, in accordance with the agreement.

            3.    In addition, the Company incurred transaction costs totaling $
                  71.

            Prior to the acquisition, MTS and Teleknowledge had an OEM
            relationship. The commercial arrangements and transactions were
            settled before the date of the acquisition.

            The acquisition was accounted for under the purchase method of
            accounting in accordance with SFAS 141, "Business Combination"
            ("SFAS 141"). Accordingly, the purchase price has been allocated to
            the assets acquired and the liabilities assumed based on the
            estimated fair value at the date of acquisition. The excess of the
            purchase price over the estimated fair value of the net assets
            acquired has been recorded as goodwill.

            Based upon a valuation of the tangible and intangible assets
            acquired and the liabilities assumed, the Company has allocated the
            total cost of the acquisition to Teleknowledge's net assets at the
            date of acquisition, as follows:


            Trade receivables                                      $   100
            Property and equipment                                      40
            Intangible assets:
            Developed technology (four-year useful life)               690
            Customer relationship (six-year useful life)               300
            Goodwill                                                 1,676
                                                                   --------

            Total assets acquired                                    2,806
            Liabilities assumed - Deferred revenues                    (76)
                                                                   --------

            Net assets acquired                                    $ 2,730
                                                                   ========

            The valuation of the Company's developed technology was based on the
            income approach, which reflects the future economic benefits from
            Teleknowledge products. The value assigned to customer relationship
            was based on the cost approach. Under this approach, the customer
            relationship was valued by calculating the savings realized by the
            Company through obtaining a pre-existing customer relationship of
            Teleknowledge.

                                      F-10

<PAGE>

                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands

NOTE 1:-    GENERAL (Cont.)

            Pro forma results:

                  The following unaudited proforma information does not purport
                  to represent what the Company's results of operations would
                  have been had the acquisitions occurred on January 1, 2003 and
                  2004, nor does it purport to represent the results of
                  operations of the Company for any future period.

<TABLE>
<CAPTION>
                                                                     Year ended December 31,
                                                                     -----------------------
                                                                        2003         2004
                                                                     ---------   -----------
<S>                                                                  <C>         <C>
 Revenues                                                            $  10,128   $    10,542
                                                                     =========   ===========

 Net loss from continuing operations                                 $ (10,247)  $ *)(4,931)
                                                                     =========   ===========
 Basic and diluted net loss per share for continuing operations      $   (2.22)  $     (1.06)
                                                                     =========   ===========
Weighted average number of Ordinary shares in computation of basic
   and diluted net loss per share                                    4,617,099     4,634,413
                                                                     =========   ===========
</TABLE>

*) Net of capital gain from sale of Teleknowledge to MTS.

NOTE 2:-    SIGNIFICANT ACCOUNTING POLICIES

            The consolidated financial statements have been prepared in
            accordance with accounting principles generally accepted in the
            United States ("U.S. GAAP").

            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 U.S. dollars:

                  The majority of the revenues of the Company and certain of its
                  subsidiaries are generated in or linked to the U.S. dollar
                  ("dollar"). In addition, a substantial portion of the
                  Company's and certain of its subsidiaries' costs is incurred
                  in dollars. Company's management believes that the dollar is
                  the currency of the primary economic environment in which the
                  Company and certain of its subsidiaries operate. Thus, the
                  functional and reporting currency of the Company and certain
                  of its subsidiaries is 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". All transaction
                  gains and losses of the remeasurement of monetary balance
                  sheet items are reflected in the consolidated statements of
                  operations as financial income or expenses, as appropriate.
                  Foreign currency translation differences for the years ended
                  December 31, 2003, 2004 and 2005, were $ (11), $ 19 and $ (11)
                  respectively, and recorded financial income (expenses).

                                      F-11
<PAGE>
                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands

NOTE 2:-      SIGNIFICANT ACCOUNTING POLICIES (Cont.)

                  For those foreign subsidiaries and affiliates, whose
                  functional currency has been determined to be their local
                  currency, assets and liabilities are translated at the year
                  end exchange rates and statements of operations items are
                  translated at the average exchange rate prevailing during the
                  period. The resulting translation adjustments are recorded as
                  a separate component of accumulated other comprehensive income
                  (loss) in shareholders' equity.

            c.    Principles of consolidation:

                  The consolidated financial statements include the accounts of
                  MTS and its wholly-owned subsidiaries. Intercompany
                  transactions and balances, including profits from intercompany
                  sales not yet realized outside the Group, have been eliminated
                  upon consolidation.

            d.    Cash equivalents:

                  The Company considers all short-term highly liquid investments
                  that are readily convertible to cash with original maturities
                  of three months or less to be cash equivalents.

            e.    Marketable securities:

                  The Company accounts for investments in debt and equity
                  securities (other than those accounted for under the equity
                  method of accounting) in accordance with Statement of
                  Financial Accounting Standard No. 115, "Accounting for Certain
                  Investments in Debt and Equity Securities" ("SFAS No. 115").

                  Management determines the classification of investments in
                  marketable debt and equity securities at the time of purchase
                  and reevaluates such designations as of each balance sheet
                  date.

                  As of December 31, 2005 and 2004, all marketable securities
                  were designated as available-for-sale. Accordingly, these
                  securities are stated at fair value, with unrealized gains and
                  losses reported in accumulated other comprehensive income
                  (loss), a separate component of shareholders' equity, net of
                  taxes. Realized gains and losses on sales of investments, as
                  determined on a specific identification basis, are included in
                  the consolidated statement of operations.

            f.    Inventories:

                  Inventories are stated at the lower of cost or market value.
                  Inventory write-offs are provided to cover risks arising from
                  slow moving items, technological obsolescence, excess
                  inventories and for market prices lower than cost. Cost is
                  determined as follows: raw materials - using the "first in,
                  first out" method. Finished products are recorded on the basis
                  of direct manufacturing costs with the addition of allocable
                  indirect manufacturing costs.

                                      F-12
<PAGE>
                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands

NOTE 2:-    SIGNIFICANT ACCOUNTING POLICIES (Cont.)

            g.    Investments in an affiliate:

                  In these financial statements, the affiliated company is Jusan
                  S.A., a company held at a rate of 50% (which is not a
                  subsidiary), where the Company can exercise significant
                  influence over the operating and financial policy of the
                  affiliate.

                  The investment in the affiliate is accounted for by the equity
                  method, in accordance with Accounting Principle Board Opinion
                  No.18, "The Equity Method of Accounting for Investments in
                  Common Stock", ("APB No.18"). Profits on intercompany sales,
                  not realized through sales to third parties, were eliminated.
                  The excess of the purchase price over the fair value of net
                  tangible assets acquired has been attributed to goodwill.

                  Goodwill is reviewed annually (or more frequently if
                  circumstances indicate impairment has occurred) for impairment
                  in accordance with the provisions of Statement of Financial
                  Accounting Standard No. 142, "Goodwill and Other Intangible
                  Assets" ("SFAS No. 142").

                  Under APB 18, an impairment of value of an investment
                  accounted for under the equity method, which is other than a
                  temporary decline, should be recognized as a realized loss,
                  establishing a new carrying value for the investment. Factors
                  the Company considers in making this evaluation include: the
                  length of time and the extent to which the market value has
                  been lower than cost, the financial condition and near-term
                  prospects of the issuer, including cash flows of the investee
                  and any specific events which may influence the operations of
                  the issuer and the intent and ability of the Company to retain
                  its investments for a period of time sufficient to allow for
                  any anticipated recovery in market value. A current fair value
                  of an investment that is less than its carrying amount may
                  indicate an impairment of value of the investment. No
                  impairment losses were recorded during 2005.

            h.    Investment in other companies:

                  The investment in these companies is stated at cost, since the
                  Group does not have the ability to exercise significant
                  influence over operating and financial policies of those
                  investments. The Company's investments in other companies are
                  reviewed for impairment whenever events or changes in
                  circumstances indicate that the carrying amount of an
                  investment may not be recoverable, in accordance with APB
                  No.18. As of December 31, 2005, based on management's most
                  recent analyses, impairment losses in the amount of $ 27 have
                  been identified and recorded.

            i.    Property and equipment:

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

                                                                    %
                                                         -----------------------
                  Computers and peripheral equipment               33
                  Office furniture and equipment                 6 - 20
                  Motor vehicles                                   15
                  Leasehold improvements                 Shorter of useful life
                                                              or lease term

                                      F-13
<PAGE>
                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands

NOTE 2:-    SIGNIFICANT ACCOUNTING POLICIES (Cont.)

            j.    Impairment of long-lived assets:

                  The Company's long-lived assets and certain identifiable
                  intangibles are reviewed for impairment in accordance with
                  Statement of Financial Accounting Standard No. 144,
                  "Accounting for the Impairment or Disposal of Long-Lived
                  Assets" ("SFAS No. 144"), whenever events or changes in
                  circumstances indicate that the carrying amount of an asset
                  may not be recoverable. Recoverability of assets to be held
                  and used is measured by a comparison of the carrying amount of
                  an asset to the future undiscounted cash flows expected to be
                  generated by the assets. If such assets are considered to be
                  impaired, the impairment to be recognized is measured by the
                  amount by which the carrying amount of the assets exceeds the
                  fair value of the assets. As of December 31, 2005, no
                  impairment losses have been identified.

            k.    Goodwill:

                  Goodwill represents excess of costs over the fair value of net
                  assets of business acquired. Under SFAS 142, goodwill acquired
                  in a business combination on or after July 1, 2001 is not
                  amortized. FAS No. 142 requires goodwill to be tested for
                  impairment on adoption and at least annually thereafter or
                  between annual tests in certain circumstances, and written
                  down when impaired, rather than being amortized as previous
                  accounting standards required. Goodwill attributable to each
                  of the reporting units is tested for impairment by comparing
                  the fair value of each reporting unit with its carrying value.
                  Fair value is determined using discounted cash flows, market
                  multiples and market capitalization. Significant estimates
                  used in the methodologies include estimates of future cash
                  flows, future short-term and long-term growth rates, weighted
                  average cost of capital and estimates of market multiples for
                  each of the reportable units. As of December 31, 2005 no
                  impairment losses have been identified (see also Note 10a).

            l.    Intangible assets:

                  Intangible assets are amortized over their useful lives using
                  a method of amortization that reflects the pattern in which
                  the economic benefits of the intangible assets are consumed or
                  otherwise used up, in accordance with SFAS 142. Developed
                  technology is amortized over a weighted average of four years
                  and customer relationship is amortized over a period of six
                  years. As for capitalized software costs, see n below.

            m.    Revenue recognition:

                  The Company generates revenues mainly from licensing the
                  rights to use its software products. In 2005, pursuant to the
                  acquisition of Teleknowledge, the Company began generating
                  revenues also from billing software license that require
                  significant customization. The Company also generates revenues
                  from rendering maintenance, service bureau, support and
                  training. The Company sells its products directly to end-users
                  and indirectly through resellers and OEM's (who are considered
                  end users).

                                      F-14
<PAGE>
                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands


NOTE 2:-    SIGNIFICANT ACCOUNTING POLICIES (Cont.)

                  Revenues from software license agreements are recognized when
                  all criteria outlined in Statement of Position No. 97-2,
                  "Software Revenue Recognition" ("SOP No. 97-2") as amended are
                  met. Revenue from license fees is recognized when persuasive
                  evidence of an agreement exists, delivery of the product has
                  occurred, no significant obligations with regard to
                  implementation remain, the fee is fixed or determinable and
                  collectibility is probable. The Company does not grant a right
                  of return to its customers.

                  Where software arrangements involve multiple elements, revenue
                  is allocated to each undelivered element based on vendor
                  specific objective evidence ("VSOE") of the fair values of
                  each undelivered element in the arrangement, in accordance
                  with the "residual method" prescribed by SOP No. 98-9,
                  "Modification of SOP No. 97-2, Software Revenue Recognition
                  With Respect to Certain Transactions". The VSOE used by the
                  Company to allocate the sales price to support services and
                  maintenance is based on the renewal rate charged when these
                  elements are sold separately. License revenues are recorded
                  based on the residual method. Under the residual method,
                  revenue is recognized for the delivered elements when (1)
                  there is VSOE of the fair values of all the undelivered
                  elements, and (2) all revenue recognition criteria of SOP No.
                  97-2, as amended, are satisfied. Under the residual method any
                  discount in the arrangement is allocated to the delivered
                  element.

                  Revenues from billing products which involve significant
                  customization of the Company's software to customer specific
                  specifications are recognized in accordance with Statement of
                  Position 81-1, "Accounting for Performance of
                  Construction-Type and Certain Production-Type Contracts",
                  using contract accounting on a percentage of completion
                  method, over the period from signing of the license through to
                  customer acceptance in accordance with the "Input Method". The
                  amount of revenue recognized is based on the total arrangement
                  and the percentage to completion achieved. The percentage to
                  completion is measured by monitoring progress using records of
                  actual costs incurred to date in the project compared with the
                  total estimated project requirement. Estimates of total
                  project requirements are based on prior experience of
                  customization, delivery and acceptance of the same or similar
                  technology and are reviewed and updated regularly by
                  management.

                  After delivery, if uncertainty exists about customer
                  acceptance of the software, license revenue is not recognized
                  until acceptance. In the years ended December 31, 2003, 2004
                  and 2005, the Company recognized revenues in accordance with
                  SOP 81-1 in the amount of $0, $0 and $ 1,118, respectively,
                  included as part of product sales in the Company's statement
                  of operations. Provisions for estimated losses on uncompleted
                  contracts are made in the period in which such losses are
                  first determined, in the amount of the estimated loss on the
                  entire contract. As of December 31, 2005, no such estimated
                  losses were identified.

                  Estimated gross profit or loss from long-term contracts may
                  change due to changes in estimates resulting from differences
                  between actual performance and original forecasts. Such
                  changes in estimated gross profit are recorded in results of
                  operations when they are reasonably determinable by
                  management, on a cumulative catch-up basis.

                                      F-15

<PAGE>
                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands


NOTE 2:-    SIGNIFICANT ACCOUNTING POLICIES (Cont.)

                  The Company believes that the use of the percentage of
                  completion method is appropriate as the Company has the
                  ability to make reasonably dependable estimates of the extent
                  of progress towards completion, contract revenues and contract
                  costs. In addition, contracts executed include provisions that
                  clearly specify the enforceable rights regarding services to
                  be provided and received by the parties to the contracts, the
                  consideration to be exchanged and the manner and terms of
                  settlement. In all cases the Company expects to perform its
                  contractual obligations and its licensees are expected to
                  satisfy their obligations under the contract.

                  Where arrangements recognized according to SOP 81-1 involve
                  maintenance and support services, revenues are recognized
                  according to Emerging Issues Task Force ("EITF"), Issue No.
                  00-21 "Revenue Arrangement with Multiple Deliverables" ("EITF
                  00-21").

                  According to EITF 00-21 a multiple-element arrangement (an
                  arrangement that involves the delivery or performance of
                  multiple products, services and/or rights to use assets) is
                  separated into more than one unit of accounting, if the
                  functionality of the delivered element is not dependent on the
                  undelivered element, there is vendor-specific objective
                  evidence (VSOE) of fair value of the undelivered element and
                  delivery of the delivered element(s) represents the
                  culmination of the earnings process for this element. The
                  Company has established VSOE for maintenance and support
                  services based on the renewal rate charged when these elements
                  are sold separately and therefore, the arrangement
                  consideration is allocated to maintenance and support services
                  based on their relative VSOE.

                  SOP 97-2 specifies that extended payment terms in a licensing
                  arrangement may indicate that the license fees are not deemed
                  to be fixed or determinable. If the fee is not fixed or
                  determinable, or if collection is not considered probable,
                  revenue is recognized as payments become due from the
                  customer, provided that all other revenue recognition criteria
                  have been met. SOP 97-2 specifies that if a company has a
                  standard business practice of using extended payment terms in
                  licensing arrangements and has a history of successfully
                  collecting the license fees under the original terms of the
                  licensing arrangement without making concessions, the company
                  should recognize the license fees when all other SOP 92-7
                  revenue recognition criteria are met. The Company has
                  concluded that for certain arrangements with extended payment
                  terms, the "fixed or determinable" presumption has been
                  overcome and license fees have been recognized upon meeting
                  the remaining SOP 97-2 revenue recognition criteria.

                  Revenues from maintenance and support services are recognized
                  over the term of the maintenance and support agreement on a
                  straight line basis.

                  Deferred revenues include unearned amounts received under
                  maintenance and support contracts, not yet recognized as
                  revenues.

                                      F-16
<PAGE>
                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands


NOTE 2:-    SIGNIFICANT ACCOUNTING POLICIES (Cont.)

            n.    Research and development costs:

                  Statement of Financial Accounting Standards 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 and its subsidiaries' product
                  development process, technological feasibility is established
                  upon completion of a working model.

                  Research and development costs incurred in the process of
                  developing product improvements or new products, are generally
                  charged to expenses as incurred, net of grants received from
                  the Office of the Chief Scientist of Israel's Ministry of
                  Industry, Trade and Labor (see Note 12b).

                  Significant costs incurred by the Company and its subsidiaries
                  between completion of the working model and the point at which
                  the product is ready for general release, have been
                  capitalized.

                  Capitalized software costs are amortized by the greater of the
                  amount computed using the: 1) ratio that current gross
                  revenues from sales of the software to the total of current
                  and anticipated future gross revenues from sales of that
                  software, or 2) the straight-line method over the estimated
                  useful life of the product (three years). The Company assesses
                  the recoverability of this intangible asset on a regular basis
                  by determining whether the amortization of the asset over its
                  remaining life can be recovered through undiscounted future
                  operating cash flows from the specific software product sold.
                  Based on its most recent analyses, management believes that no
                  impairment of capitalized software development costs exists as
                  of December 31, 2005.

            o.    Government grants:

                  Royalty-bearing grants from the Government of Israel for
                  funding certain approved research and development projects are
                  recognized at the time the Company is entitled to such grants,
                  on the basis of the related costs incurred and recorded as a
                  deduction of research and development costs. Research and
                  development grants amounted $ 0, $ 0 and $ 130 in 2003, 2004
                  and 2005, respectively. Total royalties accrued or paid
                  amounted to $ 146, $ 181 and $ 198 in 2003, 2004 and 2005,
                  respectively and were recorded as part of the cost of goods
                  sold.

            p.    Income taxes:

                  The Company accounts for income taxes, in accordance with
                  Statement of Financial Accounting Standard 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. Valuation allowances are provided to
                  reduce deferred tax assets to their estimated realizable
                  value.

                                      F-17
<PAGE>
                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands


NOTE 2:-    SIGNIFICANT ACCOUNTING POLICIES (Cont.)

            q.    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 option 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.

                  The Company adopted the disclosure provisions of Financial
                  Accounting Standards Board Statement No. 148, "Accounting for
                  Stock-Based Compensation - Transition and Disclosure" ("SFAS
                  No. 148"), which amended certain provisions of SFAS 123 to
                  provide alternative methods of transition for an entity that
                  voluntarily changes to the fair value based method of
                  accounting for stock-based employee compensation, effective as
                  of the beginning 2003. The Company continues to apply the
                  provisions of APB No. 25, in accounting for stock-based
                  compensation.

                  Pro forma information regarding the Company's net income
                  (loss) and net earnings (loss) per share is required by 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. SFAS No. 123 requires use
                  of an option valuation model to measure the fair value of the
                  options at the measurement date.

                  The fair value for options granted in 2003, 2004 and 2005 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:

                                                    Year ended December 31,
                                                   -------------------------
                                                    2003      2004     2005
                                                   ------    ------    -----

                  Dividend                             0%        0%       0%
                  Average risk-free interest rates     2%        2%     3.9%
                  Average expected life (in years)   2.5       2.2      4.0
                  Volatility                        71.8%     71.8%    56.9%

                                      F-18

<PAGE>
                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands


NOTE 2:-    SIGNIFICANT ACCOUNTING POLICIES (Cont.)

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

<TABLE>
<CAPTION>
                                                       Year ended December 31,
                                                  -----------------------------
                                                   2003       2004        2005
                                                  -------    -------    -------
<S>                                               <C>        <C>        <C>
Net income (loss) available to Ordinary shares,   $    87    $(4,127)   $(4,216)
  as reported
Add: Stock-based employee compensation -
  intrinsic value                                     213         66         66
Deduct: Stock-based compensation expense
  determined under fair value method for all
  awards, net of related tax effect                  (346)      (274)      (264)
                                                  -------    -------    -------

Pro forma net loss                                $   (46)   $(4,335)   $(4,414)
                                                  =======    =======    =======

Basic and diluted net earnings (loss) per
  share, as reported                              $  0.02    $ (0.89)   $ (0.83)
                                                  =======    =======    =======

Basic and diluted net loss per share, pro forma   $    --    $ (0.94)   $ (0.87)
                                                  =======    =======    =======
</TABLE>

                  The Company applies Statement of Financial Accounting Standard
                  No. 123, "Accounting for Stock-Based Compensation" ("SFAS No.
                  123") and Emerging Issues Task Force No. 96-18 ("EITF No.
                  96-18"), "Accounting for Equity Instruments That are Issued to
                  Other Than Employees for Acquiring, or in Conjunction with
                  Selling, Goods or Services" with respect to options issued to
                  non-employees.

            r.    Warranty costs:

                  The Company provides free warranty for up to 15 months for the
                  "OEM" distributors. A provision is recorded for probable costs
                  in connection with these services based on the Company's
                  experience.

                  The Company estimates the costs that may be incurred under its
                  basic limited warranty and records a liability in the amount
                  of such costs at the time product revenue is recognized.
                  Factors that affect the Company's warranty liability include
                  the number of sold units, historical and anticipated rates of
                  warranty claims, and cost per claim. The Company periodically
                  assesses the adequacy of its recorded warranty liabilities and
                  adjusts the amounts as necessary.

                  No changes to the provision have been recorded during 2005.

                                      F-19
<PAGE>
                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands


NOTE 2:-    SIGNIFICANT ACCOUNTING POLICIES (Cont.)

            s.    Fair value of financial instruments:

                  The following methods and assumptions were used by the Group
                  in estimating its fair value disclosures for financial
                  instruments:

                  The carrying amounts of cash and cash equivalents, trade
                  receivables, other accounts receivable, short-term bank credit
                  and trade payables approximate their fair value, due to the
                  short-term maturity of such instruments.

                  The fair value for marketable securities is based on quoted
                  market prices (see Note 3).

            t.    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 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 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 expense for the years ended December 31, 2003, 2004
                  and 2005 amounted to approximately $ 121, $ 344 and $ 585,
                  respectively.

            u.    Concentrations of credit risk:

                  Financial instruments that potentially subject the Company to
                  concentrations of credit risk consist principally of cash and
                  cash equivalents, trade receivables, marketable securities and
                  long-term loans.

                  Cash and cash equivalents are deposited with major banks in
                  Israel and major banks in United States. Such deposits in the
                  U.S. may be in excess of insured limit and are not insured in
                  other jurisdictions. Management believes that the financial
                  institutions that hold the Company's investments are
                  financially sound, and accordingly, minimal credit risk exists
                  with respect to these investments.

                  The trade receivables of the Company are mainly derived from
                  sales to customers in the U.S. and Europe (see Note 16). The
                  Company performs ongoing credit evaluations of its customers.
                  In certain circumstances, the Company may require letters of
                  credit, other collateral or additional guarantees. The
                  allowance for doubtful accounts is determined with respect to
                  specific debts that are doubtful of collection according to
                  management estimates.

                  The Company's marketable securities include investments in
                  equity securities and Israeli government securities.
                  Management believes that the portfolio is well diversified,
                  and accordingly, minimal credit risk exists with respect to
                  these marketable securities.

                                      F-20
<PAGE>
                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands


NOTE 2:-    SIGNIFICANT ACCOUNTING POLICIES (Cont.)

                  The Company's long-term loans include a loan granted to the
                  purchaser of Silverbyte Ltd. shares. The Company has received
                  check in regard of all outstanding amounts and accordingly
                  management believes that minimal credit risk exists with
                  respect to this loan.

                  The Company has no off-balance-sheet concentration of credit
                  risk such as foreign exchange contracts, option contracts or
                  other foreign hedging arrangements.

            v.    Basic and diluted net earnings (loss) per share:

                  Basic net earnings (loss) per share is computed based on the
                  weighted average number of Ordinary shares outstanding during
                  each year. Diluted net earnings (loss) per share is computed
                  based on the weighted average number of Ordinary shares
                  outstanding during each year, plus potential Ordinary shares
                  considered outstanding during the year, in accordance with
                  Statement of Financial Accounting Standard No. 128, "Earnings
                  Per Share" ("SFAS No. 128").

                  The total number of shares related to the outstanding options
                  excluded from the calculation of diluted net earnings (loss)
                  per share was 766,141, 667,101 and 1,011,584 for the years
                  ended December 31, 2003, 2004 and 2005, respectively.

            w.    Reclassification:

                  Certain amounts from prior years have been reclassified to
                  conform to current period presentation.

            u.    Impact of recently issued accounting standards:

                  In May 2005, the FASB issued Statement of Financial Accounting
                  Standard No. 154 ("SFAS No. 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 No. 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 change the
                  cumulative effect of changing to the new accounting principle.
                  SFAS No. 154 requires retroactive application to prior
                  periods' financial statements of a voluntary change in
                  accounting principles unless it is impracticable. SFAS No. 154
                  is effective for accounting changes and corrections of errors
                  made in fiscal years beginning after December 15, 2005.

                  On December 16, 2004, the Financial Accounting Standards Board
                  (FASB) issued FASB Statement No. 123 (revised 2004),
                  "Share-Based Payment", which is a revision of FASB Statement
                  No. 123, "Accounting for Stock-Based Compensation". Statement
                  123(R) supersedes APB Opinion No. 25, Accounting for Stock
                  Issued to Employees, and amends FASB Statement No. 95,
                  "Statement of Cash Flows". Generally, the approach in
                  Statement 123(R) is similar to the approach described in
                  Statement 123.

                                      F-21
<PAGE>
                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands


NOTE 2:-    SIGNIFICANT ACCOUNTING POLICIES (Cont.)

                  However, Statement 123(R) requires all share-based payments to
                  employees, including grants of employee stock options, to be
                  recognized in the income statement based on their fair values.
                  Pro forma disclosure is no longer an alternative. Statement
                  123(R) permits public companies to adopt its requirements
                  using one of two methods: A "modified prospective" method in
                  which compensation cost is recognized beginning with the
                  effective date (a) based on the requirements of Statement
                  123(R) for all share-based payments granted after the
                  effective date and (b) based on the requirements of Statement
                  123 for all awards granted to employees prior to the effective
                  date of Statement 123(R) that remain unvested on the effective
                  date.

                  A "modified retrospective" method which includes the
                  requirements of the modified prospective method described
                  above, but also permits entities to restate based on the
                  amounts previously recognized under Statement 123 for purposes
                  of pro forma disclosures either (a) all prior periods
                  presented or (b) prior interim periods of the year of
                  adoption.

                  The Company expects to adopt Statement 123(R), effective
                  January 1, 2006 using the modified-prospective method.

                  As permitted by Statement 123, the Company currently accounts
                  for share-based payments to employees using Opinion 25's
                  intrinsic value method and, as such, generally recognizes no
                  compensation cost for employee stock options. In addition,
                  non-compensatory plans under APB 25 will be considered
                  compensatory for Statement 123(R) purposes. Accordingly, the
                  adoption of Statement 123(R)'s fair value method will have an
                  impact on the Company's result of operations, although it will
                  have no material impact on the Company overall financial
                  position. Had the Company adopted Statement 123(R) in prior
                  periods, the impact of that standard would have approximated
                  the impact of Statement 123 as described in the disclosure of
                  pro forma net loss and loss per share in q above.

                  In March 2005, the SEC released SEC Staff Accounting Bulletin
                  No. 107, "Share Based Payment" ("SAB 107"). SAB 107 provides
                  the SEC's staff position regarding the application of FAS
                  123(R) and contains interpretive guidance relating to the
                  interaction between FAS 123(R) and certain SEC rules and
                  regulations, and also provides the SEC staff's view 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. The Company is currently reviewing the effect of
                  SAB 107; however it does not believe that SAB 107 will have a
                  material effect on its financial position, results of
                  operations or cash flows.

                  In November 2005, the FASB released FASB Staff Position Nos.
                  FAS 115-1 and FAS 124-1, "The Meaning of Other-Than-Temporary
                  Impairment and Its Application to Certain Investments" ("FSP
                  115-1"), which effectively replaces EITF Issue No. 03-1. FSP
                  115-1 contains a three-step model for evaluating impairments
                  and carries forward the disclosure requirements in EITF Issue
                  No. 03-1 pertaining to securities in an unrealized loss
                  position. Under the model, any security in an unrealized loss
                  position is considered impaired; an evaluation is made to
                  determine whether the impairment is other-than-temporary; and,
                  if an impairment is considered other-than-temporary, a
                  realized loss is recognized to write the security's cost or
                  amortized cost basis down to fair value.

                                      F-22
<PAGE>
                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands

NOTE 2:-    SIGNIFICANT ACCOUNTING POLICIES (Cont.)

                  FSP 115-1 references existing other-than-temporary impairment
                  guidance for determining when an impairment is
                  other-than-temporary and clarifies that subsequent to the
                  recognition of an other-than-temporary impairment loss for
                  debt securities, an investor shall account for the security
                  using the constant effective yield method. FSP 115-1 is
                  effective for reporting periods beginning after December 15,
                  2005, with earlier application permitted. The Company adopted
                  FSP 115-1 upon issuance. The Company does not expect that the
                  adoption will have a material effect on the Company's
                  consolidated financial condition or results of operations.

NOTE 3:-    MARKETABLE SECURITIES

            The following is a summary of the Company's investment in marketable
            securities:

<TABLE>
<CAPTION>
                                            December 31, 2004                               December 31, 2005
                              ----------------------------------------------- ----------------------------------------------
                                            Gross        Gross       Fair                 Gross         Gross       Fair
                               Amortized  unrealized  unrealized    market    Amortized   unrealized unrealized    market
                                 cost       gains       losses      value        cost       gains      losses      value
                              ----------  ----------  ----------  ----------- ----------- ---------- ----------- -----------
               Available-for-sale:
<S>                             <C>        <C>          <C>         <C>         <C>         <C>         <C>         <C>
               Mutual funds     $   506    $    60      $     -     $   566     $      -    $      -    $     -     $    -
               Equity
                securities           25          8            -          33           35          12         (5)        42
               Corporate
                bonds               368          8            -         376            -           -          -          -
               Israeli
                Government
                debts                72         10            -          82           87           4         (1)        90
                              ----------  ----------  ----------  ----------- ----------- ---------- ----------- -----------
                                $   971    $    86      $     -     $ 1,057     $    122    $     16    $    (6)    $  132
                              ==========  ==========  ==========  =========== =========== ========== =========== ===========
</TABLE>

            The gross realized gains on sales of available-for-sale securities
            totaled $6, $ 0 and $ 77 in 2003, 2004 and 2005, respectively,
            recorded in financial income. The net adjustment to unrealized
            holding gains (losses) on available-for-sale securities included as
            a separate component of shareholders' equity, "Accumulated other
            comprehensive gains (losses)" amounted to $ 109, $ 83 and $ (76) in
            2003, 2004 and 2005, respectively.

            The amortized cost and fair value of debt and marketable equity
            securities as of December 31, 2005, by contractual maturity, are
            shown below.

<TABLE>
<CAPTION>
                                                                 December 31, 2005
                                                           ------------------------------
                                                                                   Fair
                                                              Amortized          market
                                                                 cost            value
                                                           --------------  --------------
<S>                                                         <C>             <C>
            Matures in one year                             $          40   $          40
            Matures after one year through five years                  47              50
            Equity securities - No definite maturity date              35              42
                                                           --------------  --------------
            Total                                           $         122   $         132
                                                           ==============  ==============
</TABLE>

                                      F-23
<PAGE>

                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands

NOTE 4:-    OTHER ACCOUNTS RECEIVABLE AND PREPAID EXPENSES

<TABLE>
<CAPTION>
                                                                                                  December 31,
                                                                                     --------------------------------------
                                                                                           2004                 2005
                                                                                     -----------------    -----------------
<S>                                                                                    <C>                  <C>
               Grants receivable from the Office of the Chief Scientist                $          -         $        130
               Government authorities                                                           117                   75
               Prepaid expenses                                                                 149                  142
               Deferred income taxes (1)                                                         66                   14
               Others                                                                            59                  130
                                                                                     -----------------    -----------------
                                                                                       $        391         $        491
                                                                                     =================    =================
              (1) See Note 13f.

NOTE 5:-    INVENTORIES
                                                                                                  December 31,
                                                                                     --------------------------------------
                                                                                           2004                 2005
                                                                                     -----------------    -----------------
               Raw materials                                                           $         76         $         58
               Finished products                                                                102                  123
                                                                                     -----------------    -----------------
                                                                                       $        178         $        181
                                                                                     =================    =================

            The Company periodically assesses its inventory valuation in
            accordance with its revenues forecasts, technological obsolescence,
            and the market conditions. Marked down inventory that is expected to
            be sold at a price lower than the carrying value is not material.

NOTE 6:-    INVESTMENTS IN AFFILIATE

            a.    Composed as follows:
                                                                                                  December 31,
                                                                                     --------------------------------------
                                                                                           2004                 2005
                                                                                     -----------------    -----------------
                      Investment in Jusan S.A. (50% owned)

                        Equity, net (1)                                                $      2,084         $      1,580
                        Goodwill                                                                 35                   35
                                                                                     -----------------    -----------------

                                                                                       $      2,119         $      1,615
                                                                                     =================    =================

                      (1)   Investment as of purchase date                             $      1,171         $      1,171
                            Foreign currency translation adjustments                            316                    -
                            Retained earnings (Net of dividends)                                597                  409
                                                                                     -----------------    -----------------
                                                                                       $      2,084         $      1,580
                                                                                     =================    =================
                      Dividend received from Jusan S.A. during the year                $        136         $        195
                                                                                     =================    =================
</TABLE>

                                      F-24
<PAGE>

                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands


NOTE 6:-    INVESTMENTS IN AFFILIATE (Cont.)

            b.    Summarized financial information of Jusan S.A. (50% owned):
<TABLE>
<CAPTION>
                                                                                                  December 31,
                                                                                     --------------------------------------
                                                                                           2004                 2005
                                                                                     -----------------    -----------------
<S>                                                                                    <C>                  <C>
                      Current assets                                                   $      5,552         $      4,177
                      Non-current assets                                               $         68         $         45
                      Current liabilities                                              $     (1,438)        $     (1,057)

                                                                                      Year ended December 31,
                                                                        ---------------------------------------------------
                                                                             2003              2004               2005
                                                                        ---------------   ---------------    --------------

                      Revenues                                            $      6,049      $      6,892       $     5,682
                      Gross profit                                        $      3,079      $      3,158       $     2,530
                      Net income                                          $        594      $        444       $         4
</TABLE>

NOTE 7:-    LONG-TERM LOAN, NET OF CURRENT MATURITIES

                  The Company's long term loans include a loan granted to the
                  purchaser of Silverbyte Ltd. shares which were sold by the
                  Company in July, 2000. The loan will be fully repaid in April
                  2007.

            a.    Composed as follows:

<TABLE>
<CAPTION>
                                                                                             December 31,
                                                                                ---------------------------------------
                                                                                       2004                 2005
                                                                                ------------------   ------------------
<S>                                                                               <C>                  <C>
                  Loan to others in NIS - unlinked (1)                            $         84         $         21
                  Less - current maturities (2)                                             39                   18
                                                                                ------------------   ------------------
                                                                                  $         45         $          3
                                                                                ==================   ==================
</TABLE>

                  (1)   The weighted average interest rate for the years ended
                        December 31, 2005 and 2004 is 7.65%.

                  (2)   Included in other accounts receivable.

            b.    As of December 31, 2005, the aggregate annual maturities of
                  long-term loans are as follows:



                  2006 (current maturities)             $          18
                  2007                                              3
                                                      ------------------

                                                        $         21
                                                      ==================

                                      F-25

<PAGE>

                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands

NOTE 8:-    OTHER INVESTMENTS

<TABLE>
<CAPTION>
                                                                                                December 31,
                                                                                   --------------------------------------
                                                                                         2004                 2005
                                                                                   -----------------    -----------------
<S>                                                                                  <C>                  <C>
             Long-term leasing deposits (1)                                          $         26         $         27
             Investment in other companies                                                    347                  320
                                                                                   -----------------    -----------------

                                                                                     $        373         $        347
                                                                                   =================    =================
</TABLE>

            (1) Linked to the Israeli CPI.

NOTE 9:-    PROPERTY AND EQUIPMENT

<TABLE>
<CAPTION>
                                                                                                December 31,
                                                                                   --------------------------------------
                                                                                         2004                 2005
                                                                                   -----------------    -----------------
             Cost:
<S>                                                                                  <C>                  <C>
               Computers and peripheral equipment                                    $      2,838         $      3,022
               Office furniture and equipment                                                 558                  566
               Motor vehicles                                                                  62                   48
               Leasehold improvements                                                         112                  140
                                                                                   -----------------    -----------------

                                                                                            3,570                3,776
             Accumulated depreciation:                                                      2,989                3,205
                                                                                   -----------------    -----------------

             Depreciated cost                                                        $        581         $        571
                                                                                   =================    =================
</TABLE>

            The depreciation expense for the years ended December 31, 2003,
            2004 and 2005 amounted to $ 247, $ 211 and $ 254, respectively.

NOTE 10:-   GOODWILL AND OTHER INTANGIBLE ASSETS

            a.    Goodwill:

                  The changes in the carrying amount of goodwill for the year
                  ended December 31, 2005 are as follows:

<TABLE>
<S>                                                                              <C>
                  Balance as of January 1, 2004                                  $      2,024
                  Goodwill acquired during 2004 (see Note 1)                            1,391
                                                                               -------------------

                  Balance as of December 31, 2004                                       3,415
                  Additional consideration in conjunction with TK
                    acquisition based on post-contract billing revenues,
                    see Note 1(c)                                                         285
                                                                               -------------------

                  Balance as of December 31, 2005                                $      3,700
                                                                               ===================
</TABLE>

                                      F-26
<PAGE>
                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands


NOTE 10:-   GOODWILL AND OTHER INTANGIBLE ASSETS (Cont.)

            b.    Other intangibles consist of the following:

<TABLE>
<CAPTION>
                                                                                             December 31,
                                                                                 --------------------------------------
                                                                                       2004                 2005
                                                                                 -----------------    -----------------
                  Cost:
<S>                                                                                <C>                  <C>
                    Development technology                                         $      1,440         $      1,440
                    Capitalized software development costs                                  386                  386
                    Customer relationship                                                   300                  300
                                                                                 -----------------    -----------------

                                                                                          2,126                2,126
                                                                                 -----------------    -----------------
                  Accumulated amortization:
                    Development technology                                                  700                  923
                    Capitalized software development costs                                   32                  160
                    Customer relationship                                                     -                   50
                                                                                 -----------------    -----------------

                                                                                            732                1,133
                                                                                 -----------------    -----------------

                  Amortized cost                                                   $      1,394         $        993
                                                                                 =================    =================
</TABLE>

                  Intangible assets resulted from acquisitions of IntegraTrak,
                  the Company's U.S. subsidiary and TeleKnowledge (see Note 1c).

            c.    Amortization expenses amounted to $ 154, $ 188 and $ 401 for
                  each of the years ended December 31, 2003, 2004 and 2005,
                  respectively.

            d.    Estimated amortization expenses for:

                  Year ended December 31,
                  ----------------------------------

                  2006                                   $        352
                  2007                                            319
                  2008                                            222
                  2009                                             50
                  2010                                             50
                                                       -----------------

                                                         $        993
                                                       =================


NOTE 11:-   ACCRUED EXPENSES AND OTHER LIABILITIES

                                                      December 31,
                                            ---------------------------------
                                                 2004              2005
                                            --------------    ---------------

            Employees and payroll accruals    $        799      $        991
            Income tax payable                         330               291
            Accrued expenses                           647               760
            Customer advances                          204               187
            Related parties                             62                77
                                            --------------    ---------------

                                              $      2,042      $      2,306
                                            ==============    ===============

                                      F-27
<PAGE>

                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands


NOTE 12:-   COMMITMENTS AND CONTINGENT LIABILITIES

            a.    Lease commitments:

                  The facilities of the Company and its subsidiaries are rented
                  under operating leases for periods ending September 2006
                  through February 2008.

                  Future minimum lease commitments under non-cancelable
                  operating leases as of December 31, 2005 are as follows:

                  2006             $        384
                  2007                       17
                  2008                        1
                                 --------------
                                   $        402
                                 ==============

                  Lease expenses for the years ended December 31, 2003, 2004 and
                  2005 were approximately $ 372, $ 334 and $ 489, respectively.

            b.    Royalty commitments:

                  1.    The Company is committed to pay royalties to the Office
                        of the Chief Scientist of the Ministry of Trade ("OCS")
                        of the Government of Israel on proceeds from sales of
                        products resulting from the research and development
                        projects in which the Government participated. In the
                        event that development of a specific product in which
                        the OCS participated is successful, the Company will be
                        obligated to repay the grants through royalty payments
                        at the rate of 3% to 5% based on the sales of the
                        Company, up to 100%-150% of the grants received linked
                        to the dollar. As of December 31, 2005, the Company has
                        a contingent liability to pay royalties in the amount of
                        $ 9,094. The obligation to pay these royalties is
                        contingent upon actual sales of the products and, in the
                        absence of such sales, no payment is required.

                        The Company has paid or accrued royalties in its cost of
                        revenues relating to the repayment of such grants in the
                        amount of $ 146, $ 181 and $ 198 for the years ended
                        December 31, 2003, 2004 and 2005, respectively.

                  2.    The Israeli Government, through the Fund for
                        Encouragement of Marketing Activities, awarded the
                        Company grants for participation in foreign marketing
                        expenses. The Company is committed to pay royalties at
                        the rate of 3% of the increase in export sales, up to
                        the amount of the grants received linked to the U.S.
                        dollar. As of December 31, 2005, the Company has a
                        contingent obligation to pay royalties in the amount of
                        $ 259. Prior to the year 2003, the Company accrued
                        royalties in its sales and marketing expenses relating
                        to the repayment of such grants in the amount of $129.
                        No additional accrual was provided during the years
                        ended December 31, 2003, 2004 and 2005, respectively.

                                      F-28
<PAGE>

                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands

NOTE 12:-   COMMITMENTS AND CONTINGENT LIABILITIES (Cont.)

            c.    Claims and demands:

                  1.    In April 2000, the Tax Authorities in Israel issued to
                        the Company a demand for a tax payment, for the period
                        of 1997-1999, in the amount of approximately NIS 6,000
                        thousand ($ 1,303).

                        The Company has appealed to the Israeli Tel Aviv
                        district court in respect of the abovementioned tax
                        demand. The Company believes that certain defenses can
                        be raised against the demand of the tax authorities. The
                        Company believes that the outcome of this matter will
                        not have a material adverse effect on its financial
                        position or results of operations. The Company has
                        provided a provision for the amount considered probable.

                  2.    On April 18, 2005, Amdocs (Israel) Ltd. and Amdocs Ltd.
                        ("the plaintiffs") filed a complaint with the Tel-Aviv
                        District Court against the Company, its Chief Executive
                        Officer and others ("the Defendants") alleging, among
                        other things, that professional and commercial
                        information belonging to the plaintiffs was transferred
                        to the defendants for use in the Company's activity. The
                        plaintiffs are seeking an injunction prohibiting the
                        defendants from making any use of the information and
                        trade secrets that were allegedly transferred,
                        injunctions requiring the return of such information and
                        estimated damages of NIS 14,775 thousand (approximately
                        $ 3,210).

                        On June 27, 2005, the defendants filed a statement of
                        defense, in which the defendants claim that the factual
                        and legal allegations by the plaintiffs are baseless,
                        and the causes of action and relief requested are
                        without merit.

                        Due to the preliminary stage of the litigation, the
                        Company and its legal advisors cannot currently assess
                        its outcome or a possible adverse effect on the
                        Company's financial position or results of operations.

                        There were no further developments in respect to the
                        claim through February 2006.

                  3.    On November 22, 2005, the Company received a letter from
                        one of its customer's legal counsel alleging, among
                        other things, that the Company materially breached the
                        agreement that was entered into with the customer on
                        March 9, 2005, as subsequently amended on June 6, 2005.
                        The customer is seeking full repayment of the amounts
                        that were paid by him under the agreement, in the amount
                        of $ 100 plus interest and indemnification for damages
                        that he claims to have suffered as a result of our
                        alleged breach. On February 19, 2006, the Company
                        submitted a response letter to the customer in which it
                        denied these allegations and claimed that the customer's
                        refusal to fulfill his contractual undertakings
                        constitute a breach of the agreement and entitles the
                        Company to remedies under applicable law. The Company
                        cannot currently assess the outcome of this claim or its
                        adverse effect on the Company's financial position or
                        results of operations.

                                      F-29

<PAGE>

                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands


NOTE 12:-   COMMITMENTS AND CONTINGENT LIABILITIES (Cont.)

            d.    Guarantees:

                  1.    The Company provided a bank guarantee through April 2007
                        in the amount of $ 60 to secure its obligations under
                        one of its leasing agreement.

                  2.    The Company provided a bank guarantee through February
                        2007 in the amount of $ 55 in favor of one of its
                        customers to secure its obligations under the agreement
                        that was signed by the parties.

NOTE 13:-   TAXES ON INCOME

            a.    Tax benefits under the Law for the Encouragement of Capital
                  Investments, 1959 ("the Law"):

                  MTS was granted the status of an "Approved Enterprise" under
                  the Law in respect of several capital expenditure programs.
                  Income derived from the "Approved Enterprise" is tax-exempt
                  for a period of two years, commencing with the year the
                  Company earns taxable income, and subject to corporate tax at
                  the rate of 10% - 25% (depending on the rate of foreign
                  holdings in the Company), for additional periods of five to
                  eight years.

                  The period of tax benefits detailed above is subject to a
                  limit of the earlier of 12 years from the commencement of
                  production or 14 years from receiving the approval.

                  Tax exempt income attribute to the "Approved Enterprise"
                  cannot be distributed to shareholders without subjecting the
                  Company to taxes except upon complete liquidation of the
                  Company. Out of the Company's retained earnings as of December
                  31, 2005 approximately $ 2,250 are tax exempt. If such tax
                  exempt income is distributed in a manner other than upon the
                  complete liquidation of the Company, it would be taxed at the
                  reduced corporate tax rate applicable to such profits (between
                  10%-25%) and an income tax liability of up to approximately $
                  562 would be included as of December 31, 2005. The Company's
                  board of directors has determined that it would not distribute
                  any amounts of its undistributed tax exempt income as
                  dividend. The Company intends to reinvest the amount of its
                  tax exempt income.

                  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"
                  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.

                                      F-30

<PAGE>

                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands


NOTE 13:-   TAXES ON INCOME (Cont.)

                  In addition, the Investment Law provides that terms and
                  benefits included in any certificate of approval already
                  granted will remain subject to the provisions of the law as
                  they were on the date of such approval. Therefore the
                  Company's existing "Approved Enterprise" will generally not be
                  subject to the provisions of the Amendment.

                  Should MTS and its Israeli subsidiary derive income from
                  sources other than the "Approved Enterprise" during the
                  relevant period of benefits, such income will be taxable at
                  the regular corporate tax rate of 34%, which will be reduced
                  to 31% in 2006, and will be further reduced to 29% in 2007,
                  27% in 2008, 26% in 2009 and 25% in 2010.

                  Since MTS is operating more than one "Approved Enterprise"
                  program and since part of its taxable income is not entitled
                  to tax benefits under the abovementioned law and is taxed at
                  the regular corporate tax rate, its effective tax rate is the
                  result of a weighted combination of the various applicable
                  rate and tax exemptions, and the computation is made for
                  income derived from each program on the basis of formulas
                  specified in the law and in the approvals.

            b.    Measurement of results for tax purposes under the Income Tax
                  (Inflationary Adjustments) Law, 1985:

                  Results for tax purposes are measured in terms of earnings in
                  NIS after certain adjustments for increases in the Israeli
                  Consumer Price Index ("CPI"). As explained in Note 2b, the
                  financial statements are presented in dollars. The difference
                  between the annual change in the CPI and in the NIS/dollar
                  exchange rate causes a further difference between taxable
                  income and the income before taxes presented in the financial
                  statements. In accordance with paragraph 9(f) of SFAS 109, MTS
                  and its Israeli subsidiary have not provided for deferred
                  income taxes on the difference between the functional currency
                  and the tax bases of assets and liabilities.

            c.    Tax benefits under the Law for the Encouragement of Industry
                  (Taxation), 1969:

                  MTS is currently qualified as an "industrial company" under
                  the above 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 intangible property
                  rights as a deduction for tax purposes.

            d.    Net operating losses carryforwards:

                  As of December 31, 2005, the Company and its subsidiaries in
                  Israel, Asia and U.S. have an estimated total amount of
                  available carryforward tax losses of $ 8,750, $ 506 and $ 366,
                  respectively to offset against future taxable profits.

                  The operating tax loss carryforwards in Israel and in Hong
                  Kong (Asia) may be offset indefinitely against operating
                  income.

                                      F-31
<PAGE>

                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands


NOTE 13:-   TAXES ON INCOME (Cont.)

                  MTS IntegraTrak is subject to U.S. income taxes and has a net
                  operating loss carryforward amounting to approximately $ 366
                  as of December 31, 2005, which expires in the years 2015 to
                  2020. Utilization of the U.S. net operating losses may be
                  subject to substantial annual limitation due to the "change in
                  ownership" provisions of the Internal Revenue Code of 1986 and
                  similar state provisions. The annual limitation may result in
                  the expiration of net operating losses before utilization.


            e.    Tax assessments:

                  Regarding the claim from the tax authorities in Israel, see
                  Note 12c(1). The Company has received final tax assessments
                  until the 1996 tax year.

            f.    Deferred income taxes:

                  Deferred taxes reflect the net tax effects of temporary
                  differences between the carrying amounts of assets and
                  liabilities for financial reporting purposes and the amounts
                  used for income tax purposes. Significant components of the
                  Company's deferred tax liabilities and assets are as follows:

<TABLE>
<CAPTION>
                                                                                              December 31,
                                                                                 --------------------------------------
                                                                                       2004                 2005
                                                                                 -----------------    -----------------
<S>                                                                              <C>                  <C>
                  Tax loss carryforward of the Company                           $        1,291       $        1,985

                  Allowances for doubtful accounts and accruals for
                    employee benefits                                                       122                   57
                  In respect of marketable securities                                        76                   47
                  Capitalized software and other intangible assets-
                  liability                                                                 (36)                (208)
                  Capitalized software and other intangible assets                          129                   76
                  Other                                                                     190                  208
                                                                                 -----------------    -----------------

                  Net deferred tax asset before valuation allowance                       1,772                2,165
                  Valuation allowance                                                    (1,633)              (2,036)
                                                                                 -----------------    -----------------

                  Net deferred income taxes                                      $          139       $          129
                                                                                 =================    =================
                  Presented as follows:
                    Current assets - foreign                                     $           66       $           14
                                                                                 =================    =================

                    Other assets - foreign                                       $           73       $           115
                                                                                 =================    =================
</TABLE>

                  MTS and certain of its subsidiaries have provided valuation
                  allowances in respect of deferred tax assets resulting from
                  tax loss carryforward and other temporary differences, since
                  they have a history of losses over the past years. Management
                  currently believes that it is more likely than not that part
                  of the deferred tax regarding the loss carryforward in the
                  Company and other temporary differences will not be realized
                  in the foreseeable future.

                                      F-32
<PAGE>

                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands


NOTE 13:-   TAXES ON INCOME (Cont.)

            g.    A reconciliation between the theoretical tax expense, assuming
                  all income is taxed at the statutory tax rate applicable to
                  income of the Company and the actual tax expense as reported
                  in the statements of operations, is as follows:

<TABLE>
<CAPTION>
                                                                                    Year ended December 31,
                                                                       ---------------------------------------------------
                                                                            2003              2004              2005
                                                                       ---------------   ---------------   ---------------
<S>                                                                    <C>               <C>               <C>
                      Loss before taxes as reported in the
                        statements of operations                       $          (60)   $       (4,086)   $        (4,208)
                                                                       ===============   ===============   ===============

                      Tax rates                                                    36%               35%                34%
                                                                       ===============   ===============   ===============

                      Theoretical tax benefit                          $          (22)   $       (1,430)   $        (1,431)
                      Increase in taxes resulting from:
                      Effect of different tax rates                                 -                 2                 38
                      Tax adjustment in respect of inflation in
                        Israel and others                                         (22)               12                (17)
                      Utilization of carryforward tax losses for
                        which valuation allowance was provided                    (86)              (21)                 -
                      Non-deductible expenses and tax exempt income                 9                 -                 10
                      Taxes and deferred taxes in respect of
                        previous years                                            175               256                (21)
                      Deferred taxes for which valuation allowance
                        was  provided                                             144             1,447              1,431
                                                                       ---------------   ---------------   ---------------

                      Taxes on income as reported in the statements
                        of operations                                  $          198             $ 266    $            10
                                                                       ===============   ===============   ===============

            h.    Loss before income taxes is comprised as follows:

                      Domestic                                         $         (312)   $       (3,918)   $        (4,042)
                      Foreign                                                     252              (168)              (166)
                                                                       ----------------  ---------------   ---------------

                                                                       $          (60)   $       (4,086)   $        (4,208)
                                                                       ================  ===============   ===============
</TABLE>

                                      F-33

<PAGE>

                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)

NOTE 13:-   TAXES ON INCOME (Cont.)

            i.    Taxes on income are comprised as follows:

<TABLE>
<CAPTION>
                                                                       Year ended December 31,
                                                          ---------------------------------------------------
                                                               2003              2004              2005
                                                          ---------------   ---------------   ---------------
<S>                                                       <C>               <C>               <C>
                  Current taxes                           $            -    $           10    $            -
                  Deferred taxes                                      23                33                10
                  Taxes and deferred taxes in respect of
                    previous years                                   175               223                 -
                                                          ---------------   ---------------   ---------------
                                                          $          198    $          266    $           10
                                                          ===============   ===============   ===============
                  Domestic                                $          322    $          256    $            -
                  Foreign                                           (124)               10                10
                                                          ---------------   ---------------   ---------------
                                                          $          198    $          266    $           10
                                                          ===============   ===============   ===============
</TABLE>

NOTE 14:-   RELATED PARTIES TRANSACTIONS AND BALANCES

            a.    On November 8, 1999, the Board of Directors and the audit
                  committee approved, subject to the shareholders' approval, an
                  increase in the monthly salary of the Chairman of the Board of
                  Directors from $ 5 to $ 7 per month and the grant of options
                  to purchase 98,824 Ordinary shares. The options were granted
                  to him at his request in lieu of salary for the 12 month
                  period ending December 31, 2000. The exercise price of the
                  options is $ 6 per share, expected dividend yield is 0%, and
                  the risk free interest rate is 6%. The options will vest
                  ratably over an eight-month period beginning January 1, 2000
                  and will terminate five years from the date of grant. The
                  options were forfeited by the end of the year 2004.

            b.    The wife of the Chairman of the Board of Directors provides
                  ongoing legal services to the Company and receives a monthly
                  retainer of $ 5. The conditions for retaining her services
                  were approved by the Company's Board of Directors and audit
                  committee.

            c.    Mr. Isaac Ben-Bassat, a director and one of the Company's
                  major shareholders, receives an annual fee of approximately
                  $8,400 and a per meeting attendance fee of $300 in connection
                  with his service as a director of the Company.

            d.    MTS's subsidiaries, MTS Asia Ltd. and MTS IntegraTRAK, entered
                  into an agreement with C. Mer, pursuant to which they
                  distribute and support certain of C. Mer's (company under
                  common control) products and provide certain services on
                  behalf of C. Mer. Generally, C. Mer compensates MTS Asia Ltd.
                  for these activities at cost plus 10% and compensates MTS
                  IntegraTRAK at cost plus 5%.

            e.    In 2004 and 2005, the balance with C. Mer reflects short-term
                  debt and other receivables. Due to the short-term nature, no
                  interest was charged by or paid to C. Mer through December 31,
                  2004 and 2005.

                                      F-34

<PAGE>

                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)


NOTE 14:-   RELATED PARTIES TRANSACTIONS AND BALANCES (Cont.)

            c.    Transactions with related parties were as follows:

<TABLE>
<CAPTION>
                                                                                Year ended December 31,
                                                                   ---------------------------------------------------
                                                                        2003              2004              2005
                                                                   ----------------  ---------------   ---------------
<S>                                                                <C>               <C>               <C>
                  Sales through related parties                    $            28   $           15    $            -
                                                                   ================  ===============   ===============
                  Amounts charged by related parties:

                  Cost of revenues                                 $            34   $           32    $            8
                  Research and development                                       -                -                34
                  Selling and marketing                                          -                -                 3
                  General and administrative                                     5                7                 5
                                                                   ----------------  ---------------   ---------------
                                                                   $            39   $           39    $           50
                                                                   ================  ===============   ===============

                  Amounts charged by MTS Integra TRAK and MTS Asia to
                    related parties:

                  Selling and marketing                            $             -   $           18    $            -
                                                                   ================  ===============   ===============
                  Payments from (repayments to) the related
                    parties, net                                   $           (48)  $           20    $          (80)
                                                                   ================  ===============   ===============

            d.    Amounts due from an affiliate:

                                                                                              December 31,
                                                                                     ---------------------------------
                                                                                      2004                  2005
                                                                                     ---------------   ---------------
                  Jusan S.A                                                          $          (21)   $          (18)
                                                                                     ===============   ===============
</TABLE>

                                      F-35

<PAGE>

                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)


NOTE 15:-   SHAREHOLDERS' EQUITY

            a.    Share capital:

                  The Ordinary shares entitle their holders the right to receive
                  notice to participate and vote in general meetings of MTS and
                  the right to receive cash dividends, if declared.

            b.    Private placement agreement:

                  On August 10, 2005, the Company has entered into definitive
                  agreements with institutional and private investors for a
                  private placement of Ordinary shares and warrants to purchase
                  Ordinary shares that has raised $ 2,625 (net of issuance costs
                  of approximately $ 200).

                  Pursuant to the agreements, MTS has issued an aggregate
                  937,500 Ordinary shares at $ 3.00 per share. In addition, the
                  Company provided the investors with warrants to purchase an
                  aggregate 375,000 additional Ordinary shares of MTS at an
                  exercise price of $ 4.00 per share. Each investor received
                  warrants to purchase two Ordinary shares for each five
                  Ordinary shares purchased. The warrants will become
                  exercisable six months after their issuance and will expire
                  within three and a half years after they become exercisable.

                  According to the agreement the Company could issue to
                  investors unregistered shares upon exercise of their warrants,
                  such issuance is under the Company's control. In accordance
                  with Emerging Issues Task Force No. 00-19, "Accounting for
                  Derivative Financial Instruments Indexed to, and Potentially
                  Settled in, a Company's Own Stock", the warrants were
                  classified as equity.

            c.    Share Option Plan:

                  MTS has authorized, through its 1996 Incentive Share Option
                  plan, the grant of options to officers, management, employees
                  and directors of MTS or any subsidiary of up to 1,900,000 of
                  MTS's Ordinary shares. Up to 1,500,000 options shall be
                  granted under the option plan pursuant to section 102 of the
                  Israel Income Tax Ordinance (the "Old Plan"). Any option,
                  which is canceled or forfeited before expiration, will become
                  available for future grants.

                  Each option granted under the Plan is exercisable until the
                  earlier of five years from the date of the grant of the option
                  or the expiration dates of the option plan. The exercise price
                  of the options granted under the plans may not be less than
                  the nominal value of the shares into which such options were
                  exercised. The options vest primarily gradually over three or
                  four years of employment.

                  In 2003, Section 102 of the Israeli Income Tax Ordinance was
                  amended effective as of January 1, 2003. Therefore MTS has
                  rolled-over the remaining options available at that time to be
                  granted under a new plan that conforms with the newly amended
                  provisions of Section 102 of the Israel Income Tax Ordinance.
                  The Incentive Share Option Plan will terminate in 2013, unless
                  cancelled earlier by MTS's board of directors.

                  As of December 31, 2005, 449,625 options are available for
                  future grant.

                                      F-36
<PAGE>
                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)


NOTE 15:-   SHAREHOLDERS' EQUITY (Cont.)

                  Summary of MTS's stock options activity (except options to
                  non-employees) and related information for the three years
                  ended December 31, 2003, 2004 and 2005, is as follows:

<TABLE>
<CAPTION>
                                                                                                           Weighted
                                                              Options         Number                        average
                                                             available      of options      Options        exercise
                                                             for grant     outstanding     exercisable       price
                                                            ------------   -------------   -----------   --------------

<S>                                                           <C>              <C>         <C>           <C>
                  Balance as of January 1, 2003               1,001,170        757,580                   $      3.32
                    Options granted                            (434,500)       434,500                   $      1.85
                    Options exercised                                 -       (133,333)                  $         -
                    Options forfeited                           260,106       (260,106)                  $      2.91
                                                            ------------   -------------

                  Options  exercisable  at December  31,
                  2003                                                                         355,413   $      3.68
                                                                                           ===========   ==============

                  Balance as of December 31, 2003               826,776        798,641                   $      2.85
                    Options granted                            (226,000)       226,000                   $      2.29
                    Options exercised                                 -        (17,333)                  $      0.08
                    Options forfeited                           251,708       (251,708)                  $      4.62
                    Options forfeited from old plan            (180,459)             -                   $         -
                                                            ------------   -------------

                  Options  exercisable  at December  31,
                  2004                                                                         301,812   $      2.01
                                                                                           ===========   ==============

                  Balance as of December 31, 2004               672,025        755,600                   $      2.11
                                                                                                         ==============
                    Options granted                            (365,000)       365,000                   $      3.56
                    Options exercised                                 -       (158,000)                  $      1.97
                    Options forfeited                           222,600       (222,600)                  $      2.39
                    Deduct     options     granted    to        (80,000)             -                   $      3.33
                    non-employees
                    Options forfeited from Old Plan                   -        (14,500)
                                                            ------------   -------------

                  Options  exercisable  at December  31,
                  2005                                                                         255,962   $      2.16
                                                                                           ===========   ==============

                  Balance as of December 31, 2005               449,625        725,500                   $      2.66
                                                            ============   =============                 ==============

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

                                                            Weighted
                                            Options          average                                           Weighted
                                          outstanding       remaining         Weighted                          average
                                            as of          contractual        average                       exercise price
                         Exercise         December 31,       life (in         exercise         Options      of exercisable
                          price              2005             years)           price         exercisable        options
                     -----------------  ----------------  ---------------  ---------------  --------------- ----------------

                        $ 0.93-1.3            30,000           0.39        $     1.18             30,000    $     1.18
                        $  1.844             250,000           1.94        $    1.844            129,477    $    1.844
                        $ 2.2-2.35           113,500           2.73        $     2.27             36,251    $     2.28
                        $ 2.9-2.95            26,000           1.95        $     2.91             22,791    $      2.9
                        $ 3.27-3.4           121,500           3.44        $     3.34             17,214    $      3.3
                        $  3.49               57,500           3.34        $     3.49             11,920    $     3.49
                        $  3.87              127,000           3.74        $     3.87              8,309    $     3.87
                                        ----------------                                    ---------------

                                             725,500                       $     2.66            255,962    $     2.16
                                        ================                   ===============  =============== ================
</TABLE>

                                      F-37
<PAGE>
                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)


NOTE 15:-   SHAREHOLDERS' EQUITY (Cont.)

            d.    The weighted average fair value of options granted during
                  2003, 2004 and 2005, whose exercise price equals the fair
                  value of the stock on the date of grant, was $ 1.20, $ 0.781
                  and $ 1.70 per option, respectively.

                  During 2003, 2004 and 2005, the Company granted 434,500,
                  226,000 and 365,000 options respectively at a weighted average
                  exercise price of $ 1.85, $ 2.29 and $ 3.56 per share (the
                  fair market value of the shares on the date of grant),
                  respectively.

                  The Company has recorded deferred stock compensation expense
                  for options issued in 2003 with an exercise price below the
                  fair market value of the shares; at a weighted average
                  exercise price of $ 1.844 and a weighted average fair value of
                  $ 1.844, the deferred stock compensation expense has been
                  amortized and recorded as compensation expense ratably over
                  the vesting period of the options. Compensation expense of
                  approximately $ 60, $ 66 and $ 66 was recognized during 2003,
                  2004 and 2005, respectively.

                  During 2003, the Company reduced the exercise price of 83,000
                  options to zero resulting in a compensation expense of
                  approximately $ 153.


            e.    Options and warrants to non-employees:

<TABLE>
<CAPTION>
                                                Number of                          Options      price
                              In connection      options     Options     Options   forfeited      per        Exercisable
             Issuance date         with          granted    exercised  exercisable or expired    share         through
            ---------------------------------- ------------ ---------- ----------- -----------  ---------  ----------------
<S>                         <C>                <C>          <C>        <C>       <C>           <C>         <C>
             January 2000     Advisory Board       98,824           -      98,824      98,824   $   6.000   December 2004
             February 2001   Service provider      25,000           -      25,000           -   $   5.625   February 2006
             January 2005    Service provider      70,000           -      70,000           -   $   3.250   January 2008
             May 2005        Service provider      10,000           -      10,000           -   $   3.490   May 2010
             August 2005     Service provider      37,000           -           -           -   $   4.000   August 2009
             September 2005  Service provider      10,000           -         660           -   $   3.870   September  2010
             December 2005   Service provider     100,000           -       6,575           -   $   3.120   December 2006
                                               ------------ ---------- ----------- -----------
                                                  350,824           -     211,059      98,824
                                               ============ ========== =========== ===========
</TABLE>

            The Company had accounted for its options to non-employees under the
            fair value method of SFAS No. 123 and EITF 96-18. The fair value for
            these options was estimated at the measurement date using the
            Black-Scholes option-pricing model with the following
            weighted-average assumptions for 2005: risk-free interest rates of
            4.06%, dividend yields of 0%, volatility factors of the expected
            market price of the Company's Ordinary shares of 52.37% and a
            contractual life of 3.3 years.

            Compensation expenses related to the granting of stock options to
            consultants amounted to $ 0, $ 0 and $ 156 for the years ended
            December 31, 2003, 2004 and 2005, respectively.

                                      F-38
<PAGE>

                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands


NOTE 15:-   SHAREHOLDERS' EQUITY (Cont.)

            f.    Treasury shares:

                  During 2003, 2004 and 2005, the Company purchased 130,510,
                  3,800 and 0 treasury shares in consideration of $ 147, $ 9 and
                  $ 0, respectively, according to the stock repurchase program,
                  which authorized the Company's officers to repurchase up to
                  600,000 Ordinary shares of MTS and was approved by the
                  Company's Board of Directors.

                  During 2003, MTS cancelled $457 of its treasury shares, which
                  represent 384,610 Ordinary shares.

            g.    Dividends:

                  Dividends, if any, will be paid in NIS. Dividends paid to
                  shareholders outside Israel will be converted into dollars, on
                  the basis of the exchange rate prevailing at the date of
                  payment.


NOTE 16:-   GEOGAPHIC INFORMATION AND MAJOR CUSTOMERS AND PRODUCTS

            The Company adopted Statement of Financial Accounting Standard No.
            131, "Disclosures About Segments of an Enterprise and Related
            Information" ("SFAS No. 131"). The Company operates in one
            reportable segment (see Note 1 for a brief description of the
            Company's business). The total revenues are attributed to geographic
            areas based on the location of the customer.

            The following is a summary of revenues within geographic areas based
            on end customer location and long-lived assets:

<TABLE>
<CAPTION>
                                                   Year ended December 31,
                                      --------------------------------------------------
                                           2003              2004              2005
                                      --------------    --------------    --------------
            Revenues from sales:
<S>                                    <C>               <C>               <C>
            United States              $      4,917      $      4,967      $      6,043
            Germany                           1,826             1,724             2,059
            Holland                             924               798               747
            Others                            1,563             1,924             2,714
                                      --------------    --------------    --------------

                                       $      9,230      $      9,413      $     11,563
                                      ==============    ==============    ==============
</TABLE>

                                      F-39

<PAGE>
                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands


NOTE 16:-   GEOGAPHIC INFORMATION AND MAJOR CUSTOMERS AND PRODUCTS (Cont.)

            Total revenues from external customers divided on the basis of the
            Company's product lines are as follows:

<TABLE>
<CAPTION>
                                                                                         Year ended December 31,
                                                                                     --------------------------------
                                                                                          2004              2005
                                                                                     --------------    --------------
<S>                                                                                   <C>               <C>
             TABS                                                                     $      9,220      $       7,454
             Application suits                                                                 193              2,603
             Billing products                                                                    -              1,506
                                                                                     --------------    --------------
                                                                                      $      9,413      $      11,563
                                                                                     ==============    ==============
            Long-lived assets:

             Israel                                                                   $      3,103      $       3,013
             United States                                                                   2,244              2,194
             Others                                                                             43                 57
                                                                                     --------------    --------------
                                                                                      $      5,390      $       5,264
                                                                                     ==============    ==============
</TABLE>

NOTE 17:-   SUBSIDIARIES AND AFFILIATES

<TABLE>
<CAPTION>
                                                                                  Percentage         Jurisdiction of
                                                                                 of ownership         incorporation
                                                                                ----------------   --------------------
               Subsidiaries:
<S>                                                                                  <C>
               MTS IntegraTRAK Inc.                                                  100%               Delaware

               MER Fifth Avenue Realty Inc. (a subsidiary of MTS IntegraTRAK
                 Inc.) *) 100% New York

               MTS Asia Ltd.                                                         100%               Hong Kong

               Telegent Ltd. *)                                                      100%                Israel

               Jaraga B.V.                                                           100%            The Netherlands

               Verdura B.V. (a subsidiary of Jaraga B.V.) *)                         100%            The Netherlands

               Voltera Technologies V.O.F. (a partnership held 99% by Jaraga
                 B.V. and 1% by Verdura B.V.) *)                                     100%            The Netherlands

               Bohera B.V. (a subsidiary of Jaraga B.V.) *)                          100%            The Netherlands

               Tabs Brazil Ltd. (a subsidiary of Jaraga B.V.)                        100%                Brazil

               Affiliate:

               Jusan S.A. (a subsidiary of Jaraga B.V.)                               50%                 Spain

              *) Inactive, or having immaterial activity.
</TABLE>

                              - - - - - - - - - - -

                                      F-40


<PAGE>

                                   JUSAN, S.A.

                              FINANCIAL STATEMENTS

                             AS OF DECEMBER 31, 2005



                                      INDEX


                                                                   Page
                                                                  -----

Report of Independent Registered Public Accounting Firm            F-42

Balance Sheets                                                     F-43

Statements of Income                                               F-44

Statements of Changes in Shareholders' Equity                      F-45

Statements of Cash Flows                                           F-46

Notes to Financial Statements                                      F-47












                                      F-41
<PAGE>

                   LETTERHEAD OF BDO Audiberia Auditores, S.L.


             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
             -------------------------------------------------------


Board of Directors and Stockholders of Jusan, S.A.

1.    We have audited the accompanying balance sheets of Jusan, S.A. ("the
      Company") as of December 31, 2004 and 2005 and the related statements of
      income, shareholders' equity and cash flows for the years then ended.
      These financial statements are the responsibility of the Company's
      management. Our responsibility is to express an opinion on these financial
      statements based on our audits. The financial statements of the Company as
      of and for the year ended December 31, 2003, were audited by other
      auditors whose report dated January 14, 2004, expressed an unqualified
      opinion on those statements.

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


3.    In our opinion, the financial statements referred to above present fairly,
      in all material respects, the financial position of Jusan, S.A. as of
      December 31, 2004 and 2005 and the results of its operations and its cash
      flows for the years then ended in conformity with accounting principles
      generally accepted in the United States of America.


BDO Audiberia Auditores, S.L.


/s/ BDO Audiberia Auditores, S.L.
--------------------------------


Madrid, Spain, January, 19, 2006

                                      F-42

<PAGE>

                                   JUSAN, S.A.
                 BALANCE SHEETS AS OF DECEMBER 31, 2004 AND 2005
                               Euros in thousands
<TABLE>
<CAPTION>
                                                                                            December 31,
                                                                                        2004            2005
ASSETS                                                                                  ----            ----

CURRENT ASSETS:
<S>                                                                                    <C>             <C>
Cash and cash equivalents                                                                  589             737
Short-term bank deposits                                                                   450             400
Trade receivables (net of allowance for doubtful accounts of 43 thousand
euros as of December 31, 2004 and 57 thousand euros as of December 31, 2005
and net of provision for returns of 4 thousand euros as of December 31, 2004
and 4 thousand euros as of December 31, 2005) (Note 5)                                   2,065           1,698
Other accounts receivable and prepaid expenses (Note 3)                                    178             186
Inventories (Note 4)                                                                       912             671

Total current assets                                                                     4,194           3,692
                                                                                         -----           -----
PROPERTY AND EQUIPMENT, NET (Note 6)                                                        50              38


Total assets                                                                             4,244           3,730
                                                                                         =====           =====
LIABILITIES AND SHAREHOLDERS' EQUITY

CURRENT LIABILITIES:
Short-term bank debt (Note 7)                                                               18               8
Trade payables                                                                             659             482
Accrued expenses and other liabilities (Note 8)                                            361             365
Deferred revenues                                                                           60              49

Total current liabilities                                                                1,098             904
                                                                                         -----           -----
COMMITMENTS (Note 9)

SHAREHOLDERS' EQUITY (Note 12):
Share capital -
         15,052 Ordinary shares of (euro) 0.0042 par value - Authorized,  issued and
outstanding as of December 31, 2004 and 2005                                                63              63
Retained earnings                                                                        3,083           2,763

Total shareholders' equity                                                               3,146           2,826
                                                                                         -----           -----

Total liabilities and shareholders' equity                                               4,244           3,730
                                                                                         =====           =====
</TABLE>

     The accompanying notes are an integral part of the financial statements

                                      F-43
<PAGE>


                                   JUSAN, S.A.

           STATEMENTS OF INCOME AS OF DECEMBER 31, 2003, 2004 AND 2005
              Euros in thousands (except share and per share data)

<TABLE>
<CAPTION>
                                                                               Year ended December 31,
                                                                          2003           2004           2005
                                                                          ----           ----           ----
Revenues (Note 13):
<S>                                                                        <C>            <C>            <C>
Product sales                                                              5,353          5,154          3,935
Services                                                                     707            640            632

Total revenues                                                             6,060          5,794          4,567
                                                                           -----          -----          -----
Cost of revenues:
Product sales                                                              2,797          2,658          2,098
Services                                                                     538            447            435

Total cost of revenues                                                     3,335          3,105          2,533
                                                                           -----          -----          -----
Gross profit                                                               2,725          2,689          2,034
                                                                           -----          -----          -----
Operating expenses:
Research and development                                                     425            454            449
Selling and marketing                                                        770            872            849
General and administrative                                                   882            849            831

Total operating expenses                                                   2,077          2,175          2,129
                                                                           -----          -----          -----
Operating income / (loss)                                                    648            514           (95)
Financial income, net (Note 14)                                                9              2             20

Income before taxes on income                                                657            516           (75)
Income taxes (Note 10)                                                       131            143           (55)


Net income / (loss)                                                          526            373           (20)
                                                                           -----          -----          -----

Basic and diluted net earnings per share                                   34.95          24.78         (1.33)
                                                                           -----          -----          -----
Weighted  average  number of shares used in  computing  basic net
earnings per share                                                        15,052         15,052         15,052
                                                                          ------         ------         ------
</TABLE>

     The accompanying notes are an integral part of the financial statements

                                      F-44
<PAGE>


                                   JUSAN, S.A.

                  STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
                               Euros in thousands

<TABLE>
<CAPTION>
                                                                                                    Total
                                                                                   Retained     shareholders'
                                                                  Share Capital    earnings         Equity
                                                                  -------------    --------     -------------
<S>                                                              <C>              <C>           <C>
Balance as of January 1, 2003                                                63       2,384             2,447
                                                                  -------------    --------     -------------
Dividend paid                                                                 -       (100)             (100)
Accrued dividend                                                              -       (100)             (100)
Net income                                                                    -         526               526

Balance as of December 31, 2003                                              63       2,710             2,773
                                                                  -------------    --------     -------------
Net income                                                                    -         373               373


Balance as of December 31, 2004                                              63       3,083             3,146
                                                                  -------------    --------     -------------
Dividend paid                                                                 -       (300)             (300)
Net income                                                                    -        (20)              (20)



Balance as of December 31, 2005                                              63       2,763             2,826
                                                                  -------------    --------     -------------
</TABLE>


     The accompanying notes are an integral part of the financial statements



                                      F-45

<PAGE>

                                   JUSAN, S.A.
                            STATEMENTS OF CASH FLOWS
                               Euros in thousands

<TABLE>
<CAPTION>
                                                                                  Year ended December 31,
                                                                               2003         2004         2005
                                                                               ----         ----         -----
Cash flows from operating activities:
<S>                                                                             <C>           <C>         <C>
Net income                                                                      526           373         (20)
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Depreciation                                                                     64            47           38
Deferred taxes                                                                    -            21         (30)
Decrease (increase) in trade receivables                                      (154)         (333)          367
Decrease (increase) in other accounts receivable and prepaid expenses            22            62           12
Decrease (increase) in inventories                                              107         (119)          241
Increase (decrease) in trade payables                                           172         (136)        (177)
Increase (decrease) in accrued expenses and other liabilities                  (78)            32           14
Increase (decrease) in deferred revenues                                        106         (172)         (11)
Net cash (provided by) operating activities                                     765         (225)          434
                                                                               ----         ----         -----
Cash flows from investing activities:
Investment in short-term bank deposits                                         (48)             -           50
Purchase of property and equipment                                             (24)          (19)         (26)
Net cash provided by (used in) investing activities                            (72)          (19)           24
                                                                               ----         ----         -----
Cash flows from financing activities:
Dividend paid                                                                 (100)         (100)        (300)
Short-term bank debt                                                             22          (20)         (10)
Net cash used in financing activities                                          (78)         (120)        (310)
                                                                               ----         ----         -----
Increase (decrease) in cash and cash equivalents                                615         (364)          148
Cash and cash equivalents at the beginning of the year                          338           953          589

Cash and cash equivalents at the end of the year                                953           589          737
                                                                               ----         ----         -----
Non-cash financing information:

Accrued dividend                                                                100             -            -

Supplemental disclosure of cash flows activities: Cash paid during the year for:

Interest                                                                          9             2           20


Income taxes                                                                    131           143         (55)
                                                                               ----         ----         -----
</TABLE>


     The accompanying notes are an integral part of the financial statements

                                      F-46
<PAGE>

                                   JUSAN, S.A.
              NOTES TO FINANCIAL STATEMENTS AS OF DECEMBER 31, 2005


NOTE 1: ORGANIZATION AND OPERATIONS

a.    JUSAN, S.A. ("the Company") was incorporated in Spain on June 19, 1959.
      The Company is engaged on development, manufacturing and assembly, sales
      and distribution, and maintenance of vocal server and call billing
      applications, as well as is in the television rental business.

b.    The Company has five major customers (see also Note 13a).

c.    In accordance with Spanish Companies' Law the directors present, for
      comparative purposes, each of the balance sheet and profit and loss
      account, the figures for the previous financial years, in addition to
      those for the financial year 2005.


NOTE 2: SIGNIFICANT ACCOUNTING POLICIES

The financial statements have been prepared in accordance with generally
accepted accounting principles in the United States ("US GAAP").

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 euros

Monetary accounts maintained in currencies other than the Euro are remeasured
into Euros in accordance with Statement of Financial Accounting Standard No. 52,
"Foreign Currency Translation" ("SFAS No. 52"). All effects of foreign currency
remeasurement of monetary balance sheet items are reflected in the statements of
operations as financial income or expenses, as appropriate.

c.    Cash equivalents:

The Company considers all highly liquid investments originally purchased with
maturities of three months or less to be cash equivalents.

There are no restrictions for cash and cash equivalents.

                                      F-47
<PAGE>


d.    Short-term bank deposits:

Short-term bank deposits are deposits with maturities of more than three months
but less than one year. The deposits are in Euro and bear interest at an average
rate of 2%. The short-term deposits are presented at their cost, including
accrued interest.

e.    Inventories:

Inventories are stated at the lower of cost or market value. Cost is determined
as follows: Raw materials, parts and supplies -using the weighted average cost
method. Work in progress and finished products are recorded on the basis of
direct manufacturing costs. Inventories write-offs are provided to cover risks
arising from slow moving items or technological obsolescence.

f.    Property and equipment:

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

                                                       %
                                                     ---
           Computers and peripheral equipment         33
           Office furniture and equipment             20
           Motor vehicles                             20




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

g.    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.

                                      F-48
<PAGE>

Based on the Company's product development process, technological feasibility is
established upon completion of a working model. Costs incurred by the Company
between completion of the working models and the point at which the products are
ready for general release have been insignificant. Therefore, all research and
development costs have been expensed.

h.    Income taxes:

The Company accounts for income taxes in accordance with Statement of Financial
Accounting Standard 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. Valuation allowances are provided to reduce
deferred tax assets to an amount whose realization is considered more likely
than not.

i.    Revenue recognition:

The Company generates revenues from selling software-based products through
resellers and distributors who are considered end-users. The Company also
generates revenues from rendering maintenance and support services.

Revenues are recognized when all criteria outlined in Statement of Position No.
97-2 "Software Revenue Recognition" ("SOP No. 97-2") as amended are met. Revenue
from products is recognized when persuasive evidence of an agreement exists,
delivery of the product has occurred, no significant obligations with regard to
implementation remain, the fee is fixed or determinable and collectibility is
probable.

Where the arrangements involve multiple elements, revenue is allocated to each
element based on vendor specific objective evidence ("VSOE") of the relative
fair values of each element in the arrangement, in accordance with the "residual
method" prescribed by SOP No. 98-9, "Modification of SOP No. 97-2, Software
Revenue Recognition With Respect to Certain Transactions". The VSOE used by the
Company to allocate the sales price to support services and maintenance is based
on the renewal rate charged when these elements are sold separately. Revenues
from products are recorded based on the residual method. Under the residual
method, revenue is recognized for the delivered elements when (1) there is VSOE
of the fair values of all the undelivered elements, and (2) all revenue
recognition criteria of SOP No. 97-2, as amended, are satisfied. Under the
residual method any discount in the arrangement is allocated to the delivered
element.

Provision for returns in the amount of thousand (euro) 4 is determined
principally on the basis of past experience.

Revenues from maintenance and support services are recognized over the life of
the maintenance agreement or at the time support services are rendered.

                                      F-49
<PAGE>


Deferred revenues include unearned amounts received under maintenance and
support contracts, not yet recognized as revenues.

j.    Warranty costs:

The Company provides free warranty for up to one year. A provision in the amount
of thousand (euro) 20 (thousand (euro) 20 in 2004) is recorded for probable
costs in connection with these services based on the Company's experience.

The Company estimates the costs that may be incurred under its basic limited
warranty and records a liability in the amount of such costs at the time product
revenue is recognized. Factors that affect the Company's warranty liability
include the number of installed units, historical and anticipated rates of
warranty claims, and cost per claim. The Company periodically assesses the
adequacy of its recorded warranty liabilities and adjusts the amounts as
necessary.

k.    Fair value of financial instruments:

The carrying amounts of cash and cash equivalents, short-term bank deposits,
trade receivables, other accounts receivable and trade payables approximate
their fair value, due to the short-term maturity of such instruments.

There are short term fixed-rate securities as an amount of thousand (euro) 400.

l.    Concentrations of credit risk:

Financial instruments that potentially subject the Company to concentrations of
credit risk consist principally of cash and cash equivalents, short-term bank
deposits and trade receivables.

Cash and cash equivalents and short-term bank deposits are deposited with major
banks in Spain. Management believes that the financial institutions that hold
the Company's investments are financially sound, and accordingly, minimal credit
risk exists with respect to these investments.

The trade receivables of the Company are mainly derived from sales to customers
in Spain and Europe (see Note 13b). The Company performs ongoing credit
evaluations of its customers. The allowance for doubtful accounts is determined
with respect to specific debts that are doubtful of collection according to
management estimates (when the ageing of account receivable is more than 180
days). In certain circumstances, the Company may require letters of credit,
other collateral or additional guarantees.

The Company has no off-balance-sheet concentration of credit risk such as
foreign exchange contracts, option contracts or other foreign hedging
arrangements.

                                      F-50
<PAGE>

m.    Basic and diluted net earnings per share:

Basic net earnings per share is computed based on the weighted average number of
ordinary shares outstanding during each year. Diluted earnings per share is
computed based on the weighted average number of ordinary shares outstanding
during each year, plus potential ordinary shares considered outstanding during
the year, in accordance with Statement of Financial Accounting Standard No. 128,
"Earnings Per Share" ("SFAS No. 128").


NOTE 3: OTHER ACCOUNTS RECEIVABLE AND PREPAID EXPENSES


                                                    December 31,
                                                2004           2005
                                               -----           -----
              Tax authorities                    127            100
              Deferred taxes                      10             43
              Employee advances                   25             27
              Deposits                            16             16
                                               -----           -----
                                                 178            186



NOTE 4: INVENTORIES


                                                    December 31,
                                                2004           2005
                                               -----           -----

               Materials                         893            735
               Work in progress                   31             29
               Provision for obsolescence       (12)           (93)
                                               -----           -----
                                                 912            671



                                      F-51

<PAGE>


NOTE 5: TRADE RECEIVABLES

                                                     December 31,
                                                 2004            2005
                                                -----           -----
Trade receivables                               1,781           1,510
Bills receivable                                  327             245
Allowance for doubtful accounts                  (43)            (57)
                                                -----           -----
                                                2,065           1,698
                                                =====           =====


NOTE 6: PROPERTY AND EQUIPMENT

<TABLE>
<CAPTION>
                                                         December 31,
                                          2004      Additions    Disposals      2005
                                         -----        -----        -----       -----
Cost:
<S>                                        <C>           <C>        <C>          <C>
Computers and peripheral equipment         132           10         (20)         122
Office furniture and equipment             291           16            -         307
Motor vehicles                             103            -          (5)          98
Leasehold improvements                       -                                     -
                                         -----        -----        -----       -----
                                           526           26         (25)         527
Accumulated depreciation:
Computers and peripheral equipment       (118)         (15)           20       (113)
Office furniture and equipment           (266)         (12)            -       (278)
Motor vehicles                            (92)         (11)            5        (98)
Leasehold improvements                       -            -            -           -

                                         (476)         (38)           25       (489)
                                         -----        -----        -----       -----
Depreciated cost                            50         (12)            -          38
                                         =====        =====        =====       =====

</TABLE>


Depreciation expenses for the years ended December 31, 2003, 2004 and 2005 were
thousand (euro) 64, 47 and 38, respectively.



                                      F-52

<PAGE>


NOTE 7: SHORT-TERM BANK DEBT

The Company has a short-term bank debt in the amount of thousand (euro) 8,
bearing interest of 3.75%.


NOTE 8: ACCRUED EXPENSES AND OTHER LIABILITIES


                                                     December 31,
                                                2004            2005
                                                ----            ----
          Employees and payroll accruals          45             75
          Income tax payable                     122              -
          Deferred tax                            21             24
          Tax authorities                        119            182
          Current Accounts                        34             64
          Warranty costs                          20             20
                                                 361            365
                                                ====            ===


NOTE 9: COMMITMENTS


The facilities of the Company are rented under operating leases for periods
ending in 2009.

Future minimum lease commitments under non-cancelable operating leases as of
December 31, are as follows:




                               2006             43
                               2007              8
                               2008              8
                               2009              5
                                                64
                                                ==


Rent expenses for years ended December 31, 2003, 2004 and 2005, were
approximately thousand (euro) 152, 152 and 157, respectively. Rent expenses will
be reviewed every year with the variation of the Consumer Price Index.

                                      F-53

<PAGE>

NOTE 10: TAXES ON INCOME

Reconciliation between the theoretical tax expense, assuming all income is taxed
at the statutory tax rate applicable to income of the Company and the actual tax
expense as reported in the statements of operations, is as follows:


<TABLE>
<CAPTION>
                                                                            Year ended December 31,
                                                                         2003        2004         2005
                                                                         ----        ----         ----
<S>                                                                       <C>         <C>         <C>
            Income before taxes as reported in the statements
            of operations                                                 657         516         (75)
            Non-deductible bad debt allowance and others  2004              -          82         (82)
            Non-deductible bad debt allowance 2005                          -           -           20
            Tax depreciation                                                -           -         (37)
            Increase (decrease) in the taxable base - Forward
            sales                                                           -        (62)           29
            Increase (decrease)  in the taxable base -
            Unrealized  severance allowance                                 -           -           75
            Taxable income                                                657         536         (70)
                                                                         ----        ----         ----
            Tax rates                                                     35%         35%          35%
                                                                         ----        ----         ----

            Tax benefit                                                   230         188         (25)
            Decrease in taxes resulting from:
            Tax deduction for development                                (99)        (66)            -
            Deferred tax liability (asset)                                  -          21         (30)

            Taxes on income, tax expense (benefit), as reported
            in the statements of operations                               131         143         (55)
                                                                         ====        ====         ====
</TABLE>


Under the current tax legislation, 35% of development expense can be deducted
from the income tax with the limits of 35% of the theoretical tax charge. All
the income before income taxes is domestic.

The Directors consider the deferred tax asset will be realized as a result of
the income projected for FY 2006.


                                      F-54

<PAGE>


NOTE 11: RELATED PARTIES TRANSACTIONS

The balances with and the revenues derived from related parties (related parties
are shareholders, directors and family of both) were as follows:

a.    Payments to related parties:


                                       Year ended December 31,
                                   2003          2004          2005
                                   ----          ----          ----
              Wages                 308           255           299




In 2004 the payments of wages to related parties are based on the payments to
the directors (thousand (euro) 262), the social security paid to the directors
(thousand (euro) 16) and 20% from the leases (thousand (euro) 21).


b. Transactions with related parties were as follows:


                                                      Year ended December 31,
                                                     2003      2004      2005
                                                     ----      ----      ----

              Sales to related parties                15        18        39

              Amounts charged by related parties:
                       Cost of revenues              205       100        18












                                      F-55

<PAGE>


c.    Amounts receivable from and payables to related parties:


                                                    December 31,
                                               2004              2005
                                               ----              ----
             Receivables:
             Mer Telemagement Solutions         17                36
             MTS Asia                           11                 4
             MTS IntegraTRAK                     3                 -

             Payables:
             Mer Telemagement Solutions          -                18
             Beheer - Jaraga BV                 31                 -




NOTE 12: SHAREHOLDERS' EQUITY

a.    Share capital:

The ordinary shares entitle their holders the right to receive notice, to
participate and vote in general meetings of the Company and the right to receive
dividends, if declared.

b.    Legal reserve

As established by the Spanish Companies' Act, 10% of profits must be
allocated to the legal reserve, until such reserve is equal to 20% of share
capital. The legal reserve shall not be distributed and may only be used for
compensation of losses or to increase capital.

c.    Shareholding

There are 15,052 ordinary shares of (euro) 0.0042 par value, authorized, issued
and outstanding as of December 31, 2005.

The shareholders at December 31, 2005 are:


                                                     %
                                                    ---
             Jaraga, B.V.                           50%
             Jose Lasry Nahon                       25%
             Mauricio Toledano Marques              25%


                                      F-56

<PAGE>


d.    Distribution of dividends.

The proposed distribution of dividends amounting thousand (euro) 300 as a result
of the year ended 2004, has been paid to the shareholders in direct proportion
of their shares.




             Jaraga, B.V.                           150
             Jose Lasry Nahon                        75
             Mauricio Toledano Marques               75


NOTE 13:- SEGMENTS, CUSTOMERS AND GEOGRAPHIC INFORMATION

a.    Major customers as a percentage of total revenues:


                                             Year ended December 31,
                                      2003            2004            2005
                                      ----            ----            ----
                                                       %

             Adictis                  13%             14%             13%
             Cableuropa, S.A.          5%              8%              8%
             Siemens, S.A.             5%              8%               -
             Telefonica de Espana     10%              5%              5%
             Siemens Atea, N.V.        4%              4%               -
             Siemens Chile              -               -              2%
             Accentic                  4%              4%              2%




                                      F-57

<PAGE>


b.    The following is a summary of revenues within geographic areas based on
      end customer location:


                                            Year ended December 31,
                                      2003           2004          2005
                                      ----           ----          ----
             Spain
                                      3,360         2,287          2,275
             European Community       2,179         2,796          1,437
             Other                      521           711            855


                                      6,060         5,794          4,567



NOTE 14: SELECTED STATEMENTS OF OPERATIONS DATA

Financial income, net


                                            Year ended December 31,
                                      2003            2004          2005
                                      ----            ----          ----

             Financial expenses:

             Interest expenses           5               3             3
             Other expenses              8              11             6
                                        13              14             9
                                      ----            ----          ----
             Financial income:

             Interest income            22              16            29

             Financial income, net       9               2            20
                                      ====            ====          ====



                                      F-58

<PAGE>

                               S I G N A T U R E S

         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.




                                            MER TELEMANAGEMENT SOLUTIONS LTD.


                                            By:      /s/Eytan Bar
                                                     ------------
                                                     Eytan Bar
                                                     Chief Executive Officer



                                            By:      /s/ Shlomi Hagai
                                                     ----------------
                                                     Shlomi Hagai
                                                     Chief Financial Officer



Dated: March 31, 2006















                                       94