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, 2003

                                             OR

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

              For the transition period from _________ to _________

                         Commission file number: 0-28950

                        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 ............ 4,624,471
                            (as of December 31, 2003)

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_

This  Report  on Form  20-F is  incorporated  by  reference  into  our  Form F-3
Registration  Statement  File No.  333-11644 and into our Form S-8  Registration
Statement File No. 333-12014.


<PAGE>

                                  INTRODUCTION

        Mer Telemanagement Solutions Ltd. designs, develops, markets and
supports a comprehensive line of telecommunication management solutions that
enable business organizations and other enterprises to improve the efficiency
and performance of their IP operations and to significantly reduce associated
costs. Our products include call accounting and management products, facility
management solutions, fault management systems and Web-based management
solutions for converged voice, voice over Internet Protocol, or IP, data and
video. 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
60,000 TABS call accounting systems have been sold to end-users in more than 60
countries.

        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.

        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 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. 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"

        TABS by MER (R), TABS.IT(TM), eTABS(TM), VoIPTABS(TM), wTABS(TM),
FaciliTRAK(TM), TABSbill(TM), TOPS(TM) and PMSi(TM) are our trademarks. 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.

                                       i

<PAGE>


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.



                                       ii



<PAGE>



                                TABLE OF CONTENTS

                                                                           Page
                                                                           ----


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........................................17
            A. History and Development of the Company........................17
            B. Business Overview.............................................19
            C. Organizational Structure......................................27
            D. Property, Plants and Equipment................................28
ITEM 5.    OPERATING AND FINANCIAL REVIEW AND PROSPECTS......................28
            B. Liquidity and Capital Resources...............................39
            C. Research and Development......................................40
            D. Trend Information.............................................41
            E. Off-Balance Sheet Arrangements................................41
            F. Tabular Disclosure of Contractual Obligations.................41
ITEM 6.    DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES........................41
            A. Directors and Senior Management...............................41
            B. Compensation..................................................43
            C. Board Practices...............................................44
            D. Employees.....................................................49
            E. Share Ownership...............................................50
ITEM 7.    MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS.................53
            A. Major Shareholders............................................53
            B. Related Party Transactions....................................54
            C. Interests of Experts and Counsel..............................55
ITEM 8.    FINANCIAL INFORMATION.............................................55
            A. Consolidated Statements and Other Financial Information.......55
            B. Significant Changes...........................................56
ITEM 9.    THE OFFER AND LISTING.............................................56
            A. Offer and Listing Details.....................................56
            B. Plan of Distribution..........................................57
            C. Markets.......................................................57
            D. Selling Shareholders..........................................57
            E. Dilution......................................................57
            F. Expense of the Issue..........................................57
ITEM 10.   ADDITIONAL INFORMATION............................................57
            A. Share Capital.................................................57
            B. Memorandum and Articles of Association........................57

                                       iii

<PAGE>


            C. Material Contracts............................................60
            D. Exchange Controls.............................................60
            E. Taxation......................................................61
            F. Dividend and Paying Agents....................................72
            G. Statement by Experts..........................................72
            H. Documents on Display..........................................72
            I. Subsidiary Information........................................72
ITEM 11.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
            RISKS............................................................73
ITEM 12.   DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES............73

PART II......................................................................73

ITEM 13.   DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES...................73
ITEM 14.   MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS
           AND USE OF PROCEEDS...............................................73
ITEM 15.   CONTROLS AND PROCEDURES...........................................74
ITEM 16.   [RESERVED]........................................................74
ITEM 16A.  AUDIT COMMITTEE FINANCIAL EXPERT..................................74
ITEM 16B.  CODE OF ETHICS....................................................74
ITEM 16C.  PRINCIPAL ACCOUNTING FEES AND SERVICES............................74
ITEM 16D.  EXEMPTIONS FROM THE LISTING REQUIREMENTS AND
             STANDARDS FOR AUDIT COMMITTEE...................................75
ITEM 16E.  PURCHASE OF EQUITY SECURITIES BY THE ISSUER AND
             AFFILIATES AND PURCHASERS.......................................75

PART III.....................................................................77

ITEM 17.   FINANCIAL STATEMENTS..............................................77
ITEM 18.   FINANCIAL STATEMENTS..............................................77
ITEM 19.   EXHIBITS..........................................................77

S I G N A T U R E S..........................................................79





                                       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, 2003 are derived from our audited consolidated
financial statements, which have been prepared in accordance with U.S. GAAP. Our
consolidated financial statements were audited by Kost Forer Gabbay & Kasierer,
a Member of Ernst & Young Global. Our audited consolidated financial statements
with respect to the three years ended December 31, 2003 and as of December 31,
2002 and 2003 appear elsewhere in this 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,
                                            ------------------------------------------------------
                                             1999        2000       2001        2002        2003
                                             ----        ----       ----        ----        ----
                                                     (in thousands, except per share data)

<S>                                         <C>         <C>         <C>         <C>        <C>
Revenues.............................       $12,780     $11,067     $10,725     $9,787     $9,230
Cost of revenues.....................         3,137       2,842       2,552      1,896      1,849
                                              -----       -----       -----      -----      -----
Gross profit.........................         9,643       8,225       8,173      7,891      7,381
Selling and marketing, net...........         4,186       4,853       4,911      3,954      3,916
Research and development, net........         3,491       4,039       3,562      2,127      1,825
General and administrative...........         1,593       1,845       1,943      1,858      1,830
In process research and development
  write-off .........................            --         945          --         --         --
                                              -----       -----       -----      -----      -----
Operating income (loss)..............           373      (3,457)     (2,243)       (48)      (190)
Financial income, net................            35         374         138        134        124
Other income (expenses)..............         5,150       1,591        (654)      (140)         6
                                              -----       -----       -----      -----      -----
Income (loss) before taxes...........         5,558      (1,492)     (2,759)       (54)       (60)
Taxes on income (tax benefit)........         1,277        (155)         16         52        198
                                              -----       -----       -----      -----      -----
Net income (loss) before equity in
  earnings of affiliates and minority
  interest...........................         4,281      (1,337)     (2,775)      (106)      (258)
Equity in earnings of affiliates...             211          66         221        236        345
Minority interest in a subsidiary....            --          --          --         --         --
                                              -----       -----       -----      -----      -----
Net income (loss)....................        $4,492     $(1,271)    $(2,554)     $ 130      $  87
                                             ======     =======     =======      =====      =====
Basic net earnings (loss) per share..         $0.96      $(0.26)     $(0.53)     $0.03      $0.02
                                             ======     =======     =======      =====      =====
Diluted net earnings (loss) per share         $0.94      $(0.26)     $(0.53)     $0.03      $0.02
                                             ======     =======     =======      =====      =====
</TABLE>


                                       5

<PAGE>



Balance Sheet Data:
<TABLE>
<CAPTION>
                                                           As of December 31,
                                         ------------------------------------------------------
                                             1999        2000        2001       2002       2003
                                             ----        ----        ----       ----       ----
<S>                                      <C>         <C>         <C>         <C>        <C>
Working capital......................    $  13,701   $   10,342  $    9,060  $   9,244  $ 9,437
Total assets.........................       21,615       21,812      18,095     17,707   18,182
Long-term loans......................            8           84          13          8       --
Shareholders' equity.................       17,557       16,497      13,856     14,013   14,464
</TABLE>

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 four last fiscal years
and we cannot assure you that we will be able to achieve or sustain profitable
operations in the future.

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;

     o    the number, timing and significance of product enhancements;

     o    new product announcements by us and our competitors;

     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;

                                        6

<PAGE>




     o    budgeting cycles of our customers;

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

     o    product life cycles;

     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 solutions is rapidly evolving and our sales cycle,
from initial evaluation to purchase, is lengthy and varies substantially from
customer to customer. We typically ship product orders 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 in any quarter depend substantially on
orders booked and shipped in that quarter.

        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 we have experienced revenue growth in the past, we may not
be able to sustain this growth rate, and you should not consider such past
growth indicative of future revenue growth, or of future operating results.

Our operating results vary quarterly and seasonally.

        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 reflect seasonal trends and we expect to continue
to be affected by such trends in the future. We expect to continue to experience
relatively higher sales in the fourth quarter ending December 31, and relatively
lower sales in the third quarter ending September 30, as a result of reduced
sales activity in Europe during the summer months. Due to the foregoing factors,
in some future quarter, our operating results may be below the expectations

                                       7

<PAGE>


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.

        We have derived substantially all of our revenues and expect to continue
to derive the vast majority of our revenues in the foreseeable future from sales
of our TABS.IT call accounting and billing products. Our future financial
performance will depend, in significant part, on the successful development,
introduction, marketing and customer acceptance of the new versions of TABS.IT
and related telemanagement products. Our revenues have declined each year since
1999 and there can be no assurance that the market for these products will grow
in the future. If the market for TABS.IT and related telemanagement products
fails to return to previous levels, or 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 PBX original equipment manufacturers, or OEMs, and
vendors who market our products to end-users in conjunction with their own
products. Sales by PBX manufacturers and vendors have declined markedly in the
recent past, and no assurance can be given that sales through this channel will
recover. Our success will be dependent to a substantial degree on the marketing
and sales efforts of such third parties in marketing products integrating our
products. There can be no assurance that these customers will 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, no assurance can be given that these manufacturers and
vendors, including our current customers, will not develop their own competing
products or purchase competing products from others.

        We are highly dependent upon the active marketing and distribution
efforts of our PBX OEM's. In 2001, 2002 and 2003, our three major OEMs, Siemens
Gmbh, Philips Communications Systems B.V. and Ericsson, generated 44.0%, 46.0%
and 51.0% of our consolidated revenues respectively. The percentage of sales
attributable to each of these OEMs in each of the three years ended December 31,
2003 follows:

                                    2001         2002        2003
                                    ----         ----        ----
Siemens....................         32.0%        36.0%       40.0%
Philips....................          8.0%         6.0%        7.0%
Ericsson...................          4.0%         4.0%        4.0%

        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.
There can be no assurance that our distributors will continue to provide
adequate maintenance and support to end-users or will provide maintenance and
support for new products, which might cause us to seek new or additional
distributors or incur



                                       8

<PAGE>


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 are subject to any minimum purchase
requirements under their agreements with us. There can be no assurance that we
will continue our relationships with our OEM customers or, if such relationships
are not maintained, that we would be able to attract and retain comparable PBX
original equipment manufacturers. Although we have distribution agreements with
a number of our resellers, we do not have any agreements with the PBX
manufacturers who market our products. The loss of any of our major resellers,
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.

We may decide to acquire other  businesses in the future,  which could result in
potentially  dilutive  issuances,  the  incurrence of debt and the incurrence of
other expenses which could negatively impact our operating results and financial
condition.

        In April 2000 we acquired IntegraTRAK Inc., a privately held developer
and marketer of high-end telemanagement software, and in April 2002 we acquired
software technology that we are presently marketing under the name FaciliTRAK.
FaciliTRAK is a comprehensive software system that greatly simplifies the
day-to-day task of maintaining and managing the physical layer details for any
network. If we continue to acquire businesses or products in the future, such
acquisitions could result in dilutive issuances of equity securities, the
incurrence of debt and contingent liabilities and amortization expenses related
to goodwill and other intangible assets, any of which could negatively impact
our operating results and financial position. Acquisitions may also involve
other risks, including entering markets in which we have limited or no direct
prior experience and the potential loss of key employees.

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, establishing and maintaining relationships with distributors,
and recruiting and training additional direct sales personnel. We plan to invest
significant resources to expand our direct sales force and to develop new
distribution relationships. Historically, we have at times experienced
difficulty in recruiting qualified sales personnel and in establishing effective
distribution relationships. There can be no assurance that we will be able to
successfully expand our direct sales force or other distribution channels or
that any such expansion will result in an increase in revenues. The failure to
expand or maintain our direct sales force or other distribution channels could
have a material adverse effect on our business, operating results and financial
condition.

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<PAGE>




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 61.0%,
66.0% and 53.0% of our total revenues for the years ended December 31, 2001,
2002 and 2003, respectively. Although we continue to expand our international
operations and commit significant management time and financial resources to
developing direct and indirect international sales and support channels, we
cannot be certain that we will 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;

     o    potentially adverse tax consequences; and

     o    political and economic instability.

        We cannot be certain that we, our distributors or resellers will be able
to sustain or increase revenues from international operations or that the
foregoing factors will not 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, there can be no assurance that we will be able to do
so or that such transactions, if entered into, will 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. Although exposure to currency fluctuations
to date has not had a material adverse effect on our business, there can be no
assurance such fluctuations in the future will not have a material adverse
effect on revenues from international sales and, consequently, on our business,
operating results and financial condition.

                                       10

<PAGE>




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. Despite our efforts to protect our
proprietary rights, 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. We cannot be certain that our means of protecting our
proprietary rights in the United States or abroad will be adequate or that our
competition will not independently develop similar technology.

        We are not aware that we are infringing upon any proprietary rights of
third parties. It is possible, however, 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;

     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. We
cannot be certain that these third-party software licenses will 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.

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

                                       11

<PAGE>


(including providers of telecommunications services), many of whom have
significantly greater financial, technical and marketing resources than us. We
anticipate continuing competition in 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. 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.

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. There
can be no assurance that we will be successful in developing and marketing
enhancements to our products that will respond to technological change, evolving
industry standards or customer requirements, that we will not experience
difficulties that could delay or prevent the successful development,
introduction and sale of such enhancements or that such enhancements will
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, substantially all of whom have
written employment agreements. 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, currently control
the vote of approximately 44.3% of our outstanding ordinary shares, and Isaac
Ben-Bassat, one of our directors, is the owner of 14.8% 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.

                                       12

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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 eighteen 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, there can be no assurance that errors will not 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.

Risk Factors Related to Our Ordinary Shares

Holders of our ordinary  shares who are United States  residents face income tax
risks.

        There is a substantial risk that we will be classified as a passive
foreign investment company, or 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 value of all of our assets for the taxable year produce
or are held for the production of passive income. For this purpose, passive
income includes dividends, interest, royalties, rents, annuities and the excess
of gains over losses from the disposition of assets which produce passive
income. If we were determined to be a PFIC for U.S. federal income tax purposes,
highly complex rules would apply to U.S. holders owning our ordinary shares.
Accordingly, you are urged to consult your tax advisors regarding the
application of such rules.

        As a result of our substantial cash position and the decline in the
value of our stock, there is a substantial risk that we will be classified as a
PFIC under the asset test described in the preceding paragraph. However, because
the determination of whether we are a PFIC is based upon the composition of our
income and assets from time to time, this determination can not be made with
certainty until the end of the calendar year.

        Based on studies performed by an independent consultant, we believe that
we were not a PFIC in the years 2001, 2002, or 2003.

        U.S. residents should carefully read "Item 10E. Additional Information -
Taxation - United States Federal Income Tax Consequences" for a more complete
discussion of the U.S. federal income tax risks related to owning and disposing
of our ordinary shares.

                                       13

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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 securities analysts and 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    changes in the status of our intellectual property rights;

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

     o    additions or departures of key personnel;

     o    future sales of our ordinary shares; and

     o    stock market price 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.

We do not expect to distribute cash dividends.

        We do not anticipate paying cash dividends in the foreseeable future.
Our Board of Directors will decide whether to declare any cash dividends in the
future based on the conditions then existing, including our earnings and
financial condition. According to the Israeli Companies Law, a company may
distribute dividends out of its profits, so long as the company reasonably
believes that such dividend distribution will not prevent the company from
paying all its current and future debts. Profits, for purposes of the Companies
Law, means the greater of retained earnings or earnings accumulated during the
preceding two years.

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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. There is no indication as to how long the current hostilities will
last or whether there will be any further escalation. Any further escalation in
these hostilities or 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
or Israeli companies. Restrictive laws or policies of those countries directed
towards Israel or Israeli businesses may have an adverse impact on our
operations, our financial results or the expansion of 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 are obligated to perform
up to 36 days, depending on rank and position, of military reserve duty annually
and are subject to being called for active duty under emergency circumstances.
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.

Economic conditions in Israel.

        In recent years Israel has been going through a period of recession in
economic activity, resulting in low growth rates and growing unemployment. Our
operations could be adversely affected if the economic conditions in Israel
continue to deteriorate. In addition, due to significant economic measures
proposed by the Israeli Government, there have been several general strikes and
work stoppages in 2003 and 2004, affecting banks, airports and ports. These
strikes have had an adverse effect on the Israeli economy and on business,
including our ability to deliver products to our customers. Following the
passage by the Israeli Parliament of laws to implement the economic measures,
the Israeli trade unions have threatened further strikes or work-stoppages, and
these may have a material adverse effect on the Israeli economy and on us.

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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. The majority 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. We
believe that the rate of inflation in Israel has not had a material adverse
effect on our business to date. However, 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. In 1999 and 2000, while the rate of inflation was
low and in 2003 when there was a negative rate of inflation, there was a
devaluation of the dollar against the NIS. In the years 2001 and 2002, and in
2003 when there was a negative rate of inflation, the rate of devaluation of the
NIS against the dollar exceeded the rate of inflation. 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.

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. 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.
We do not expect to receive any grants during 2004 or 2005.

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 in this annual report 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.

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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.

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

        We are incorporated under Israeli law. The rights and responsibilities
of holders of our ordinary shares are governed by our memorandum of association,
our articles of association and by Israeli law. These rights and
responsibilities differ in some respects from the rights and responsibilities of
shareholders in typical U.S. corporations. In particular, a shareholder of an
Israeli company has a duty to act in good faith toward the company and other
shareholders and to refrain from abusing his power in the company, including,
among other things, in voting at the general meeting of shareholders on certain
matters.

ITEM 4. INFORMATION ON THE COMPANY
        --------------------------

A.   HISTORY AND DEVELOPMENT OF THE COMPANY

        MER Telemanagement Solutions Ltd. 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.

        We design, develop, market and support a comprehensive line of
telecommunication management 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 Internet Protocol, or IP, data and video. 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 60,000 TABS call
accounting systems have been sold to end-users in more than 60 countries.

        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

                                       17

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re-written our call accounting and management systems as the industry and
technology advanced providing full compatibility to support the Windows
operating systems (3.1, 95, 98, 2000) 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. 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 then
added additional modules 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, FTP servers, voice over IP (VoIP) and external
buffers. We then 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.

        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 line with our strategic planning, we determined in late 2001 not to
promote TRAK-View and IP.TRAK as stand-alone products, but to offer them as part
of larger solutions.

        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. 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.

        Our strategy is to maintain and enhance our position as a leading
supplier in the enterprise communication management market of call accounting,
facility management solutions and other management solutions while expanding our
product line to address the telemanagement needs of the rapidly converging
voice, video and data communication markets.

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        In July 2000, we sold a 31% interest in Silverbyte, a 50% owned
privately held affiliate. We received $150,000 in consideration from the sale
payable in 24 equal monthly payments. In December 2000, we reached an agreement
to reschedule the remaining balance of the payments due. According to this
agreement, the balance of $110,000 will be repaid in 19 monthly payments
starting April 2002. In April 2002, we reached a new agreement rescheduling the
remaining $85,000 balance to be repaid in 48 monthly payments starting April
2002. We recorded a $73,000 gain from the sale. Although we continue to hold a
19% interest in Silverbyte, we do not have any representation on its board of
directors. Accordingly, our investment in Silverbyte is accounted for according
to the cost method.

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.

        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

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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.

        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.

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<PAGE>




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 to offer a PC-based non-dedicated call accounting
system when we introduced the first version of TABS in 1985. To date, over
60,000 TABS accounting systems have been sold to end-users located in over 60
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.

        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.

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<PAGE>




     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 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

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<PAGE>


performed remotely using Internet Explorer. Full security and privacy is assured
by use of various levels of password protection.

        The WinTRAK family of products is MTS IntegraTrak's telemanagement
solution that has been sold in the U.S. market since 1985. After incorporating
all the functionality of WinTRAK, we migrated TABS.IT for use in the United
States in 2002. Although we are no longer marketing WinTRAK, we continue to
support this product.

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. The purchase of this software, now 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

                                       23

<PAGE>


recorded in the site database, or used for items within the current site. We
intend to migrate to a new facilities management product in late summer 2004.

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 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, 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.

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.

New Trends

        We have implemented a new strategy for our company that has led to the
introduction of an application suite. The 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 the traditional telemanagement
solutions. We are currently investing heavily in research and development to
support these new operations.

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.

                                       24

<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 60 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 15 persons in our sales and marketing force and 31 persons
in support as of December 31, 2003. 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 60,000 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 being offered as an added value service. This solution has been offered
in the U.S. 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 have been selling our products are Siemens, Philips, Ericsson,
Nortel, Alcatel, ECI/Tadiran, NEC, Cisco, Damovo and Panasonic. The percentages
of sales attributable to our three largest OEM customers, Siemens, Philips and
Ericsson, in each of the three years ended December 31, 2003 are as follows:

                                       25

<PAGE>




                                            2001          2002        2003
                                            ----          ----        ----
        Siemens....................         32.0%         36.0%       40.0%
        Philips....................          8.0%          6.0%        7.0%
        Ericsson...................          4.0%          4.0%        4.0%

        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 and to expand our direct sales force and field
organization 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 may
use 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.

        We recently entered into an OEM agreement with TeleKnowledge Group Ltd.,
a leading provider of carrier-class billing & rating solutions, pursuant to
which we will market TeleKnowledge's Total-e billing, rating and customer care
solutions on an OEM basis as a comprehensive end-to-end solution.

        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.

                                       26

<PAGE>


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 we do. 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. 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 do not hold any patents and rely upon a combination of security
devices, copyrights, trademarks, trade secret laws, confidentiality procedures
and contractual restrictions to protect our rights in our products. 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
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.

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 and distribution of telemanagement products.

                                       27

<PAGE>




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
7,310 feet. The lease, which expires on December 31, 2005, has an annual rental
charge of approximately $107,335.

        Our U.S. operations are headquartered in an 8,408 square foot space in
Bellevue, Washington at annual rental of approximately $208,000. The lease will
expire in September 2004. We have subleased 2,040 square feet of this space
until September 2004 and are receiving annual rental income of approximately
$46,305. The lease for space we previously utilized in Secaucus, New Jersey
expired in April 2003. The annual rental for the Secaucus space was $103,780.
The annual rental cost for our Hong Kong and Sao Paulo offices is approximately
$34,000.

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

        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.

General

Overview

        We design, develop, market and support a comprehensive line of
telecommunication management 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 Internet Protocol, or IP,
data and video. 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 60,000 TABS call accounting systems have been sold to end-users in
more than 60 countries.

General

        Our consolidated financial statements are stated in dollars and prepared
in accordance with generally accepted accounting principles in the United
States. 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

                                       28



<PAGE>


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).

Discussion of Critical Accounting Policies

        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.

        Impairment of long-lived assets

        Our 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," or SFAS No. 144, whenever events
or changes in circumstances indicate that the carrying amount of an asset may
not be recoverable. Recoverability of assets to be held and used is measured by
a comparison of the carrying amount of an asset to the future undiscounted cash
flows expected to be generated by the assets. If such assets are considered to
be impaired, the impairment to be recognized is measured by the amount by which
the carrying amount of the assets exceeds the fair value of the assets. As of
December 31, 2003, no impairment was required. The use of different assumptions
with respect to the expected cash flows from our assets and other economic
variables, primarily the discount rate, may lead to different conclusions
regarding the recoverability of our assets' carrying values and to the potential
need to record an impairment loss for our long-lived assets.

        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. Under SFAS
No. 142, goodwill acquired in a business contraction on or after July 1, 2001
will not be amortized.

                                       29

<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 December 31, as the date we will perform our annual goodwill impairment
tests. The annual goodwill impairment test for 2003 was prepared for us by an
independent consulting firm. As of December 31, 2003, 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.

        Investments in affiliates and other companies

        Investments in privately held companies, in which we hold 20% to 50%
ownership of voting rights and can exercise significant influence over operating
and financial policy of the affiliate, are presented using the equity method of
accounting. In accordance with SFAS No. 142, goodwill related to investments in
affiliates is no longer amortized. The goodwill is reviewed annually (or more
frequently if circumstances indicate impairment has occurred) for impairment in
accordance with Accounting Principles Board Opinion No. 18. "The Equity Method
of Accounting for Investments in Common Stock," or "APB No. 18." Before the
adoption of SFAS No. 142 on January 1, 2002, goodwill was amortized on a
straight-line basis over 10 years, in accordance with APB Opinion No. 17,
"Intangible Assets."

        Investments in privately held companies in which the we hold less than
20% and do not have the ability to exercise significant influence over their
operating and financial policy, are presented at cost. We periodically review
the carrying value, in accordance with APB No. 18. If this review indicates that
the carrying value is not recoverable, the carrying value is reduced to its
estimated fair value. As of December 31, 2003, no impairment losses have been
identified. Any changes in our key assumptions concerning their carrying value
could have a material adverse affect on our financial position and results of
operations.

        Research and development costs

        Research and development costs, net of grants received, are charged to
expenses as incurred. Statement of Financial Accounting Standard No. 86,
"Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise
Marketed," requires capitalization of certain software development costs
subsequent to the establishment of technological feasibility. Based on our
product development process, technological feasibility is established upon
completion of a working model. Costs incurred by us between completion of the
working model and the point at which the product is ready for general release
should be capitalized. During 2003 such costs were immaterial.

        Capitalized software costs are amortized by the greater of: (i) ratio of
current gross revenues from sales of the software to the total of current and
anticipated future gross revenues from sales of that software or (ii) the
straight-line method over the remaining estimated useful life of the product
(not greater than three years). We assess the recoverability of this intangible
asset on a regular basis by determining whether the amortization of the asset
over our remaining

                                       30



<PAGE>


life can be recovered through undiscounted future operating cash flows from the
specific software product sold. Based on the most recent analyses, our
management believes that no impairment of capitalized software development costs
exists as at December 31, 2003. Under different assumptions with respect to the
recoverability of this intangible asset, our determination may be different,
which may negatively affect our financial position and results of operations.

        Concentrations of credit risk

        Financial instruments that potentially subject us and our subsidiaries
to concentrations of credit risk consist principally of cash and cash
equivalents, short and long-term bank deposits, trade receivables and long-term
trade receivables. Our cash and cash equivalents and short-term and long-term
bank deposits are invested in major Israeli and U.S. banks. Such deposits in
U.S. banks may be in excess of insured limits and are not insured in other
jurisdictions. We believe that the financial institutions that hold our
investments are financially sound and, accordingly, minimal credit risk exists
with respect to these investments.

        We perform ongoing credit evaluations of our customers and have not
experienced any material losses in recent years. An allowance for a doubtful
account is determined with respect to those amounts that we have determined to
be doubtful of collection. Any changes in our assumptions relating to the
collectability of our accounts receivable may affect our financial position and
results of operations.

Recently Issued Accounting Standards

        In January 2003, the FASB issued FASB Interpretation No. 46, or FIN 46,
"Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51,"
which addresses consolidation by business enterprises of variable interest
entities, or VIEs, either: (1) that do not have sufficient equity investment at
risk to permit the entity to finance its activities without additional
subordinated financial support, or (2) in which the equity investors lack an
essential characteristic of a controlling financial interest. In December 2003,
the FASB completed deliberations of proposed modifications to FIN 46, or the
Revised Interpretation, resulting in multiple effective dates based on the
nature as well as the creation date of the VIE. VIEs created after January 31,
2003, but prior to January 1, 2004, may be accounted for either based on the
original interpretation or the Revised Interpretation. However, the Revised
Interpretation must be applied no later than our first quarter of fiscal 2004.
VIEs created after January 1, 2004 must be accounted for under the Revised
Interpretation. Special Purpose Entities, or SPEs, created prior to February 1,
2003 may be accounted for under the original or Revised Interpretation's
provision no later than our fourth quarter of fiscal 2003. Non-SPEs created
prior to February 1, 2003, should be accounted for under the Revised
Interpretation's provisions no later than our first quarter of fiscal 2004.

        We have not entered into any material arrangements with VIEs created
prior to or after January 31, 2003.

                                       31

<PAGE>


Operating Results

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

<TABLE>
<CAPTION>
                                                                   Year Ended December 31,
                                                              -----------------------------------
                                                               2001           2002         2003
                                                               ----           ----         ----
      <S>                                                     <C>           <C>            <C>
      Revenues
      Product sales.......................................     73.1%         75.6%          75.2%
      Services............................................     26.9          24.4           24.8
      Total revenues......................................    100.0%        100.0%         100.0%
      Cost of revenues
      Product sales.......................................     17.8          16.9           16.5
      Services............................................      6.0           2.5            3.5
                                                             ------        ------         ------
      Total cost of revenues..............................     23.8          19.4           20.0
      Gross profit........................................     76.2          80.6           80.0
      Selling and marketing...............................     45.8          40.4           42.5
      Research and development............................     33.2          21.7           19.8
      General and administrative..........................     18.1          19.0           19.8
      Operating loss......................................    (20.9)         (0.5)          (2.1)
      Financial income, net...............................      1.3           1.4            1.3
      Other income (expenses).............................     (6.1)         (1.5)           0.1
                                                             ------        ------         ------
      Loss before taxes...................................    (25.7)         (0.6)          (0.7)
      Taxes on income.....................................      0.2           0.5            2.1
                                                             ------        ------         ------
      Net loss before equity in earnings of affiliate.....    (25.9)         (1.1)          (2.8)
      Equity in earnings of affiliate.....................      2.1           2.4            3.7
                                                             ------        ------         ------
      Net income (loss)...................................    (23.8)%         1.3%           0.9%
                                                             ======        ======         ======
</TABLE>

Years Ended December 31, 2003 and 2002

        Revenues. Revenues consist primarily of products sales and revenues from
services, including service center income, custom made projects, maintenance and
support. Revenues decreased 5.8% to $9.23 million in 2003 from $9.8 million in
2002 as a result of the continued global decline in the demand for
telecommunication products, such as PBX systems, which effected our revenue
stream. In 2003, the revenues from our wholly owned U.S. subsidiary, MTS
IntegraTRAK, declined 23% from 2002 and accounted for 53.0% of our total
revenues. In 2004, we took measures to reverse the sales decline in the United
States, but no assurance can be given that we will be successful in our efforts.

        Cost of Revenues. 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, or OCS) and (iii) warranty and support costs for up to one year for
end-users. Cost of revenues decreased 2.6% to $1.85 million in 2003 from $1.9
million in 2002, principally as a result of the overall decrease in revenues.

        Gross margin. Gross profit as a percentage of revenues was 80% in 2003
compared to 80.6% in 2002. We expect that our gross margin will fluctuate on a
quarterly basis due to the changing nature of our sales and the timing of
product introductions.

                                       32

<PAGE>




        Selling and Marketing, Net. Selling and marketing expenses consist
primarily of costs relating to promotion, advertising, trade shows and
exhibitions, sales compensation, presales support, and travel expenses. Selling
and marketing expenses were $3.92 million in 2003, a decrease of 1% from $3.95
million in 2002. In 2003, we succeeded in increasing our sales to existing OEM
customers, which increased by 45% to $2.3 million compared to $1.59 million in
2002. During 2004, we began to increase our selling efforts, particularly in the
U.S. and Europe, and we expect to increase our selling and marketing investment
during the year.

        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
research and development costs decreased 14% to $1.83 million in 2003 from $2.13
million in 2002. The total research and development expenses decreased due to
the downsizing process that we continued to implement until the end of the third
quarter of 2003. Beginning in the fourth quarter of 2003, we began to increase
our research and development expenses. We did not receive any royalty-bearing
grants from the OCS in 2002 or 2003 and we do not expect to receive any grants
during 2004. We did not capitalize any software development costs in either
year.

        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 decreased 1.6% to
$1.83 million in 2003 from $1.86 million in 2002 as we attempted to contain such
expenses in light of our decreased sales.

        Financial Income, Net. Financial income consists primarily of interest
income on bank deposits and foreign currency translation adjustments. As a
result of interest income earned on the remaining proceeds from our initial
public offering, the sale of our wholly owned subsidiary, STS Software Systems
Ltd., to NICE Systems Ltd. and the sale of our office condominium space on Fifth
Avenue in New York, we recorded financial income of $124,000 in 2003 as compared
to financial income of $134,000 in 2002. During the last three years our
interest income was negatively affected by the prevailing low interest rates in
both the United States and in Israel.

        Other Income. During 2003 we recorded income of $6,000 from the exercise
of marketable securities compared to a loss of $140,000 in 2002. During 2002 the
loss was the result of the decline in the value of our marketable securities
whose value had decreased as a result of the global recession.

        Taxes on Income. In 2003 our taxes on income were $198,000 as compared
to $52,000 in 2002. Most of the taxes in 2003 were the result of our realization
of the deferred tax assets according to our conservative accounting policy.
During 2003 we realized a tax benefit of $80,000 from a tax return received from
the Spanish tax authorities.

        Equity Interest in Results of Affiliates. We recognize income and loss
from the operations of our 50%-owned affiliate, Jusan S.A. In 2003 and in 2002,
we recognized income of $345,000 and $236,000, respectively.

                                       33



<PAGE>




Years Ended December 31, 2002 and 2001

        Revenues. Revenues decreased 8.4% to $9.8 million in 2002 from $10.7
million in 2001 as a result of the depressed global economic environment and the
decline in worldwide sales of telecommunication products. In 2002, revenues from
software products increased while revenues from products with hardware
components decreased. In 2002, our wholly owned U.S. subsidiary, MTS
IntegraTRAK, accounted for 66.0% of our total revenues.

        Cost of Revenues. Cost of revenues decreased 25.5% to $1.9 million in
2002 from $2.55 million in 2001, principally as a result of the significant
efforts that we initiated beginning in the fourth quarter of 2001 to reduce
costs and the decrease in our revenues.

        Gross Margin. Gross profit as a percentage of revenues, increased to
80.6% in 2002 from 76.2% in 2001, principally as a result of our cost cutting
measures.

        Selling and Marketing, Net. Selling and marketing expenses decreased
significantly by 19.4% to $3.95 million in 2002 from $4.9 million in 2001.
Although we reduced our selling and marketing expenses in 2002 by participating
in fewer trade shows and focusing on development of new channels and direct
sales, we enhanced our marketing efforts, particularly in the United States, and
were able to maintain our sales to existing OEM customers.

        Research and Development, Net. Net research and development costs
decreased 40.2% to $2.13 million in 2002 from $3.56 million in 2001, as a result
of a downsizing process that we implemented during 2002. We did not receive any
royalty-bearing grants from the OCS in 2002 as compared to $990,000 received in
2001 and we do not expect to receive any grants during 2003. We did not
capitalize any software development costs in either 2002 or 2001.

        General and Administrative. General and administrative expenses
decreased 4.1% to $1.86 million in 2002 from $1.94 million in 2001, principally
as a result of downsizing that we implemented during year 2002.

        Financial Income, Net. As a result of interest income earned on the
remaining proceeds from our initial public offering, the sale of our wholly
owned subsidiary, STS Software Systems Ltd. to NICE Systems Ltd. and the sale of
our office condominium space on Fifth Avenue in New York, we recorded financial
income of $134,000 in 2002 as compared to financial income of $138,000 in 2001.
During both 2002 and 2001 our interest income was negatively affected by the
prevailing low interest rates in both the U.S. and in Israel.

        Other Income (Expenses). During 2001 we recorded a one-time capital loss
of $741,000 ($606,000 after tax) from a permanent value depreciation of the NICE
Systems Ltd. securities we acquired as part of the consideration received from
the sale of STS Software Ltd. to NICE Systems Ltd. During 2002 we recorded a
loss of $140,000 from an exercise of marketable securities, whose value had
decreased as a result of the global recession.

        Taxes on Income. In 2002 our taxes on income was $52,000 as compared to
$16,000 in 2001.

        Equity Interest in Results of Affiliate. In 2002 and in 2001, we
recognized income of $236,000 and $221,000 respectively from the operations of
our 50%-owned affiliate, Jusan S.A.

                                       34



<PAGE>




Quarterly Results of Operations

        The following tables set forth certain unaudited quarterly financial
information for the two years ended December 31, 2003. 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.

<TABLE>
<CAPTION>
                                                                Three months ended
                                    ----------------------------------------------------------------------------
                                                    2002                                  2003
                                    ------------------------------------- --------------------------------------
                                    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........................     $2,581   $2,494    $2,196   $2,516    $2,240   $2,193    $2,286    $2,511
                                     ------   ------    ------   ------    ------   ------    ------    ------
Cost of revenues................        569      407       475      445       540      411       457       441
                                     ------   ------    ------   ------    ------   ------    ------    ------
Gross profit....................      2,012    2,087     1,721    2,071     1,700    1,782     1,829     2,070
                                     ------   ------    ------   ------    ------   ------    ------    ------
Selling and marketing, net......      1,014    1,071       970      899       918    1,061       938       999
Research and development, net...        605      539       497      486       441      386       434       564
General and administrative......        460      473       459      466       483      422       462       463
Operating expenses..............      2,079    2,083     1,926    1,851     1,842    1,869     1,834     2,026
                                     ------   ------    ------   ------    ------   ------    ------    ------
Operating income (loss).........        (67)       4      (205)     220      (142)     (87)       (5)       44
Financial income (expense), net.          3      101        42      (12)       16       22       (11)       97
Other income (loss).............         17       (5)      (71)     (81)       --        6        --        --
                                     ------   ------    ------   ------    ------   ------    ------    ------
Income (loss) before taxes......        (47)     100      (234)     127      (126)     (59)      (16)      141
Taxes on income (tax benefit)...         --       65       (51)      38        --       (2)       98       102
                                     ------   ------    ------   ------    ------   ------    ------    ------
Net income (loss) before equity in
  earnings (loss) of affiliate..        (47)      35      (183)      89      (126)     (57)     (114)       39
Equity interest in results of
affiliate.......................         38       84        84       30       139       48       117        41
                                     ------   ------    ------   ------    ------   ------    ------    ------
Net income (loss)...............        $(9)    $119     $ (99)   $ 119      $ 13     $ (9)      $ 3       $80
                                     ======   ======    ======   ======    ======   ======    ======    ======

Revenues........................      100.0%   100.0%    100.0%   100.0%    100.0%   100.0%    100.0%    100.0%
Cost of revenues................       22.0     16.3      21.6     17.7      24.1     18.7      20.0      17.6
                                     ------   ------    ------   ------    ------   ------    ------    ------
Gross profit....................       78.0     83.7      78.4     82.3      75.9     81.3      80.0      82.4
                                     ------   ------    ------   ------    ------   ------    ------    ------
Selling and marketing, net......       39.3     42.9      44.2     35.7      41.0     48.4      41.0      39.8
Research and development,
   net .........................       23.4     21.6      22.6     19.3      19.7     17.6      19.0      22.5
General and administrative......       17.8     19.0      20.9     18.5      21.6     19.2      20.2      18.4
Operating expenses..............       80.5     83.5      87.7     73.5      82.3     85.2      80.2      80.7
                                     ------   ------    ------   ------    ------   ------    ------    ------
Operating income (loss).........       (2.5)     0.2      (9.3)     8.8      (6.4)    (3.9)     (0.2)      1.7
Financial income (expense), net.        0.1      4.1       1.9     (0.5)      0.7      1.0      (0.5)      3.9
Other income (loss).............        0.7     (0.2)     (3.2)    (3.2)     --        0.3      --        --
                                     ------   ------    ------   ------    ------   ------    ------    ------
Income (loss) before taxes......       (1.7)     4.1     (10.6)     5.1      (5.7)    (2.6)     (0.7)      5.6
Taxes on income (tax benefit)...         --     (2.6)      2.3     (1.5)      --      (0.1)      4.3       4.1
                                     ------   ------    ------   ------    ------   ------    ------    ------
Net income (loss) before equity in
  results of affiliate..........       (1.7)     1.5      (8.3)     3.6      (5.7)    (2.5)     (5.0)      1.5
Equity interest in results of
  affiliate.....................        1.5      3.4       3.8      1.2       6.2      2.2       5.1       1.6
                                     ------   ------    ------   ------    ------   ------    ------    ------
Net income (loss)...............       (0.2%)    4.9%     (4.5%)    4.8%      0.5%    (0.3)%     0.1%      3.1%
                                     ======   ======    ======   ======    ======   ======    ======    ======
</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.

                                       35

<PAGE>




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 or dollar-linked NIS for most of our sales, while we incur a
portion of our expenses in NIS.

        In addition, since part of our sales are quoted in NIS, and a portion of
our expenses are incurred in NIS, our results may be adversely affected by a
change in the rate of inflation in Israel if the amount of our revenues in NIS
decreases and is less than the amount of our expenses in NIS (or if such
decrease is offset on a lagging basis) 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 %
    ------------     ----------------- - ----------------   ------------------
        1999                1.3               (0.2)                1.5
        2000                0                 (2.7)                 --
        2001                1.4                9.3                (7.2)
        2002                6.5                7.3                (0.7)
        2003               (1.9)              (7.6)                6.2

        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

        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

                                       36



<PAGE>


affected by political, economic and military conditions in 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.

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.
There is no indication as to how long the current hostilities will last or
whether there will be any further escalation. Any further escalation in these
hostilities or 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 may have an adverse impact on our operations, our
financial results or the expansion of our business.

        In addition, some of our executive officers and employees in Israel are
obligated to perform up to 36 days, depending on rank and position, of military
reserve duty annually and are subject to being called for active duty under
emergency circumstances. 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

        Israel's economy has been subject to numerous destabilizing factors,
including a period of rampant inflation in the early to mid-1980s, low foreign
exchange reserves, fluctuations in world commodity prices, military conflicts
and civil unrest. Due to the continuing budget deficit of the Israeli Government
and the slow down of the Israeli economy in recent years, the Israeli Parliament
approved, during 2003, several economic measures which entail, among other
things, budget cuts in various sources of government spending, the increase of
various tax liabilities and cuts in various social benefits. It is not known at
this stage what impact the implementation of the approved economic plan will
have on the Israeli economy.

        As a result of political instability, the increased level of hostilities
with the Palestinian Authority and the world-wide economic crisis in the hi-tech
and communication industries, the Israeli rate of economic growth deteriorated
in 2001 and 2002, the NIS was devalued and the rate

                                       37



<PAGE>


of inflation increased. The Israeli Government has proposed certain budgetary
cuts and other changes, which were recently adopted by the Israeli Parliament.
Although with the assistance of the U.S. Government economic stability was
reached in 2003 and the rate of inflation was negative for the first since the
establishment of the State, we cannot assure you that the Israeli Government
will be successful in its attempts to stabilize the Israeli economy or to
maintain Israel's current credit rating. Should Israel's credit rating decline,
the ability of the Israeli Government to generate foreign financial and economic
assistance may be adversely affected. Economic decline as well as price and
exchange rate instability may have a material adverse effect on us.

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 tax at the rate of 36% of
taxable income. 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. The tax benefits under the Investment Law are not available with
respect to income derived from products manufactured outside of Israel. 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 to four years,
commencing in the first year in which such income is earned, and will be
entitled to a reduced tax rate of 15% for an additional 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.

                                       38

<PAGE>




        Our effective tax rates in Israel were 25% during the years 2001, 2002
and 2003. Our effective corporate tax rate may substantially exceed the Israeli
tax rate.

        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, which historically have been profitable.

B.   LIQUIDITY AND CAPITAL RESOURCES

        On December 31, 2003, we had $8.7 million in cash and cash equivalents,
$1.6 million in marketable securities and working capital of $9.4 million as
compared to $9.1 million in cash and cash equivalents, $1.2 million in
marketable securities and $9.2 million in working capital on December 31, 2002.
The increase in working capital in 2003 is mainly due to an increase in both
accounts receivables and other accounts receivable and prepaid expenses. During
2003 we continued our stock buy back program, purchasing 130,510 ordinary shares
through December 31, 2003 at a cost of $147,000, an average of $1.13 per share.
During 2003 we retired 384,610 ordinary shares, which we purchased pursuant to
our stock buy-back program. Depending upon market conditions, we may decide to
continue this program during 2004. We may use the repurchased shares for
issuance upon exercise of employee stock options or other corporate purposes.

        One of the principal factors affecting our working capital is the
payment cycle on our sales. Payment for goods shipped is generally received from
60 to 70 days after shipment. Any material change in the aging of our accounts
receivable could have an adverse effect on our working capital.

        The decrease in inventory for the year ended December 31, 2003 was
primarily due to our efforts to reduce inventories in light of the difficult
economic conditions prevailing worldwide. Our net accounts receivable at
year-end 2003 were $1.39 million compared to $1.26 million as of December 31,
2002. The change is attributed to outstanding accounts receivable belong to
recent projects that were performed at the end of 2003. The allowance for
doubtful accounts was $356,000 and $350,000 as of December 31, 2002 and 2003,
respectively.

        Our operations provided $163,000 for the year ended December 31, 2003,
compared to $489,000 for the year ended December 31, 2002. The decrease in cash
provided from operations was primarily due the reduced equity in the earnings of
our affiliates and an increase in trade payables, accounts receivable and
prepaid expenses.

        As of December 31, 2003, our principal commitments consisted of
obligations outstanding under operating leases. 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 to 18 months. Thereafter, if we do not generate sufficient cash from
operations, we may be required to obtain additional financing. There can be no
assurance that such financing will be available in the future, or, if available,
will be on terms satisfactory to us.

                                       39

<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. We are ISO
9001:1994 certified and we are currently in the process of upgrading the quality
system according to ISO 9001:2000.

        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, 2003, we employed 23 persons in research and
development. As part of our product development team, we employ technical
writers who prepare user documentation for our products.

        We have committed substantial financial resources to research and
development for our telemanagement business. We enjoyed the aid of the Israeli
Ministry of Industry and Trade's Office of the Chief Scientist for selected
research and development projects. During 2001, 2002 and 2003, our research and
development expenditures were $4.6 million, $2.1 million and $1.8 million,
respectively, for which the Office of the Chief Scientist reimbursed us
approximately $0.99 million in 2001. We did not receive any grants in 2002 or
2003.

        Under research and development agreements with the Office of the Chief
Scientist, we are required to pay royalties on the revenues derived from
products incorporating know-how developed with grants received from the Office
of the Chief Scientist (including ancillary services in connection therewith),
up to a dollar-linked amount equal to 100% to 150% of such grants and bearing
LIBOR interest. Commencing in 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. Under these agreements and existing laws and
regulations, we are required to pay royalties at a rate of 3%-5% of our software
sales. 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 such grants in
the amounts of $176,000, $132,000 and $146,000 for the years ended December 31,
2001, 2002 and 2003, respectively.

        As of December 31, 2003, we had a contingent obligation to pay royalties
in the amount of approximately $7.52 million. The $3.45 million of grants
received after January 1999 are subject to interest at a rate equal to the 12
month LIBOR rate. We do not expect to receive additional grants from the
Government of Israel during 2004.

                                       40

<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, 2003 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>
Long-term debt obligations.......           --           --          --          --          --
Capital (finance) lease obligations         --           --          --          --          --
Operating lease obligations......          $540,000    $276,000    $264,000      --          --
Purchase obligations.............           --           --          --          --          --
Other long-term liabilities reflected
    on our balance sheet under U.S.
    GAAP ........................           --           --          --          --          --

Total............................          $540,000    $276,000    $264,000      --          --
                                            =======     =======     =======      ==          ==
</TABLE>


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:

   Name                      Age           Position with the Company
   ----                      ---   ---------------------------------
   Chaim Mer...............   56   Chairman of the Board
   Eytan Bar...............   38   President and Chief Executive Officer
   Yossi Brikman...........   46   Corporate Chief Operating Officer and Chief
                                   Financial Officer-Israel
   Richard Bruyere.........   40   Chief Operating Officer-MTS IntegraTRAK Inc.
   Alon Aginsky............   41   Director
   Isaac Ben-Bassat........   50   Director



                               41

<PAGE>



   Name                      Age           Position with the Company
   ----                      ---   ---------------------------------
   Dr. Yehoshua Gleitman...   54   Director
   Steven J. Glusband......   57   Director
   Yaacov Goldman..........   49   Director
   Prof. Nava Pliskin......   56   Director


        Messrs. Mer, Aginsky, Ben-Bassat, Glusband and Goldman will serve as
directors until our 2004 Annual General Meeting of Shareholders. Dr. Gleitman
and Prof. Pliskin serve as outside directors pursuant to the provisions of the
Israeli Companies Law for a three-year term from the date of their appointment
until our 2004 annual general meeting of shareholders. At that time, they may be
re-elected 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 President,
Chief Executive Officer and Chairman of the Board of C. Mer Industries Ltd.
since 1988. 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 a Vice President of Professional Services at NICE
Systems Inc. From 1993 through 1999, Mr. Bar served as a General Manager of STS
Software Systems Ltd., a company that developed a unique VoIP technology for
recording solutions.

        Yossi Brikman has been our Vice President and Chief Financial Officer
since January 1998. Since March 2000, Mr. Brikman has also served as our
Secretary. He was appointed as General Manager of our operations in Israel in
August 2000. Before joining us, he served as co-founder and co-manager of STS
Software Systems Ltd. from its inception in 1988 until January 1998. Mr. Brikman
holds a B.Sc. degree from Fairleigh Dickenson University and an M.B.A. degree
from Haifa University.

        Richard Bruyere has been the Chief Operating Officer of our subsidiary,
MTS IntegraTRAK Inc., since January 2002. After having served as Director of
Telecommunications for Memorial Hospital from 1987 to 1995, Mr. Bruyere joined
IntegraTRAK Inc. in January 1995. In October 1998, he was elected Vice President
of Operations of IntegraTRAK Inc. Mr. Bruyere joined MTS as part of our
acquisition of IntegraTRAK Inc. in April 2000.

        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, when he was appointed
Manager of C. Mer Industries Ltd. He served as President of MTS Inc., our U.S.
based marketing subsidiary from 1990 until September 1996. 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. He has been Executive Vice President and a director of C. Mer Industries
Ltd. since 1988.

                                       42



<PAGE>


Mr. Ben-Bassat holds a B.Sc. degree in Civil Engineering from the Technion
Israel Institute for Technology.

        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, he was Director General of the
Israeli Ministry of Industry and Trade and was Chief Scientist at the Ministry
of Industry and Trade from January 1993 through February 1997. From 1991 through
1992, he was the general manager of AIMS Ltd., and between 1990-1991, was an
advisor in charge of marketing and business for Ashtrom Ltd. Dr. Gleitman holds
a Ph.D. and an 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 was elected as a director by our Board of Directors in
May 2004 and will be a nominee for election at our 2004 Annual General Meeting
of Shareholders. 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. and Elron Electronic Industries Ltd. From March 2002 until
October 2002, he served as consultant for Poalim Capital Markets and Investments
Ltd. From September 2000 until November 2001, he 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, he 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.

        Prof. Nava Pliskin has served as an outside director since July 2001.
Prof. Pliskin has been a Full Professor since 2002 in the areas of Information
Systems (IS) and Information Technology (IT) at the Department of Industrial
Engineering and Management of Ben-Gurion University in Israel. She has been a
faculty member at Ben-Gurion University since 1985, receiving tenure in 1992.
Prof. Pliskin was a Thomas Henry Carroll Ford Foundation Visiting Associate
Professor at the Harvard Business School in 1996-1997. Prof. Pliskin holds Ph.D.
and S.M. degrees in Engineering and Applied Physics from Harvard University and
a B.Sc. in Mathematics and Statistics 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, 2003.

                                       43

<PAGE>




                                          Salaries, fees,        Pension,
                                          commissions and     retirement and
                                              bonuses        similar benefits
                                          ----------------   ----------------
 All directors and executive officers
 as a group, consisting of twelve (12)
 persons                                      $625,694           $179,327

        All our executive officers work full time for us, except for Mr. Mer,
who is employed on a part-time basis. We provide automobiles to our executive
officers at our expense. During the year ended December 31, 2003, we paid each
of our independent directors an annual fee of approximately $8,400 and a per
meeting attendance fee of $300.

        As of December 31, 2003, our directors and executive officers as a
group, consisting of 12 persons, held options to purchase an aggregate 262,990
ordinary shares.

C.   BOARD PRACTICES

        Our Articles of Association provide for a Board of Directors consisting
of up to 10 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. All directors (except the outside directors) hold
office until the next annual general meeting of shareholders and until their
successors have been elected.

Election of Directors

        Pursuant to our articles of association, all of our 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. 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 2003.

Independent and Outside 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. 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.

                                       44

<PAGE>




        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.

        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 are present at the meeting and
voting 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 Stock Market requires us to have at least two
independent directors on our Board of Directors and to establish an audit
committee. Under Nasdaq rules promulgated pursuant to the Sarbanes-Oxley Act of
2002, we will be required in the future to have three independent directors on
our audit committee. Dr. Yehoshua Gleitman and Prof. Nava Pliskin qualify both
as independent directors under the Nasdaq Stock Market requirements and as
outside directors under the Israeli Companies Law requirements. Messrs. Alon
Aginsky and Yaacov Goldman qualify as independent directors under the Nasdaq
Stock Market requirements.

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 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. 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.

                                       45

<PAGE>




        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, such
a transaction must be approved by the audit committee and by the board of
directors itself (with further shareholder approval required in the case of
extraordinary transactions). 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 some transactions between a
public company and a controlling shareholder, or transactions in which a
controlling shareholder of the company has a personal interest but which are
between a public company and another entity, require the approval of the board
of directors and of the shareholders. Moreover, an extraordinary transaction
with a controlling shareholder or the terms of compensation of a controlling
shareholder 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 and are present at the meeting. 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) do not require shareholder approval.

        In addition, pursuant to the recent amendment to these regulations,
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.

        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

                                       46

<PAGE>


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% shareholder of the company. This
rule does not apply if there is already another 25% shareholder of the company.
Similarly, the 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 45% shareholder of the company, unless
there is a 50% shareholder of the company. Regulations under the Companies Law
provide that the 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

        The Israeli Companies Law provides that an Israeli company cannot
exculpate an office holder from liability with respect to a breach of his duty
of loyalty, but may, if permitted by its articles of association, exculpate in
advance an office holder from his liability to the company, in whole or in part,
with respect to a breach of his duty of care. Our Articles of Association permit
us to exempt an officer for his liability, in whole or in part, for damage
caused due to the breach of the duty of care, subject to the provisions of the
Israeli Companies Law.

        Our Articles of Association provide that, subject to the provisions of
the Israeli Companies Law, we may enter into an insurance contract for the
liability of an officer with respect to an act performed by him in his capacity
as an officer, for:

     o    a breach of his duty of care to us or to another person;

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

     o    a financial liability imposed upon him in favor of another person.

        In addition, our Articles of Association provide that we may, with
respect to an act performed by an officer in such capacity, (i) undertake in
advance to indemnify an officer, provided that the undertaking shall be
restricted to types of events that the board of directors shall deem to have
been foreseeable at the time the undertaking to indemnify is made, and to a sum
which shall not exceed an amount in NIS equal to $3 million; and (ii) indemnify
an officer retroactively; against:

     o    a financial liability imposed on him in favor of another person by any
          judgment, including a settlement or an arbitration award approved by a
          court; and

                                       47

<PAGE>




     o    reasonable litigation expenses, including attorneys' fees, expended by
          such office  holder or charged to him by a court,  in a proceeding  we
          instituted  against  him or  instituted  on our  behalf or by  another
          person,  or in a criminal  charge  from which he was  acquitted  or in
          which he was  convicted of an offense  that does not require  proof of
          criminal intent.

        These provisions are specifically limited in their scope by the Israeli
Companies 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.

        Pursuant to the 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 such office holder is a director, also by our shareholders.

        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. We currently maintain a directors' and officers' liability insurance
policy with a per claim and aggregate coverage limit of $2.5 million including
legal costs incurred in Israel. We intend to increase our coverage to $5
million, subject to shareholder ratification at our Annual General Meeting that
is scheduled to take place in July 2004.

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.

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,
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.

        Our audit committee consists of four board members 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, Prof. Nava Pliskin 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.

                                       48

<PAGE>




        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.

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 serves as our internal auditor.

D.   EMPLOYEES

        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.

        On December 31, 2002, we and our consolidated subsidiaries employed 90
persons, of which 27 persons were employed in research and development, 31 in
training and technical support, 15 in marketing and sales and 17 in operations
and administration.

        On December 31, 2001, we and our consolidated subsidiaries employed 106
persons, of which 33 persons were employed in research and development, 37 in
training and technical support, 20 in marketing and sales and 16 in operations
and administration.

        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 2003, 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.

                                       49



<PAGE>


        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
satisfy approximately 8.3% of this obligation by contributing funds to a fund
known as "Managers' Insurance." This fund provides a combination of savings
plans, insurance and severance pay benefits to the employee, giving the employee
a lump sum payment upon retirement and a severance payment, if legally entitled,
upon termination of employment. The remaining part of this obligation is
presented in our balance sheet as "provision of severance pay."

E.   SHARE OWNERSHIP

        The following table sets forth certain information as of June 1, 2004
regarding the beneficial ownership of our ordinary shares by each of our
directors and executive officers.

                                            Number of       Percentage of
                                         Ordinary Shares     Outstanding
                                          Beneficially        Ordinary
Name                                        Owned(1)          Shares(2)
----                                    ----------------    -------------
Chaim Mer...........................    2,099,778 (3)(4)       44.3%
Eytan Bar ..........................       31,250                *
Yossi Brikman.......................      150,000 (5)           3.2
Richard Bruyere.....................       20,000 (5)            *
Alon Aginsky........................        --    (5)            --
Isaac Ben-Bassat....................      689,214 (6)           14.8
Dr. Yehoshua Gleitman...............        --                   --
Steven J. Glusband..................        5,722 (5)(7)         *
Yaacov Goldman......................        --                   --
Prof. Nava Pliskin..................        --                   --
----------
* 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 4,641,804 ordinary shares (excluding
        7,000 shares held in treasury) issued and outstanding as of June 1,
        2004.

(3)     Mr. Chaim Mer and his wife, Mrs. Dora Mer, are the holders of 244,821
        ordinary shares, and are the beneficial owners of 1,744,453 ordinary
        shares through their

                                       50



<PAGE>


        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)     Includes 98,824 ordinary shares issuable upon exercise of stock options.

(5)     Subject to currently exercisable stock options.

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

(7)     Includes 4,722 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 in 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 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 2003, options to purchase 35,000 ordinary shares were granted
under our 1996 Plan, with an average exercise price of $2.94 and no options were
exercised into ordinary shares. At December 31, 2003, options to purchase
103,350 ordinary shares were outstanding under the 1996 Plan, exercisable at an
average exercise price of $2.85 per share.

                                       51

<PAGE>




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 new 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 2003, options to purchase 67,000 ordinary shares were granted
under the 1996 102 Plan at an exercise price below the fair market value of the
stock on the date of grant and options to purchase 133,333 ordinary shares were
exercised into ordinary shares. At December 31, 2003, options to purchase
362,791 ordinary shares were outstanding, exercisable at an average exercise
price of $2.85 per share.

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

                                       52



<PAGE>


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. However, such committee,
if appointed, is not entitled to grant options. 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 2003, options to purchase an aggregate of 332,500 ordinary shares
were granted under the 2003 Plan at an average exercise price of $2.11 per
share, including 250,000 options having exercise prices below the fair market
value of our ordinary shares on the date of grant. No options were exercised
into ordinary shares in 2003. At December 31, 2003, there were 332,500 options
outstanding under the 2003 Plan having an exercise price of $2.11 per share.

Warrants

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

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

A.   MAJOR SHAREHOLDERS

        The following table sets forth certain information as of June 1, 2004
regarding the beneficial ownership by all shareholders known to us to own
beneficially 5.0% or more of our ordinary shares:

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<PAGE>




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

Chaim Mer and Dora Mer............      2,099,778 (3)(4)              44.3%
Isaac Ben-Bassat..................        689,214                     14.8%
                                                                      ----
Total.............................       2,788,992                    59.1%
                                         =========                    ====
-----------

(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 4,641,803 ordinary shares (excluding
        384,610 shares held in treasury) issued and outstanding as of June 1,
        2004.

(3)     Mr. Chaim Mer and his wife, Mrs. Dora Mer, are the holders of 234,821
        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)     Includes 98,824 ordinary shares issuable upon exercise of stock options.

        As of June 1, 2004 there were 26 holders of record of our ordinary
shares, of which 8 record holders holding approximately 32% of our ordinary
shares had registered addresses in the United States. We believe that there were
over 52 beneficial holders of our ordinary shares on June 1, 2004.

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 the Board of Directors and by the 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 its President, Chief Executive Officer and Chairman of its Board of
Directors since 1988.

                                       54



<PAGE>


        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.

C.   INTERESTS OF EXPERTS AND COUNSEL

        Not applicable.

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

A.   CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION

        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 17(b) of our Consolidated Financial Statements.

Legal Proceedings

        In March 2004, our U.S.-based subsidiary was named as a defendant in
a complaint filed in the United States District Court for the Northern  District
of Georgia, Atlanta Division,  captioned Telemate.net Software, Inc. v. James A.
Myers,  Total Wire Software  Company,  Inc. and MTS Integratrak,  Inc., Civ. No.
1:04-CV  0570.  The  plaintiff  alleges  among other  things  federal  copyright
infringement,  federal unfair  competition,  common law unfair  competition  and
misappropriation  of trade  secrets in  connection  with our license of software
from James A. Myers.  In a related  action in the State Court of Fulton  County,
State of Georgia, captioned James A. Myers v. Telemate.net Software, Inc. v. MTS
Integratrak,  Inc. and Total Wire Software Company, Inc., Case No. OIVS021284-Y,
Telemate filed a third-party complaint against MTS Integratrak based on the same
license, claiming misappropriation of trade secrets. The plaintiff is seeking an
injunction  against our future sales of the product,  damages,  an accounting of
any sales of such  product,  and  attorneys'  fees. We have moved to dismiss the
federal  complaint  and have not  responded  to the state  complaint as yet, but
believe that we have good and valid defenses that we will assert.

Tax assessment

        In April 2000, the tax authorities in Israel issued to us a demand for a
tax payment in the amount of approximately NIS 6,000,000 (approximately
$1,350,000) for the period of 1997 to 1999.

        We have appealed to the Israeli district court in respect of the
abovementioned tax demand. Based on the opinion of our tax counsel, we believe
that certain defenses can be raised against the demand of the tax authorities.
We believe that the outcome of this matter will not have a material adverse
effect on our financial position or results of operations. We made a provision
for such assessment based on the current evidence and the opinion of our tax
consultants, which we believe is adequate.

                                       55

<PAGE>




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 the 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, so long as the company reasonably believes that
such dividend distribution will not prevent the company from paying all its
current and future debts. Profits, for purposes of the Israeli Companies Law,
means the greater of retained earnings or earnings accumulated during the
preceding two years. In the event cash dividends are declared, such dividends
will be paid in NIS.

B.   SIGNIFICANT CHANGES

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
SmallCap Market.

          Year                      High        Low
          ----                      ----        ---
          2003...................   $3. 56     $0. 87
          2002...................    1. 65      0. 75
          2001...................    4. 63      0. 90
          2000...................   17. 75      2. 50
          1999...................    7. 13      1. 25

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 SmallCap Market.

                               High        Low
                               ----        ---
2002
----
First Quarter...........     $1. 65     $0. 98
Second Quarter..........      1. 05      0. 91
Third Quarter...........      1. 00      0. 80
Fourth Quarter..........      1. 23      0. 75

2003
----
First Quarter...........     $1. 05     $0. 87
Second Quarter..........      1. 90      0. 97
Third Quarter...........      2. 65      1. 65
Fourth Quarter..........      3. 56      2. 01


                                       56

<PAGE>


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
SmallCap Market.

Month                        High        Low
-----                        ----        ---
December 2003............   $3. 56      $2. 82
January 2004.............    4. 00       3. 20
February 2004............    3. 90       3. 15
March 2004...............    3. 90       3. 18
April 2004...............    3. 62       3. 29
May 2004.................    3. 45       3. 00

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 SmallCap
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

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.

                                       58



<PAGE>


        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.

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." 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

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<PAGE>


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.

        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 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. 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-

                                       59



<PAGE>


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."

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

        None.

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

                                       60



<PAGE>


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

        On January 1, 2003, a comprehensive tax reform took effect in Israel.
Pursuant to the reform, resident companies are subject to Israeli tax on income
accrued or derived in Israel or abroad. In addition, the concept of "controlled
foreign corporation" was introduced according to which an Israeli company may
become subject to Israeli taxes on certain income 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). The tax reform also
substantially changed the system of taxation of capital gains.

        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.

General Corporate Tax Structure

        Israeli companies are subject to "Company Tax" at the rate of 36% of
taxable income. However, the effective tax rate payable by a company, which
derives income from an approved enterprise (as further discussed below), may be
considerably less.

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

        The Law for the Encouragement of Capital Investments, 1959, as amended,
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

                                       61



<PAGE>


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 company tax at the maximum rate of 25% (rather than 36%) 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. 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 between two and ten years from
the first year of taxable income, depending on the geographic and social
economical location of the approved enterprise within Israel, 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 more than 25% of whose 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:

                                                            The company
            For a company with foreign investment of        tax rate is
            ----------------------------------------        -----------
            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.

        Subject to applicable provisions concerning income under the alternative
track , all dividends are considered to be attributable to the entire enterprise
and their effective tax rate is the result of a weighted average of the various
applicable tax rates. We currently intend to reinvest any income derived from
our approved enterprise programs and not to distribute such income as a
dividend.

                                       62

<PAGE>




        The Investment Center bases its decision as to whether or not to approve
an application on the criteria set forth in the Investment Law and regulations,
the prevailing policy of the Investment Center and the specific objectives and
financial criteria of the applicant. Accordingly, we cannot assure you that any
of our applications, if made, will be approved in the future.

        C. Mer Industries Ltd. was granted approved enterprise status with
respect to five investment projects and chose the alternative track with respect
to each of these projects. Subsequent to our incorporation, C. Mer Industries
Ltd. transferred four continuing approved programs to us were also granted
approval. A fifth and sixth program were also granted approval. 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,
it would be required to refund the amount of tax benefits, with the addition of
the Israeli consumer price index linkage adjustment and interest. In our
opinion, we have been in full compliance with the conditions of the above
programs through December 31, 2003.

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

        Under the Law for the Encouragement of Industrial Research and
Development, 1984, or 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 of the Israeli Ministry of Industry and Trade are
eligible for grants of up to 50% of certain of the project's expenditure, as
determined by the research committee, in exchange for the payment of royalties
from revenues derived from products (and ancillary services) incorporating
technology developed within the framework of the approved research and
development program. Regulations promulgated under the Research Law generally
provide for the payment of royalties to the Office of the Chief Scientist of
3%-5% of such revenues, until 100% to 150% of the U.S. dollar-linked grant is
repaid. Effective for grants received from the Office of the Chief Scientist
under programs approved after January 1, 1999, the outstanding balance of such
grants will be subject to interest equal to the 12 month LIBOR rate applicable
to U.S. dollar deposits that is published on the first business day of each
calendar year. Following the full repayment of the grant, there is no further
liability for repayment.

        The terms of the Israeli Government participation generally requires
that the manufacture of products developed with such grants be performed 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 and the aggregate repayment amount is increased, depending on the
portion of the total manufacturing volume that is performed outside Israel (120%
of the grant if the manufacturing volume performed outside of Israel is less
than 50%; 150% of the grant if the manufacturing volume performed outside of
Israel is between 50% and 90%, and 300% of the grant if the manufacturing volume
performed outside of Israel is more than 90%). As of April 1, 2003, the Research
Law also allows for the approval of grants in cases in which the applicant
declares that part of the manufacturing will be performed outside of Israel or
by non-Israeli residents and the research committee is convinced that the same
is essential for the execution of

                                       63

<PAGE>


the program. This declaration will be a significant factor in the determination
of the Office of Chief Scientist whether to approve a research and development
program and the amount and other terms of benefits to be granted. In such cases,
the increased royalty and repayment amount will be required.

        The technology developed pursuant to the Chief Scientist grants may not
be transferred to third parties in Israel without the prior approval of the
research committee. Approval of the transfer of technology may be granted in
specific circumstances, only if the recipient agrees to abide by the provisions
of the Research Law and regulations promulgated thereunder, including the
restrictions on the transfer of technology and the obligation to pay royalties
in an amount that may be increased. We cannot assure you that such consent, if
requested, will be granted. The Research Law provides that the technology
developed under an approved research and development program may not be
transferred to any third parties outside Israel. No approval is required for the
export of any products developed under the funded plan.

        The funds generally available for grants from the Office of the Chief
Scientist were reduced in 1998, and the Israeli authorities have indicated in
the past that the government may further reduce or abolish grants from the
Office of the Chief Scientist in the future. We did not receive any grants from
the Office of the Chief Scientist during 2003, and we do not expect to receive
any grants during 2004. In the event that development of a specific product in
which the Chief Scientist participates is successful, we will become obligated
to repay the grants received relating to the specific product through royalty
payments at the rate of 3% to 5%, based on our sales revenues, up to an amount
equal to 100% to 150% of the grant received, linked to the exchange rate of the
U.S. dollar. As of December 31, 2003, we had a contingent obligation to pay
royalties in the amount of approximately $7,520,000. The outstanding balance of
grants received after January 1999 is subject to interest equal to the 12-month
LIBOR rate.

Tax Benefits and Grants for Research and Development

        Israeli tax law allows, under specific conditions, a tax deduction in
the year incurred for expenditures, including capital expenditures, 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.
Expenditures not so approved are deductible over a three-year period.

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

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

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

                                       64

<PAGE>




     o    amortization  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.

        Eligibility for benefits under the Industry Encouragement Law is not
subject to receipt of prior approval from any governmental authority. We cannot
assure you that we will continue to qualify as an Industrial Company or that the
benefits described above will be available to us in the future.

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:

        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.

     o    Capital gains on specific  marketable  securities  are exempt from tax
          for  individuals  until  December  31, 2002 and from  January 1, 2003,
          individuals  are subject to a 15% tax rate on the real capital  gains,
          companies  are subject to a 36% tax rate on the real capital gains and
          dealers in securities are subject to the regular tax rules  applicable
          to business income in Israel.

Capital Gains Tax on Sales of Our Ordinary Shares

        Israeli law imposes a capital gains tax on the sale of capital assets.
The law distinguishes between real gain and inflationary surplus. The
inflationary surplus is a portion of the total capital gain that is equivalent
to the increase of the relevant asset's purchase price which is attributable to
the increase in the Israeli consumer price index between the date of purchase
and the date of sale. The real gain is the excess of the total capital gain over
the inflationary surplus. The inflationary surplus accumulated from and after
December 31, 1993 is exempt from any capital gains tax in Israel while the real
gain is added to ordinary income, which is taxed at ordinary rates of 30% to 50%
for individuals and 36% for corporations. For purchases subject to capital gains
treatment made since January 1, 2003, the tax has been reduced to 25%. Purchases
made prior to January 1, 2003 will be subject to taxes ranging up to 36%.

                                       65

<PAGE>




        Under current law, sales of our ordinary shares until December 31, 2002,
are exempt from Israeli capital gains for individuals so long as they are quoted
on Nasdaq or listed on a stock exchange in another country and we qualify as an
Industrial Company. We cannot assure you that we qualify or will maintain such
qualification or our status as an Industrial Company. Notwithstanding the
foregoing, dealers in securities in Israel are taxed at regular tax rates
applicable to business income. From January 1, 2003, individuals are subject to
a 15% tax rate on the real capital gain.

        Pursuant to the Convention Between the government of the United States
of America and the government of Israel with respect to Taxes on Income, as
amended (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 Treaty 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 a Treaty 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 the Treaty, such Treaty 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 in 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 other than bonus
shares or stock dividends, income tax at the rate of 25% (12.5% for dividends
not generated by an approved enterprise if the non-resident is a U.S.
corporation that holds 10% of our voting power, and 15% for dividends generated
by an approved enterprise) is withheld at source, unless a different rate is
provided by a treaty between Israel and the shareholder's country of residence.
Under the Treaty, the maximum tax on dividends paid to a holder of ordinary
shares who is a Treaty U.S. Resident will be 25%. However, under the Investment
Law, dividends generated by an approved enterprise are taxed at the rate of 15%.

        Under an amendment to the Inflationary Adjustments Law, non-Israeli
entities might be subject to Israeli taxes on the sale of traded securities in
an Israeli company, subject to the provisions of any applicable double taxation
treaty.

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.

                                       66

<PAGE>




Recent Tax Reform Legislation

        On July 24, 2002, Amendment 132 to the Israeli Tax Ordinance was
approved by the Israeli parliament and came into effect on January 1, 2003. The
principal objectives of the amendment were to broaden the categories of taxable
income and to reduce the tax rates imposed on employees' income.

        The material consequences of the amendment applicable to our company
include, among other things, imposing a tax upon all income of Israeli
residents, individuals and corporations, regardless of the territorial source of
the income and certain modifications in the qualified taxation tracks of
employee stock options.

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 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,

     o    certain insurance companies,

     o    investors liable for alternative minimum tax,

     o    tax-exempt organizations,

     o    regulated investment companies,

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

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

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

     o    investors that own, or have owned,  actually or constructively own 10%
          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.

                                       67



<PAGE>




        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;

     o    a partnership,  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

        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 principles. You will be required to include this amount of dividends
in gross income as ordinary income (see "-New Tax Law Applicable to Dividends
and Long-Term Capital Gain," below). 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 such day 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.

        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.

                                       68

<PAGE>


federal income taxes otherwise payable with respect to each such class of income
(see "-New Tax Law Applicable to Dividends and Long-Term Capital Gain," below).
Dividends generally will be treated as foreign-source passive income or
financial services income for United States foreign tax credit purposes. Foreign
income taxes exceeding the credit limitation for the year of payment or accrual
may be carried back for two taxable years and forward for five taxable years in
order to reduce U.S. federal income taxes, subject to the credit limitation
applicable in each of such years. Other restrictions on the foreign tax credit
include a prohibition on the use of the credit to reduce liability for the U.S.
individual and corporation alternative minimum taxes by more than 90%. A U.S.
Holder will be denied a foreign tax credit with respect to Israeli income tax
withheld from dividends received on the ordinary shares to the extent such U.S.
Holder has not held the ordinary shares for at least 16 days of the 30-day
period beginning on the date which is 15 days before the ex-dividend date or to
the extent such U.S. Holder is under an obligation to make related payments with
respect to substantially similar or related property. Any days during which a
U.S. Holder has substantially diminished its risk of loss on the ordinary shares
are not counted toward meeting the 16-day holding period required by the
statute. 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.

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 U.S. dollar value of the amount realized, as discussed
below, 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.

        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,
or the IRS. 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

                                       69

<PAGE>


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.

New Tax Law Applicable to Dividends and Long-Term Capital Gain

        Under recently enacted amendments to the Code, dividends received by
individual U.S. Holders from certain foreign corporations, and long-term capital
gain realized by individual U.S. Holders, generally are subject to a reduced
maximum tax rate of 15 percent through December 31, 2008. Dividends received
with respect to ordinary shares should qualify for the 15 percent rate. The rate
reduction does not apply to dividends received from "foreign investment
companies," "foreign personal holding company" or "passive foreign investment
companies" (see below), or in respect of certain short-term or hedged positions
in the common stock or in certain other situations. The legislation contains
special rules for computing the foreign tax credit limitation of a taxpayer who
receives dividends subject to the rate reduction. U.S. Holders should consult
their own tax advisors regarding the implications of these rules in light of
their particular circumstances.

Passive Foreign Investment Companies

        For U.S. federal income tax purposes, we will be considered a passive
foreign investment company, or 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, passive income includes
dividends, interest, royalties, rents, annuities and the excess of gains over
losses from the disposition of assets which produce passive income. If we were
determined to be 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.

        As a result of our substantial cash position and the declining value of
our stock, there is a substantial risk that we will be classified as a PFIC
under the asset test described in the preceding paragraph. However, because the
determination of whether we are a PFIC is based upon the composition of our
income and assets from time to time, this determination can not be made with
certainty until the end of each calendar year. Based on studies preformed by an
independent consultant, we believe that we were not a PFIC in 2001, 2002 or
2003.

        If we are treated as a PFIC for any taxable year, then, unless you elect
either to treat your investment in ordinary shares as an investment in a
"qualified electing fund," or a QEF election, or to "mark-to-market" your
ordinary shares, as described below, dividends would not qualify for the reduced
maximum tax rate, discussed above, and

     o    you would 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, and an interest

                                       70



<PAGE>


          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

     o    you  would 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.

        If you make either a timely QEF election or a timely mark-to-market
election in respect of your ordinary shares, you would not be subject to the
rules described above. If you make a timely QEF election, you would be required
to include in your income for each taxable year your pro rata share of our
ordinary earnings as ordinary income and your pro rata share of our net capital
gain as long-term capital gain, whether or not such amounts are actually
distributed to you. You would not be eligible to make a QEF election unless we
comply with certain applicable information reporting requirements. We will
provide U.S. Holders with the information needed to report income and gain under
a QEF election if we are classified as a PFIC.

        Alternatively, if you elect to "mark-to-market" your ordinary shares,
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 on the
disposition of ordinary shares with respect to which the mark-to-market election
is made, is treated as ordinary income or loss.

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.



                                       71

<PAGE>




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 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: 450 Fifth Street, N.W., Judiciary Plaza, Room 1024, 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. The Exchange Act file number for our Securities
and Exchange Commission filings is 0-28950.

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

     I.   SUBSIDIARY INFORMATION

        Not applicable.

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<PAGE>




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 1.0% to 1.5%, 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 results
of operations and cash flows can be affected by fluctuations in foreign currency
exchange rates (primarily the Euro). A hypothetical 10% movement in foreign
currency rates (primarily the Euro) against the dollar, with all other variables
held constant on the expected sales, would result in a decrease or increase in
expected 2004 sales of $500,000. In 2003 we entered into a commitment to
purchase dollars and sell euros having a value of euro 700,000, of which euro
300,000 was purchased in January 2001.

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.

                                       73

<PAGE>




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

        During 2003, we carried out an evaluation, under the supervision and
with the participation of our senior management, including our chief executive
officer and chief financial officer, of the effectiveness of the design and
operation of our disclosure controls and procedures pursuant to Rule 13(a)-14 of
the Securities Exchange Act of 1934. Based upon that evaluation, our management,
including our chief executive officer and chief financial officer, concluded
that our company's disclosure controls and procedures are effective in timely
alerting them to material information relating to us required to be included in
the our periodic SEC filings.

        There have been no significant changes in our internal controls or other
factors which could significantly affect internal controls subsequent to the
date of the evaluation.

        It should be noted that any system of controls, however well designed
and operated, can provide only reasonable, and not absolute, assurance that the
objectives of the system are met. In addition, the design of any control system
is based in part upon certain assumptions about the likelihood of future events.
Because of these and other inherent limitations of control systems, there can be
no assurance that any design will succeed in achieving its stated goals under
all potential future conditions.

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

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

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

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 independent public accountants and the percentage of each of
the fees out of the total amount paid to the accountants.

                                       74

<PAGE>



<TABLE>
<CAPTION>
                                                 Year Ended December 31,
                                     ------------------------------------------------------
                                              2002                         2003
                                     -------------------------    -------------------------
          Services Rendered             Fees       Percentages      Fees        Percentages
       ---------------------         --------      -----------    -------       -----------
       <S>                           <C>              <C>         <C>             <C>
       Audit (1)............          $53,269          51.0%      $45,500          61.0%
       Audit-related (2)....            2,047           2.0%          484           1.0%
       Tax (3)..............           48,485          47.0%       28,700          38.0%
       Other (4)............               --             --           --             --
       Total ...............         $103,801         100.0%      $74,684         100.0%
</TABLE>
--------------
(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 accountant can
       reasonably provide.

(2)    Audit-related fees relate to attestation services that are required by
       statute or regulation.

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

(4)    Other fees relate to products and services provided by the independent
       accountant, other than the services reported under the categories above.


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 SEC, and
also requires the audit committee to consider whether proposed services are
compatible with the independence of the public accountants all the services
provided by our independent accountants in 2003 were approved in advance by our
Audit committees.

ITEM 16D.  EXEMPTIONS  FROM THE LISTING  REQUIREMENTS  AND  STANDARDS  FOR AUDIT
           COMMITTEE
           ---------------------------------------------------------------------

        Not applicable.

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

Issuer Purchase of Equity Securities

        The following table sets forth, for each of the months indicated, the
total number of shares purchased by us or on our behalf or any affiliated
purchaser, the average price paid per share, the number of shares purchased as
part of a publicly announced repurchase plan or

                                       75


<PAGE>


program, the maximum number of shares or approximate dollar value that may yet
be purchase under the plans or programs.

<TABLE>
<CAPTION>
                                                                                Maximum Number
                                                             Total Number of    (or Approximate
                                                            Shares Purchased   Dollar Value) of
                                                               as Part of       Shares that May
                                                                Publicly       Yet Be Purchased
                       Total Number of     Average Price     Announced Plans    Under the Plans
   Period in 2003     Shares Purchased    Paid per Share       or Programs        or Programs
   --------------     ----------------    --------------       -----------        -----------
<S>                           <C>                <C>                <C>                <C>
January..........               4,450             $0.963            265,550             34,450
February.........               7,360              $0.99            272,910             27,090
March............               2,900             $1.035            275,810             24,190
April............             108,800            $1.0489            384,610            215,390
May..............                 ---                ---            384,610            215,390
June.............                 ---                ---            384,610            215,390
July.............                 ---                ---            384,610            215,390
August...........               2,000             $2.095            386,610            213,390
September........               1,100              $2.06            387,710            212,290
October..........                 ---                ---            387,710            212,290
November.........                 ---                ---            387,710            212,290
December.........               3,900             $3.077            391,610            208,390
</TABLE>

1.      Under our stock repurchase program, which was publicly announced in
December 2000, 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 under our stock repurchase program to 600,000 ordinary
shares. Through June 1, 2004 we have repurchased 391,610 ordinary shares, at a
total cost of $477,000.


                                       76

<PAGE>



                                    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.

Index to Consolidated Financial Statements. ................................F-1

        Report of Independent Auditors .....................................F-2

        Consolidated Balance Sheets.........................................F-3

        Consolidated Statements of Operations...............................F-5

        Statements of Changes in Shareholders' Equity.......................F-6

        Consolidated Statements of Cash Flows...............................F-7

        Notes to Consolidated Financial Statements..........................F-9

        Appendix to Consolidated Financial Statements.......................F-37

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

        Index to Exhibits

        Exhibit   Description
        -------   -----------

          *3.1    Memorandum of Association of the Registrant

          *3.2    Articles of Association of the Registrant

          *4.1    Specimen of Ordinary Share Certificate

          8.1     List of Subsidiaries of the Registrant

        *10.1     1996 Employee Stock Option Plan

        *10.2     Section 102 Stock Option Plan

         10.3     2003 Israeli Share Option Plan

       **10.4     Form of Consultant's Warrant

         14.1     Code of Ethics

                                       77

<PAGE>


         23.1     Consent of Kost Forer Gabbay & Kasierer, a Member of Ernst &
                  Young Global

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

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

         32.1     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.

         32.2     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.

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

        *      Filed as an exhibit to our registration statement on Form F-1,
               registration number 333-05814, filed with the Securities and
               Exchange Commission, and incorporated herein by reference.

        **     Filed as exhibit 10.5 to our Annual Report on Form 20-F for the
               year ended December 31, 2002, and incorporated herein by
               reference.

                                       78


<PAGE>



             MER TELEMANAGEMENT SOLUTIONS LTD. AND ITS SUBSIDIARIES


                        CONSOLIDATED FINANCIAL STATEMENTS


                             AS OF DECEMBER 31, 2003


                            U.S. DOLLARS IN THOUSANDS




                                      INDEX


                                                                      Page
                                                                   ------------

Report of Independent Auditors                                         F-2

Consolidated Balance Sheets                                         F-3 - F-4

Consolidated Statements of Operations                                  F-5

Statements of Changes in Shareholders' Equity                          F-6

Consolidated Statements of Cash Flows                               F-7 - F-8

Notes to Consolidated Financial Statements                         F-9 - F-36

Appendix to Consolidated Financial Statements                          F-37



                               - - - - - - - - - -



                                      F-1

<PAGE>


ERNST & YOUNG

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






                         REPORT OF INDEPENDENT AUDITORS

                             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,  2002  and  2003,  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, 2003. 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  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.  An  audit  includes
examining,  on a test basis,  evidence supporting the amounts and disclosures in
the  financial  statements.  An audit also  includes  assessing  the  accounting
principles  used  and  significant  estimates  made  by  management,  as well as
evaluating the overall  financial  statement  presentation.  We believe that our
audits provide a reasonable basis for our opinion.


     In our opinion,  the 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, 2002 and 2003, and the consolidated  results
of their  operations  and their  cash  flows for each of the three  years in the
period  ended  December 31,  2003,  in  conformity  with  accounting  principles
generally accepted in the United States.


     As discussed in Note 10a to the financial  statements,  the Company adopted
Statement of Financial Accounting Standards No. 142 in 2002.



                                              /s/ Kost Forer Gabbay and Kasierer
 Tel-Aviv, Israel                               KOST FORER GABBAY & KASIERER
 February 2, 2004                             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,
                                                                   ---------------------
                                                                      2002       2003
                                                                   ----------  ---------
<S>                                                                  <C>       <C>
   ASSETS

CURRENT ASSETS:
  Cash and cash equivalents                                          $ 9,062   $ 8,684
  Marketable securities (Note 3)                                       1,153     1,644
  Trade receivables (net of allowance for doubtful accounts of
   $ 356 and $ 350 as of December 31, 2002 and 2003, respectively)     1,259     1,391
  Other accounts receivable and prepaid expenses (Note 4)                511       566
  Inventories (Note 5)                                                   240       193
                                                                     -------   -------

Total current assets                                                  12,225    12,478
-----                                                                -------   -------

LONG-TERM INVESTMENTS:
  Investments in an affiliate (Note 6)                                 1,335     1,859
  Long-term loans, net of current maturities (Note 7)                     86        95
  Severance pay fund                                                     545       564
  Other investments (Note 8)                                             368       368
                                                                     -------   -------
Total long-term investments                                            2,334     2,886
----                                                                 -------   -------

PROPERTY AND EQUIPMENT, NET (Note 9)                                     602       482
                                                                     -------   -------
OTHER ASSETS:
  Goodwill (Note 10a)                                                  2,025     2,025
  Other intangible assets, net (Note 10b)                                360       206
  Deferred income taxes (Note 14)                                        161       105
                                                                     -------   -------
Total other assets                                                     2,546     2,336
-----                                                                -------   -------
Total assets                                                         $17,707   $18,182
-----                                                                =======   =======
</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 data)

<TABLE>
<CAPTION>
                                                                        December 31,
                                                                   ---------------------
                                                                      2002       2003
                                                                   ----------  ---------
<S>                                                                 <C>          <C>
   LIABILITIES AND SHAREHOLDERS' EQUITY

CURRENT LIABILITIES:
  Current maturities of long-term loans (Note 12)                   $       8    $      8
  Trade payables                                                          350         393
  Accrued expenses and other liabilities (Note 11)                      1,439       1,421
  Deferred revenues                                                     1,184       1,219
                                                                    ---------    --------

Total current liabilities                                               2,981       3,041
-----                                                               ---------    --------

LONG-TERM LIABILITIES:
Long-term loans, net of current maturities (Note 12)                        8           -
Accrued severance pay                                                     705         677
                                                                    ---------    --------

Total long-term liabilities                                               713         677
-----                                                               ---------    --------

COMMITMENTS AND CONTINGENT LIABILITIES (Note 13)

SHAREHOLDERS' EQUITY (Note 16):
  Share capital -
   Ordinary shares of NIS 0.01 par value - Authorized: 12,000,000
     shares as of December 31, 2002 and 2003; Issued: 4,882,748
     and 4,631,471 shares as of December 31, 2002 and 2003,
     respectively; Outstanding: 4,621,648 and 4,624,471 shares as
     of December 31, 2002 and 2003, respectively                           15          14
  Additional paid-in capital                                           12,846      12,603
  Treasury  shares (261,100 and 7,000  shares as of December 31,
     2002 and 2003, respectively)                                        (330)        (20)
  Accumulated other comprehensive income (loss)                          (211)         87
  Retained earnings                                                     1,693       1,780
                                                                    ---------    --------

Total shareholders' equity                                             14,013      14,464
-----                                                               ---------    --------

Total liabilities and shareholders' equity                          $  17,707    $ 18,182
----                                                                =========    ========
</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,
                                                       --------------------------------------------
                                                            2001            2002            2003
                                                       -------------   ------------    ------------
<S>                                                     <C>            <C>            <C>
Revenues (Note 17):
  Products sales                                        $     7,843    $     7,397    $     6,944
  Services                                                    2,882          2,390          2,286
                                                        -----------    -----------    -----------
Total revenues                                               10,725          9,787          9,230
                                                        -----------    -----------    -----------
Cost of revenues:
  Products sales                                              1,909          1,655          1,523
  Services                                                      643            241            326
                                                        -----------    -----------    -----------
Total cost of revenues                                        2,552          1,896          1,849
                                                        -----------    -----------    -----------

Gross profit                                                  8,173          7,891          7,381
                                                        -----------    -----------    -----------
Operating expenses:
  Research and development, net (Note17c)                     3,562          2,127          1,825
  Selling and marketing                                       4,911          3,954          3,916
  General and administrative                                  1,943          1,858          1,830
                                                        -----------    -----------    -----------
Total operating expenses                                     10,416          7,939          7,571
                                                        -----------    -----------    -----------
Operating loss                                               (2,243)           (48)          (190)
Financial income, net (Note 17d)                                138            134            124
Other income (expenses), net (Note 17e)                        (654)          (140)             6
                                                        -----------    -----------    -----------
Loss before taxes on income                                  (2,759)           (54)           (60)
Taxes on income (Note 14)                                        16             52            198
                                                        -----------    -----------    -----------
                                                             (2,775)          (106)          (258)
Equity in earnings of affiliate                                 221            236            345
                                                        -----------    -----------    -----------
Net income (loss)                                       $    (2,554)   $       130    $        87
                                                        ===========    ===========    ===========
Net earnings (loss) per share:
Basic net earnings (loss) per ordinary share            $     (0.53)   $      0.03    $      0.02
                                                        ===========    ===========    ===========
Diluted net earnings (loss) per ordinary share          $     (0.53)   $      0.03    $      0.02
                                                        ===========    ===========    ===========

  Weighted  average number of ordinary shares used in
     computing basic net earning (loss) per share         4,826,126      4,709,796      4,617,099
                                                        ===========    ===========    ===========

  Weighted  average number of ordinary shares used in
     computing diluted net earning (loss) per share       4,826,126      4,709,796      4,628,249
                                                        ===========    ===========    ===========
</TABLE>

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

                                      F-5

<PAGE>




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

<TABLE>
<CAPTION>

                                                                                Accumulated
                                                                                  other                    Total
                                                       Additional             comprehensive             comprehensive       Total
                                               Share    paid-in    Treasury      Income      Retained      income      shareholders'
                                              capital   capital     shares       (loss)      earnings      (loss)         equity
                                              -------  ----------  --------   -------------  --------   -------------  -------------
<S>                                           <C>      <C>         <C>        <C>            <C>        <C>             <C>
Balance as of January 1, 2001                 $   15   $ 12,836    $   (40)   $    (431)     $ 4,117                    $  16,497
  Exercise of options                          *)  -         10          -            -            -                           10
  Purchases of treasury shares                     -          -       (118)           -            -                         (118)
  Other comprehensive income (loss):
   Unrealized  gains on  available  for sale
     marketable securities                         -          -          -           72            -    $      72              72
   Foreign currency translation adjustments        -          -          -          (51)           -          (51)            (51)
                                                                                                        -------------
  Total other comprehensive income                                                                             21
  Net loss                                         -          -          -            -       (2,554)      (2,554)         (2,554)
                                              ------   --------   ---------- --------------  -------    -------------   ------------
                                                                                                        $  (2,533)
  Total comprehensive loss                                                                              =============

Balance as of December 31, 2001                   15     12,846       (158)        (410)       1,563                       13,856
  Purchase of treasury shares                      -          -       (172)           -            -                         (172)
  Other comprehensive income:
   Unrealized  losses on available  for sale
     marketable securities                         -          -          -           (3)           -    $      (3)             (3)
   Foreign currency translation adjustments        -          -          -          202            -          202             202
                                                                                                        -------------
  Total other comprehensive income                                                                            199
  Net income                                       -          -          -            -          130          130             130
                                              ------   --------   ---------- --------------  -------    -------------   ------------
                                                                                                        $     329
  Total comprehensive income                                                                            =============

Balance as of December 31, 2002                   15     12,846       (330)        (211)       1,693                       14,013
  Exercise of options                          *)  -          -          -            -            -                         *) -
  Employee stock based compensation                -        213          -            -            -                          213
  Retirement of treasury shares                   (1)      (456)       457            -            -                            -
  Purchase of treasury shares                      -          -       (147)           -            -                         (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 hedges transaction         -          -          -           (7)           -           (7)             (7)
                                                                                                       -------------
  Total other comprehensive income                                                                            298
  Net income                                       -          -          -            -           87           87              87
                                              ------   --------   ---------- --------------  -------    -------------   ------------
                                                                                                        $     385
  Total comprehensive income                                                                            =============

Balance as of December 31, 2003               $   14   $ 12,603    $   (20)   $      87      $ 1,780                    $  14,464
                                              ======   ========   ==========  =============  =======                    ============
Accumulated  unrealized  gains  from
  available-for-sale
  marketable securities                                                               3
Accumulated foreign currency translation
  adjustments                                                                        91
Accumulated losses from cash flow hedges                                             (7)
                                                                              -------------
                                                                              $      87
                                                                              =============
</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,
                                                        -----------------------------
                                                          2001       2002       2003
                                                        -------    -------    -------
<S>                                                     <C>        <C>        <C>
Cash flows from operating activities:
-------------------------------------
Net income (loss)                                       $(2,554)   $   130    $  87
Adjustments required to reconcile net income (loss)
  to net cash provided by (used in) operating
  activities:
  Loss (gain) on sale of available-for-sale and
   trading marketable securities, net                       279        140       (6)
  Loss on sale of property and equipment                     51          6       39
  Loss from impairment of investment in warrants            375          -        -
  Equity in earnings of affiliates                         (221)      (236)    (345)
  Proceeds from trading securities, net                       -         81        -
  Depreciation and amortization                           1,110        501      401
  Deferred income taxes, net                                (20)        29       23
  Employee stock-based compensation                           -          -      213
  Accrued severance pay, net                                 57         (2)     (47)
  Decrease (increase) in trade receivables                  269        (87)    (132)
  Decrease (increase) in other accounts receivable
   and prepaid expenses                                     673        215      (89)
  Decrease in inventories                                   220         82       47
  Increase (decrease) in trade payables                    (169)      (149)      43
  Decrease in accrued expenses and other liabilities       (623)      (419)     (99)
  Increase (decrease) in deferred revenues                 (173)       187       35
  Others                                                      -         11       (7)
                                                        -------    -------    -----
Net cash provided by (used in) operating activities        (726)       489      163
                                                        -------    -------    -----

Cash flows from investing activities:
-------------------------------------
Changes in related parties account, net                      50        108        -
Proceeds from sale of property and equipment                 45         26        5
Purchase of property and equipment                         (226)      (166)    (171)
Investment in short-term bank deposit                    (7,528)         -        -
Proceeds from realization of short-term bank deposits     7,448      1,942        -
Investment in  available for sale marketable
  securities                                               (401)    (1,512)    (969)
Investment in held-to-maturity marketable securities          -       (476)       -
Proceeds from sale of  available-for-sale  marketable
  securities                                              1,631      2,508      318
Proceeds from redemption of held-to-maturity
  marketable securities                                       -        201      275
Dividend from an affiliate                                   56        190      100
Others                                                        -        (12)      16
                                                        -------    -------    -----
Net cash provided by (used in) investing activities       1,075      2,809     (426)
                                                        -------    -------    -----
</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,
                                                            -----------------------
                                                          2001       2002       2003
                                                          ----       ----       ----
<S>                                                   <C>        <C>        <C>
Cash flows from financing activities:
-------------------------------------
Changes in related parties, net                           -            4         51
Repayment of long-term loans                              (91)       (55)        (8)
Proceeds from exercise of options and warrants, net        10        -         *) -
Purchase of treasury shares                              (118)      (172)      (147)
                                                      -------    -------    -------
Net cash used in financing activities                    (199)      (223)      (104)
                                                      -------    -------    -------
Effect of exchange rate changes on cash and cash
  equivalents                                             -          -          (11)
                                                      -------    -------    -------
Increase (decrease) in cash and cash equivalents          150      3,075       (378)
Cash and cash  equivalents  at the  beginning
  of the year                                           5,837      5,987      9,062
                                                      -------    -------    -------
Cash and cash equivalents at the end of the year      $ 5,987    $ 9,062    $ 8,684
                                                      =======    =======    =======
Supplemental disclosure of cash flows activities:
-------------------------------------------------
  Cash paid during the year for:
  Interest                                            $    45    $    10    $     1
                                                      =======    =======    =======
  Income taxes                                        $     8    $    58    $    49
                                                      =======    =======    =======

</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 (except share data)


NOTE 1:- GENERAL

          MER Telemanagement Solutions Ltd. ("MTS") was incorporated on December
          27, 1995. MTS and its subsidiaries ("the Company") designs,  develops,
          markets  and  supports  a  comprehensive  line  of   telecommunication
          management  solutions  that enable  business  organizations  and other
          enterprises  to  improve  the  efficiency  and  performance  of all IP
          operations,  and  reduce  associated  costs.  The  Company's  products
          include call  accounting and  management  products,  fault  management
          systems and web based management  solutions for converged voice, voice
          over   Internet   Protocol  or  IP  data  and  video.   As  for  MTS's
          subsidiaries, see Note 18.

          These   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  Company  markets its  products  worldwide  through  distributors,
          business telephone switching systems manufacturers and vendors and its
          direct sales force. Several international PBX manufacturers market the
          Company's  products  as part of their  PBX  selling  efforts  or on an
          Original Equipment  Manufacturer  ("OEM") basis. The Company is highly
          dependent upon the active  marketing and distribution of its OEM's. In
          2001, 2002 and 2003, two major customers generated 40%, 42% and 47% of
          the Company's revenues, respectively (see Note 17a).

          Certain  components  and  subassemblies   included  in  the  Company'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  source 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 cash position.

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


NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES

          The consolidated 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.

                                       F-9

<PAGE>

                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)

          b.   Financial statements in U.S. dollars:

               The majority of the  Company's  sales is made  outside  Israel in
               U.S. dollars  ("dollars").  In addition, a substantial portion of
               MTS and certain portion of its subsidiaries  costs is incurred in
               dollars.  Since the Company's management believes that the dollar
               is the primary currency of the economic  environment in which MTS
               and  certain  of its  subsidiaries  operate,  the dollar is their
               functional and reporting currency.

               Accordingly,  monetary  accounts  maintained in currencies  other
               than the dollar are  remeasured  into U.S.  dollars 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.

               The  subsidiairies  and affiliate whose  functional  currency has
               been  determined  to be  other  than  U.S.  dollars,  assets  and
               liabilities  are  translated  at  year-end   exchange  rates  and
               statement of operations  items are translated at average exchange
               rates prevailing  during the year. Such  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 subsidiaries. Intercompany balances and transactions have
               been eliminated upon consolidation.

          d.   Cash equivalents:

               The Company  considers all highly liquid  investments  originally
               purchased  with  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").

                                      F-10

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

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)

               Management  determines  the  appropriate  classification  of  its
               investments in marketable debt and equity  securities at the time
               of purchase and reevaluates such  determinations  at each balance
               sheet date.  Debt  securities  are classified as held to maturity
               when the  Company  has a positive  intent and ability to hold the
               securities  to maturity,  and are stated at amortized  cost.  The
               amortized cost of debt securities is adjusted for amortization of
               premiums  and   accretion   of   discounts   to  maturity.   Such
               amortization  and  interest  are  included  in the  statement  of
               operations as other expenses or income. Debt securities for which
               the  Company  does not  have the  intent  or  ability  to hold to
               maturity are  classified  as  available-for-sale,  along with any
               investments in equity securities that have not been classified as
               "trading  securities".  Securities available for sale are carried
               at fair  value,  with the  unrealized  gains and  losses,  net of
               income taxes,  reported as a separate  component of shareholders'
               equity,  under  accumulated  other  comprehensive  income (loss).
               Realized gains and losses on sales of investments,  as determined
               on  a  specific   identification   basis,  are  included  in  the
               consolidated statements of operations in other income (expenses).

               The Company's trading  securities are carried at their fair value
               based upon the quoted market price of those  investments  at each
               balance sheet date. Net realized and unrealized  gains and losses
               on these  securities are included in the statements of operations
               in other income (expenses).

               At December 31, 2003, all marketable  securities  covered by SFAS
               No. 115 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. Cost
               is  determined  as follows:  Raw  materials,  parts and  supplies
               -using the "first in,  first out"  method  with the  addition  of
               allocable  indirect  manufacturing  costs.  Finished products are
               recorded  on the basis of  direct  manufacturing  costs  with the
               addition of allocable indirect  manufacturing costs.  Inventories
               write-offs  are provided to cover risks  arising from slow moving
               items or technological obsolescence.

          g.   Investments in affiliate and other companies:

               Investment  in privately  held company in which the Company holds
               20%  to  50%   ownership  of  voting   rights  and  can  exercise
               significant  influence over operating and financial policy of the
               affiliate is  presented  using the equity  method of  accounting.
               Profits on intercompany  sales, not realized outside the Company,
               were  eliminated.  The excess of the purchase price over the fair
               value of net  tangible  assets  acquired has been  attributed  to
               goodwill.  In accordance  with Statement of Financial  Accounting
               Standard No. 142,  "Goodwill and Other Intangible  Assets" ("SFAS
               No. 142")  goodwill  related to  investments  in affiliates is no
               longer  amortized.  The  goodwill is reviewed for  impairment  in
               accordance with Accounting  Principles Board Opinion No. 18, "The
               Equity  Method of  Accounting  for  Investments  in Common Stock"
               ("APB No. 18"). Before the adoption of SFAS No. 142 on January 1,
               2002,  goodwill was  amortized on a  straight-line  basis over 10
               years,  in  accordance  with  APB  Opinion  No.  17,  "Intangible
               Assets".

                                      F-11

<PAGE>

                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)

               Investments  in  privately  held  companies  in which the Company
               holds  less than 20% and does not have the  ability  to  exercise
               significant  influence over operating and financial policy of the
               Company,   are   presented  at  cost.   The  carrying   value  is
               periodically  reviewed by management,  in accordance with APB 18.
               If  this  review   indicates  that  the  carrying  value  is  not
               recoverable,  the carrying value is reduced to its estimated fair
               value.  As of December 31, 2003, no  impairment  losses have been
               identified.

          h.   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                      Over the term of the
                                                             lease agreement

          i.   Impairment of long-lived assets:

               Long-lived  assets of the Company 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, 2003 no impairment was required.

          j.   Goodwill:

               Goodwill  represents  excess of the costs  over the net assets of
               business  acquired.  Goodwill from acquisitions  prior to July 1,
               2001 was amortized until December 31, 2001, by the  straight-line
               method, over 10 years. Under SFAS No. 142, goodwill acquired in a
               business  combination  on or  after  July 1,  2001,  will  not be
               amortized.

               SFAS No. 142  requires  goodwill to be tested for  impairment  on
               adoption and at least annually thereafter of between annual tests
               in certain circumstances,  and written down when impaired, rather
               than being amortized as previous  accounting  standards required.
               Goodwill is tested for  impairment by comparing the fair value of
               the  reporting  unit  with  its  carrying  value.  Fair  value is
               determined  using  discounted cash flows.  Significant  estimates
               used in the methodologies include estimates of future cash flows,
               future  short-term  and  long-term  growth  rates,  and  weighted
               average cost of capital.  The Company has selected December 31 as
               the date it will perform its annual goodwill impairment tests. As
               of  December  31,  2003  no  impairment  was  required.   As  for
               application of SFAS No. 142, see Note 10a.

                                      F-12

<PAGE>

                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)

          k.   Other intangible assets:

               Intangible  assets  acquired in a business  combination are being
               amortized  on a  straight-line  basis,  over their  useful  life.
               Acquired   developed    technology   is   amortized   using   the
               straight-line method over 5 years.

               Distributor  relationship and Assembled  workforce were amortized
               over 10 and 4  years,  respectively,  until  December  31,  2001.
               According to SFAS No. 142, the net carrying amount of Distributor
               relationship  and Assembled  workforce was subsumed into goodwill
               at January 1, 2002 (see Note 10a).

          l.   Research and development costs:

               Research  and  development  costs,  net of grants  received,  are
               charged to the Statement of Operations as incurred.  Statement of
               Financial Accounting Standard No. 86 "Accounting for the Costs of
               Computer  Software  to be Sold,  Leased  or  Otherwise  Marketed"
               ("SFAS No.  86"),  requires  capitalization  of certain  software
               development    costs   subsequent   to   the   establishment   of
               technological feasibility.

               Based on the Company's product development process, technological
               feasibility  is established  upon  completion of a working model.
               Costs incurred by the Company  between  completion of the working
               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.

          m.   Royalty-bearing 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.

          n.   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.

          o.   Revenue recognition:

               The Company  generates  revenues from licensing the rights to use
               their  software  products  directly to end-users  and  indirectly
               through  resellers and OEM's (who are considered end users).  The
               Company  also  generates  revenues  from  rendering  maintenance,
               service bureau and support.

                                      F-13

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

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,  the fee
               is fixed or  determinable  and  collectibility  is probable.  The
               Company  generally  does  not  grant a  right  of  return  to its
               customers.  When a right of return  exists,  the  Company  defers
               revenue until the right of return expires,  at which time revenue
               is  recognized   provided  that  all  other  revenue  recognition
               criteria are met.

               Where software arrangements involve multiple elements, revenue is
               allocated to each  undelivered  element based on vendor  specific
               objective  evidence  ("VSOE") of the relative 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.   Arrangements  that  include  services  are
               evaluated to determine  whether  those  services are essential to
               the functionality of other elements of the arrangement.

               When  services  are  considered  essential,   revenue  under  the
               arrangement  is  recognized  using  contract   accounting.   When
               services are not considered  essential,  the revenue allocable to
               the  software   services  is   recognized  as  the  services  are
               performed.  To date, the Company had determined that the services
               are  not  considered  essential  to the  functionality  of  other
               elements of the arrangement.

               Revenues from  maintenance  and support  services are  recognized
               over the life of the  maintenance  agreement  or at the time that
               support services are rendered.

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

          p.   Warranty costs:

               The  Company  provides  free  warranty  for  up to one  year  for
               end-users  and 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 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.  The provision for the year ending December
               31, 2003 amounted to of $ 22.

                                      F-14

<PAGE>



                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)

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 following  table  illustrates the effect on net income (loss)
               and  earnings  (loss) per share as if the fair  value  method had
               been  applied  to all  outstanding  and  unvested  awards in each
               period:
<TABLE>
<CAPTION>
                                                                   Year ended December 31,
                                                         --------------------------------------------
                                                             2001            2002            2003
                                                         -------------   ------------    ------------
                  <C>                                      <C>           <C>               <C>
                  Net income (loss), as reported           $(2,554)      $   130           $   87
                  Add: Stock-based employee
                    compensation - intrinsic value               -             -              213
                  Deduct: Total stock-based
                    compensation expense determined
                    under fair value method for all
                    awards, net of related tax effect         (769)         (177)            (286)
                                                         -------------   ------------    ------------
                  Pro forma net income (loss)              $(3,323)      $   (47)          $   14
                                                         =============   ============    ============
                  Basic and diluted net earnings
                    (loss) per share, as reported          $ (0.53)      $  0.03           $ 0.02
                                                         =============   ============    ============
                  Basic and diluted net loss per           $ (0.68)      $ (0.01)          $    -
                    share, pro forma                     =============   ============    ============
</TABLE>

               The fair value for each option  granted was estimated at the date
               of grant using a Black-Scholes  option-pricing model, assuming no
               expected   dividends   and   the   following   weighted   average
               assumptions:

<TABLE>
<CAPTION>
                                                             Year ended December 31,
                                                       ------------------------------------
                                                       2001            2002            2003
                                                       ----            ----            ----
                  <S>                                  <C>             <C>             <C>
                  Dividend                              0%              0%              0%
                  Average risk-free interest rates      3.5%            2%              2%
                  Average expected life (in years)      4               4               2.5
                  Volatility                           87.2%           66.8%           71.8%
</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.  SFAS
               No. 123 requires use of an option  valuation model to measure the
               fair value of the options at the grant date.

                                      F-15

<PAGE>

                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)

          r.   Severance pay:

               The Company's  liability for severance pay is calculated pursuant
               to Israeli  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 Israeli  severance  pay law or labor
               agreements. The value of the deposited funds is based on the cash
               surrendered  value of these  policies,  and  includes  immaterial
               profits.

               Severance  expenses for the years ended  December 31, 2001,  2002
               and  2003  amounted  to  approximately  $  189,  $ 104  and $ 13,
               respectively.

          s.   Fair value of financial instruments:

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

               The  carrying  amounts  of  cash  and  cash  equivalents,   trade
               receivables,   other  accounts   receivable  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).

               Long-term   loans  -  The  carrying   amounts  of  the  Company's
               borrowings under its long-term  agreements,  both as a lender and
               as a borrower,  approximate  their fair value. The fair value was
               estimated  using  discounted  cash  flow  analyses,  based on the
               Company's   incremental  borrowing  rates  for  similar  type  of
               borrowing arrangements.

          t.   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.

                                      F-16

<PAGE>

                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)

               The trade  receivables  of the  Company are mainly  derived  from
               sales to  customers  in the U.S.  and Europe (see Note 17b).  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.  In certain circumstances,  the Company may
               require  letters  of  credit,   other  collateral  or  additional
               guarantees.

               The Company's marketable securities include mainly investments in
               corporate  debts and mutual funds.  Management  believes that the
               portfolio is well  diversified,  and accordingly,  minimal credit
               risk exists with respect to these marketable securities.

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

          u.   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  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").

               The total  number of shares  related to the  outstanding  options
               excluded from the  calculation of diluted net earnings (loss) per
               share was  1,227,141,  757,580  and  766,141  for the years ended
               December 31, 2001, 2002 and 2003, respectively.

          v.   Derivatives and hedging:

               The Company in 2003 hedged the  exposure of revenues  denominated
               in foreign  currencies with forward.  To protect against the risk
               of overall changes in cash flows resulting from export sales over
               the year.

               The  Company  accounts  for  derivatives  and  hedging  based  on
               Statement of Financial  Accounting Standard No. 133,  "Accounting
               for Derivative  Instruments  and Hedging  Activities"  ("SFAS No.
               133").  SFAS No.  133  requires  the  Company  to  recognize  all
               derivatives on the balance sheet at fair value. If the derivative
               meets the definition of a hedge and is so  designated,  depending
               on the  nature  of  the  hedge,  changes  in the  fair  value  of
               derivatives  will  either be offset  against  the  change in fair
               value of the  hedged  assets,  liabilities,  or firm  commitments
               through  earnings or  recognized  in other  comprehensive  income
               until the hedged item is recognized in earnings. The derivative's
               change in fair value is recognized in earnings. During 2003 there
               were no  significant  gains or losses  recognized  in earning for
               hedge ineffectiveness.

                                      F-17

<PAGE>


                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)

          w.   Impact of recently issued accounting standards:

               In  April  2003,  the FASB  issued  SFAS No.  149  ("SFAS  149"),
               "Amendment of Statement 133 on Derivative Instruments and Hedging
               Activities."  SFAS 149 amends and  clarifies  (1) the  accounting
               guidance on derivative  instruments (including certain derivative
               instruments   embedded  in  other   contracts)  and  (2)  hedging
               activities  that fall within the scope of FASB  Statement No. 133
               ("SFAS 133"),  "Accounting for Derivative Instruments and Hedging
               Activities."  SFAS 149 amends SFAS 133 to reflect  decisions made
               (1) as  part  of the  Derivatives  Implementation  Group  ("DIG")
               process that effectively  required amendments to SFAS 133, (2) in
               connection   with   other   projects   dealing   with   financial
               instruments,  and (3) regarding  implementation issues related to
               the  application of the  definition of a derivative.  SFAS 149 is
               effective (1) for contracts  entered into or modified  after June
               30,  2003,   with  certain   exceptions,   and  (2)  for  hedging
               relationships  designated after June 30, 2003. The guidance is to
               be applied prospectively.  Generally, SFAS 149 improves financial
               reporting  by  (1)  requiring  that  contracts  with   comparable
               characteristics  be accounted for  similarly  and (2)  clarifying
               when a derivative  contains a financing  component  that warrants
               special reporting in the statement of cash flows. SFAS 149 is not
               expected  to have a material  impact on the  Company's  financial
               statements.

               In January 2003, the Financial  Accounting Standards Board issued
               Interpretation   No.  46,   Consolidation  of  Variable  Interest
               Entities,  an interpretation of Accounting  Research Bulletin No.
               51 ("the interpretation"). In general, a variable interest entity
               (VIE) is an entity that has (1) insufficient amount of equity for
               the  entity  to  carry  on  its  principal  operations,   without
               additional subordinated financial support from other parties, (2)
               equity  investors that as a group do not have the ability through
               voting or similar  rights to make  decisions  about the  entity's
               activities,  or (3)  investors  that as a group  do not  have the
               obligation  to absorb  the  entity's  losses or have the right to
               receive the benefits of the entity. The  interpretation  requires
               the  consolidation  of a VIE  by  the  primary  beneficiary.  The
               primary  beneficiary is the entity that absorbs a majority of the
               entity's  expected  losses,  receives a majority of the  entity's
               expected  residual  returns,  or both,  as a result of ownership,
               contractual   or  other   financial   interests  in  the  entity.
               Presently,  entities are generally  consolidated by an enterprise
               that has a controlling  financial interest through ownership of a
               majority voting interest in the entity.

               The  Interpretation  requires  a public  entity  with a  variable
               interest in a VIE that is a special-purpose entity created before
               February  1,  2003  to  apply  the   provisions  of  the  revised
               Interpretation,  or the  Interpretation as originally  issued, to
               that entity no later than the end of the first  reporting  period
               ending after December 15, 2003, and the provisions of the revised
               Interpretation to all variable interests no later than the end of
               the first reporting period ending after March 15, 2004.

               The  Company  is  currently   evaluating   the  effects  of  this
               interpretation in respect of its investments. It is possible that
               some of its  unconsolidated  investees may be considered a VIE in
               accordance  with  the  interpretation,  but it is the  management
               opinion  that the  Company  would not be  considered  the primary
               beneficiary of the above VIE.

                                      F-18


<PAGE>


                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)

NOTE 3:- MARKETABLE SECURITIES

          The following is a summary of the  Company's  investment in marketable
          securities:
<TABLE>
<CAPTION>
                                                                  December 31, 2002
                                                ------------------------------------------------------
                                                                  Gross        Gross       Estimated
                                                  Amortized    unrealized    unrealized   fair market
                                                     cost         gains        losses        value
                                                ------------    ----------   ----------    -----------
             <S>                                  <C>           <C>          <C>           <C>
             Held-to-maturity corporate debt      $      275    $       26   $        -    $      301
             Available-for-sale:
             Mutual funds                                566             -          (49)          517
             Equity securities                           418             -          (57)          361
                                                ------------    ----------   ----------    -----------
                                                  $    1,259    $       26   $     (106)   $    1,179
                                                ============    ==========   ==========    ===========
</TABLE>
<TABLE>
<CAPTION>
                                                                  December 31, 2003
                                                ------------------------------------------------------
                                                                  Gross        Gross       Estimated
                                                  Amortized    unrealized    unrealized   fair market
                                                     cost         gains        losses        value
                                                ------------    ----------   ----------    -----------
             <S>                                  <C>           <C>          <C>           <C>
             Available-for-sale:
             Mutual funds                         $      623    $        5   $        -    $      628
             Equity securities                            51            12            -            63
             Corporate bonds                             702             -           (8)          694
             Israeli governmental debts                  265             -           (6)          259
                                                ------------    ----------   ----------    -----------
                                                  $    1,641    $       17   $      (14)   $    1,644
                                                ============    ==========   ==========    ===========
</TABLE>

          The  gross  realized  gains  (losses)  on sales of  available-for-sale
          securities  totaled  $ 31,  $ (128)  and $ 6 in 2001,  2002 and  2003,
          respectively. The net increase (decrease) to unrealized holding losses
          on  available-for-sale  securities included as a separate component of
          shareholders' equity, under other comprehensive income (loss), totaled
          $ (3) and $ 109 in 2002 and 2003, respectively.

          During 2001, the Company  recorded a loss in the gross amount of $ 282
          due to other than temporary decline in the value of available for sale
          marketable securities.

          The  amortized  cost and estimated  fair value of debt and  marketable
          equity  securities as of December 31, 2003, by  contractual  maturity,
          are shown  below.


                                                           December 31, 2003
                                                           -----------------
                                                          Amortized    Market
                                                            cost        value
                                                            ----        -----
             Matures in one year                          $    295      $   291
             Matures after one year through nine years         672          662
             Equity securities and mutual funds                674          691
                                                          --------      -------
             Total                                        $  1,641      $ 1,644
                                                          ========      =======

                                      F-19

<PAGE>

                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)

NOTE 4:- OTHER ACCOUNTS RECEIVABLE AND PREPAID EXPENSES

                                                        December 31,
                                               ------------------------------
                                                   2002             2003
                                               -------------    -------------
              Government authorities             $      288       $      232
              Prepaid expenses                           91              103
              Deferred income taxes                      33               66
              Others                                     99              165
                                               -------------    -------------
                                                 $      511       $      566
                                               =============    =============


NOTE 5:- INVENTORIES

              Raw materials                      $      118       $       73
              Finished products                         122              120
                                               -------------    -------------
                                                 $      240       $      193
                                               =============    =============

          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,
                                                      --------------------------
                                                          2002           2003
                                                      -----------    -----------
 Investment in Jusan S.A.: (50% owned)
   Equity, net (1)                                      $  1,300       $  1,824
   Goodwill                                                   35             35
                                                      -----------    -----------
                                                        $  1,335       $  1,859
                                                      ===========    ===========

 (1)Investment as of purchase date                      $  1,171       $  1,171
    Foreign currency translation adjustments                (136)           143
    Accumulated net earnings                                 265            510
                                                      -----------    -----------
                                                        $  1,300       $  1,824
                                                      ===========    ===========
 Dividend received from Jusan S.A. during the year:     $    190       $    100
                                                      ===========    ===========

                      F-20

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

NOTE 6:- INVESTMENTS IN AFFILIATE (Cont.)

          b.   Summarized financial information of Jusan S.A. (50% owned):

                                                     December 31,
                                            ------------------------------
                                                2002             2003
                                            -------------    -------------
                 Current assets               $    4,397       $    5,266
                 Non-current assets           $      149       $       99
                 Current liabilities          $   (1,454)      $    (1,861)


                                                        Year ended
                                                        December 31,
                                        ----------------------------------------
                                           2001           2002           2003
                                        -----------    -----------    ----------
                Revenues                  $  5,906       $  6,848       $  6,049
                Gross profit              $  2,944       $  3,260       $  3,079
                Net income                $    704       $    708       $    594



NOTE 7:- LONG-TERM LOANS

          a.   Composed as follows:

                                                          December 31,
                                                 ------------------------------
                                                     2002             2003
                                                 -------------    -------------
         Loans to others in NIS (New  Israeli
         Shekels) - unlinked (1)                  $      140      $      131
         Less - current maturities (2)                    54              36
                                                --------------  --------------
                                                  $       86      $       95
                                                ==============  ==============

          (1)  The weighted  average  interest rate for the year ended  December
               31, 2003 and 2002 is 6.375%.

          (2)  Included in other accounts receivable.

          b.   As of December 31,  2003,  the  aggregate  annual  maturities  of
               long-term loans are as follows:

                                                               December 31,
                                                                   2003
                                                             ----------------
                   First year (current maturities)            $        36
                   Second year                                         39
                   Third year                                          36
                   Fourth year                                         20
                                                             ----------------
                                                              $       131
                                                             ================

                                      F-21

<PAGE>

                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)


NOTE 8:- OTHER INVESTMENTS

                                                         December 31,
                                                ------------------------------
                                                    2002             2003
                                                -------------    -------------
             Long-term deposits (1)               $       21       $       21
             Investment in other companies (2)           347              347
                                                -------------    -------------
                                                  $      368       $      368
                                                =============    =============

               (1)  Linked to the Israeli CPI.

               (2)  These   investments   are  stated  at  cost  and   represent
                    investments  in which the Company holds less than 20% of the
                    voting   rights   and  does  not  have  the  right  to  have
                    representation   on  the  board  of   directors.   Based  on
                    assessment   performed  by  the  Company  no  impairment  is
                    required.


NOTE 9:- PROPERTY AND EQUIPMENT, NET

                                                         December 31,
                                                     -------------------
                                                       2002       2003
                                                     --------   -------
                Cost:
                  Computers and peripheral equipment   $2,387   $2,528
                  Office furniture and equipment          492      536
                  Motor vehicles                          107       96
                  Leasehold improvements                  191      100
                                                       ------   ------
                                                        3,177    3,260
                                                       ------   ------
                Accumulated depreciation:
                  Computers and peripheral equipment    2,116    2,300
                  Office furniture and equipment          310      358
                  Motor vehicles                           66       64
                  Leasehold improvements                   83       56
                                                       ------   ------
                                                        2,575    2,778
                                                       ------   ------
                Depreciated cost                       $  602   $  482
                                                       ======   ======

               Depreciation expenses for the years ended December 31, 2001, 2002
               and 2003 were $ 488, $ 348 and $ 247, respectively.

                                      F-22

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

NOTE 10:- GOODWILL AND OTHER ASSETS

          a.   Goodwill:

               Effective January 1, 2002, the Company adopted SFAS No. 142.

               The Company evaluated its goodwill and intangibles acquired prior
               to June 30,  2001  using  the  criteria  of SFAS No.  142,  which
               resulted in the net carrying  amount of $ 1,872  related to other
               intangibles  to  be  subsumed  into  goodwill.  Such  intangibles
               comprise  assembled  workforce,  with an  original  cost of $ 848
               (amortized cost of $ 495), and distributors' relationship with an
               original  cost  of $ 1,653  (amortized  cost  of $  1,377)  being
               subsumed  into  goodwill at January 1, 2002.  As of December  31,
               2003,  $ 2,025  of the  goodwill  balance  is  attributed  to the
               Company's operation since the Company has one reporting unit.

               The  results  of  operations  presented  below for the year ended
               December 31, 2001, reflect the operations had the Company adopted
               the non-amortization provisions of SFAS No. 142 effective January
               1, 2001:


                                                                  Year ended
                                                                  December 31,
                                                                     2001
                                                                 -------------

                    Reported net loss                              $   (2,554)
                    Goodwill amortization                                 431
                                                                 -------------
                  Adjusted net loss                                $   (2,123)
                                                                 =============
                  Basic and diluted net loss per share:
                  Reported net loss per share                      $    (0.53)
                  Goodwill amortization                                  0.09
                                                                 -------------
                  Adjusted basic and diluted net loss per share    $    (0.44)
                                                                 =============

          b.   Other intangibles consist of the following:

<TABLE>
<CAPTION>
                                        December 31, 2002                  December 31, 2003
                                ---------------------------------- -----------------------------------
                                  Gross                   Other      Gross                    Other
                                carrying   Accumulated  intangibles,carrying   Accumulated  intangibles,
                                 amount    amortization    net       amount    amortization    Net
                                ---------- -----------  ---------- ----------- ------------ ----------
                 <S>              <C>        <C>          <C>        <C>         <C>          <C>
                 Developed
                 technology       $  750     $ (390)      $  360     $  750      $  (544)     $  206
                                ========== ===========  ========== =========== ============ ==========
</TABLE>

               Developed  technology  amortization  expenses for the years ended
               December  31, 2001,  2002 and 2003,  were $ 142, $ 154 and $ 154,
               respectively.  The  expected  amortization  expenses for 2004 and
               2005 are $ 154 and $ 52, respectively.

                                      F-23

<PAGE>

                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)

NOTE 11:- ACCRUED EXPENSES AND OTHER LIABILITIES

                                                       December 31,
                                               ----------------------------
                                                   2002            2003
                                               ------------    ------------
             Employees and payroll accruals     $      550      $      473
             Income tax payable                         26             242
             Accrued expenses                          422             456
             Customer advances                         437             203
             Related parties                             4              47
                                               ------------    ------------
                                                $    1,439      $    1,421
                                               ============    ============

NOTE 12:- LONG-TERM LOANS

                                                       December 31,
                                               ----------------------------
                                                   2002            2003
                                               ------------    ------------
             Loan from others (1)                $      16      $        8
             Less - current maturities                   8               8
                                               ------------    ------------
                                                 $       8      $        -
                                               ============    ============

          (1)  In U.S. dollars, bearing an average interest rate of 18.14%.


NOTE 13:- COMMITMENTS AND CONTINGENT LIABILITIES

          a.   Lease commitments:

               1.   The  facilities  of the Company are rented  under  operating
                    leases for periods ending in 2005.

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

                       2004            $    276
                       2005                 264
                                       -----------
                                       $    540
                                       ===========

                    Rent  expenses for the years ended  December 31, 2001,  2002
                    and  2003,  were  approximately  $  576,  $ 446  and $  372,
                    respectively.

                                      F-24

<PAGE>

                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)

NOTE 13:- COMMITMENTS AND CONTINGENT LIABILITIES (Cont.)

          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 up to the amount received
                    by the Company.  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, 2003,  the Company
                    has a contingent  obligation  to pay royalties in the amount
                    of $  7,520.  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 outstanding  balance of obligations in respect of grants
                    received  after  January  1999  amounts  to $ 3,447 and also
                    bears LIBOR interest.

                    The  Company has paid or accrued  royalties  relating to the
                    repayment of such grants in the amount of $ 176, $ 132 and $
                    146 for the years ended  December 31,  2001,  2002 and 2003,
                    respectively.

               2.   The Israeli  Government,  through the Fund for Encouragement
                    of  Marketing  Activities,  awarded the  Company  grants for
                    participation in marketing expenses overseas. 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,  2003,  the
                    Company has a contingent  obligation to pay royalties in the
                    amount  of $ 259.  The  Company  did not pay or  accrue  any
                    royalties  during the three  years  ending on  December  31,
                    2003.

          c.   Claim and demand:

               In April  2000,  the tax  authorities  in Israel  issued to MTS a
               demand for a tax payment,  for the period of 1997 - 1999,  in the
               amount of  approximately  NIS  6,000  thousand  (approximately  $
               1,350).

               MTS has appealed to the Israeli  district court in respect of the
               abovementioned  tax  demand.  Based  on the  opinion  of its  tax
               counsel, MTS believes that certain defenses can be raised against
               the demand of the tax authorities.  MTS believes that the outcome
               of this  matter  will not have a material  adverse  effect on its
               financial  position or results of operations  and, MTS provided a
               provision,  based on the current evidence and on the basis of the
               said opinion of its tax consultants,  which in the opinion of MTS
               is an adequate provision.

                                      F-25

<PAGE>


                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)

NOTE 14:- 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 expansion projects. According to the provisions
               of the Law, MTS elected to enjoy "alternative  benefits" - waiver
               of grants in return for tax exemption  and,  accordingly,  income
               derived from the "Approved Enterprise" is tax-exempt for a period
               of two to four  years,  commencing  with the year it first  earns
               taxable income,  and subject to corporate tax at the rate of 25%,
               for additional periods of three to five years.

               The expansion programs which are assigned to MTS are as follows:

               1.   One program  entitled  MTS to  tax-exemption  for a two-year
                    period ended  December 31, 1999, and is subject to a reduced
                    tax rate of 25% for a five-year  period ending  December 31,
                    2004.

               2.   The current program  entitles MTS to tax exemption for a two
                    year  period  and were  subject  to tax rate of 25% for five
                    year  period.  The  benefits in respect of this program have
                    not yet commenced.

               The period of tax benefits  detailed above is subject to limit of
               the earlier of 12 years from the commencement of production or 14
               years from receiving the approval.

               The  entitlement to the above benefits is conditional  upon MTS's
               fulfilling   the   conditions   stipulated   by  the  above  Law,
               regulations  published  hereunder and the instruments of approval
               for the specific  investment  in "Approved  Enterprises".  In the
               event of failure to comply with these  conditions,  the  benefits
               may be  canceled  and MTS may be required to refund the amount of
               the  benefits,  in whole or in part,  including  interest.  As of
               December 31, 2003, management believes that MTS is meeting all of
               the aforementioned conditions.

               The tax-exempt income  attributable to the "Approved  Enterprise"
               amounting to $ 2,250 as of December  31, 2003 can be  distributed
               to  shareholders  without  subjecting  MTS to taxes only upon the
               complete  liquidation  of  MTS.  MTS  has  determined  that  such
               tax-exempt  income  will  not be  distributed  as  dividends  and
               permanently re-invested these profits.  Accordingly,  no deferred
               taxes have been nor will be  provided on income  attributable  to
               MTS's "Approved Enterprise".

               Should the retained  tax-exempt income be distributed in a manner
               other than in the complete  liquidation of MTS, it would be taxed
               at the  corporate  tax rate  applicable to such profits as if MTS
               had not elected the alternative tax benefits (currently - 25% for
               an "Approved Enterprise").

               Should MTS and its Israeli  subsidiary derive income from sources
               other than an "Approved Enterprise",  they will be subject to tax
               at regular rates of 36%.

               Since MTS is operating under more than one "Approved  Enterprise"
               and  since  part of its  taxable  income is not  entitled  to tax
               benefits under the abovementioned law and is taxed at the regular
               tax  rate of 36%,  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.


                                      F-26

<PAGE>

                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)

NOTE 14:- TAXES ON INCOME (Cont.)

          b.   Measurement  of results for tax purposes under the Income Tax Law
               (Inflationary Adjustments), 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 an  "industrial  company"  as defined by this law and,  as
               such,  is entitled to certain tax  benefits,  mainly  accelerated
               depreciation  of  machinery  and  equipment,   as  prescribed  by
               regulations published under the Inflationary Adjustments Law, the
               right to claim  public  issuance  expenses  and  amortization  of
               intangible property rights as a deduction for tax purposes.

          d.   Tax loss carryforward:

               The Company's subsidiaries in Asia, U.S., Holland and Israel have
               estimated a total amount of available  carryforward tax losses of
               $ 177,  $486,  $ 212 and $ 71,  respectively  to  offset  against
               future taxable profits.

               Tax loss  carryforward  in  Israel  may be used  indefinitely  to
               offset against operating income. The operating loss carryforwards
               of  MTS  and  its   Israeli   subsidiary,   which   can  be  used
               indefinitely, amounted to approximately $ 2,662.

          e.   Tax assessment:

               Regarding the claim from the tax authorities in Israel,  see Note
               13c.


                                      F-27

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

NOTE 14:- TAXES ON INCOME (Cont.)

          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:

                                                               December 31,
                                                            ------------------
                                                               2002      2003
                                                            --------   -------

          Tax loss carryforwards of the Company               $ 364    $   845
          Allowances for doubtful  accounts and provisions
            for employee benefits                                92        121
          In respect of marketable securities                    29         84
          Capitalized software and other intangible assets       93        134
          Other                                                (140)         5
                                                              -----    -------
          Net deferred tax asset before valuation allowance     438      1,189
          Valuation allowance                                  (244)    (1,018)
                                                              -----    -------
          Net deferred income taxes                           $ 194    $   171
                                                              =====    =======
          Presented as follows:
            Current assets - foreign                          $  21    $    66
                                                              =====    =======
            Other assets - foreign                            $   -    $    73
                                                              =====    =======
           Current assets - domestic                          $  12 $        -
                                                              =====    =======
            Other assets - domestic                           $ 161    $    32
                                                              =====    =======

               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-28

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

NOTE 14:- 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,
                                                               ---------------------------------------
                                                                  2001          2002         2003
                                                               ------------  -----------  ------------
          <S>                                                   <C>          <C>          <C>
                Loss before taxes as reported in the
                 statements
                of operations                                   $ (2,759)    $     (54)   $     (60)
                                                               ============  ===========  ============

                Tax rates                                             36%           36%          36%
                                                               ============  ===========  ============

                Theoretical tax benefit                        $    (993)    $     (19)   $     (22)
                Increase in taxes resulting from:
                Effect of different tax rates and "Approved
                 Enterprise" benefit                                 396           200            -
                Tax adjustment in respect of inflation in
                 Israel and others                                   193           (61)         (22)
                Utilization of carryforward tax losses for
                 which valuation allowance was provided                -          (246)         (86)
                Non-deductible expenses and tax exempt income        (43)          (24)           9
                Taxes and deferred taxes in respect of
                 previous years                                        -             -          175
                Deferred taxes for which valuation allowance
                 was  provided                                       463           202          144
                                                               ------------  -----------  ------------
                Taxes on income as reported in the
                 statements of operations                      $      16     $      52    $     198
                                                               ============  ===========  ============

          h.   Loss before income taxes is comprised as follows:

                  Domestic                                     $  (1,772)    $    (841)   $    (312)
                  Foreign                                           (987)          787          252
                                                               ------------  -----------  ------------
                                                               $  (2,759)    $     (54)   $     (60)
                                                               ============  ===========  ============

          i.   Taxes on income are comprised as follows:

                 Current taxes                                 $      36     $      23    $       -
                 Deferred taxes                                      (20)           29           23
                 Taxes  and  deferred  taxes  in  respect
                   of previous years                                   -             -          175
                                                               ------------  -----------  ------------
                                                               $      16     $      52    $     198
                                                               ============  ===========  ============

                 Domestic                                      $     (42)    $      29    $     322
                 Foreign                                              58            23         (124)
                                                               ------------  -----------  ------------
                                                               $      16     $      52    $     198
                                                               ============  ===========  ============
</TABLE>

                                      F-29

<PAGE>

                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)

NOTE 14:- TAXES ON INCOME (Cont.)

          j.   On January 1, 2003,  a  comprehensive  tax reform  took effect in
               Israel. Pursuant to the reform, resident companies are subject to
               Israeli tax on income accrued or derived in Israel or abroad.  In
               addition,  the concept of "controlled  foreign  corporation"  was
               introduced  according  to which an  Israeli  company  may  become
               subject  to  Israeli  taxes on  certain  income 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).  The tax  reform  also  substantially
               changed the system of taxation of capital gains. The Company does
               not  expect  the tax  reform  to have a  material  impact  on its
               results of operations or financial position.


NOTE 15:- RELATED PARTIES TRANSACTIONS

          a.   On  November  8,  1999,  the  board of  directors  and the  audit
               committee  approved,   subject  to  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  twelve  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  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 of retaining the services of her
               were  approved  by the  Company's  board of  directors  and audit
               committee.

               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%.

          b.   In 2002 and 2003,  the balance  with C. Mer  reflects  short-term
               debt  and  other  receivable.  Due to the  short-term  nature  no
               interest  was charged by or paid to C. Mer through  December  31,
               2002 and 2003.

                                      F-30

<PAGE>

                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)

NOTE 15:- RELATED PARTIES TRANSACTIONS (Cont.)

          c.   Transactions with related parties were as follows:

<TABLE>
<CAPTION>
                                                                       Year ended December 31,
                                                                --------------------------------------
                                                                   2001         2002          2003
                                                                -----------  -----------   -----------
                 <S>                                            <C>          <C>           <C>
                 Sales through related parties                  $      58    $      65     $      28
                                                                ===========  ===========   ===========
                 Amounts charged by related parties:
                   Cost of revenues                                    62    $     239     $      34
                   Research and development                            58            8             -
                   Selling and marketing                                -            2             -
                   General and administrative                           -            4             5
                                                                -----------  -----------   -----------
                                                                $     120    $     253     $      39
                                                                ===========  ===========   ===========
                 Amounts charged by MTS Integra TRAK and
                   MTS Asia to related parties:
                   Selling and marketing                        $      44    $       2     $       -
                                                                ===========  ===========   ===========
                   Repayments to the related parties, net       $     (10)   $    (172)    $     (48)
                                                                ===========  ===========   ===========
</TABLE>


          d.   Amounts due from an affiliate:

                                                          December 31,
                                                  ------------------------------
                                                      2002             2003
                                                  -------------    -------------
                 Jusan S.A                        $     10         $     (2)
                                                  =============    =============

NOTE 16:- 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.   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.  1,500,000  options  were  granted  pursuant to
               section 102 of the Israel Income Tax Ordinance. Any option, which
               is canceled or forfeited before expiration, will become available
               for future grants.

                                      F-31

<PAGE>

                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)

NOTE 16:- SHAREHOLDERS' EQUITY (Cont.)

               Each  option  granted  under  the Plan is  exercisable  until the
               earlier of four 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 2002,  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 for grant into 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, 2003, 826,776 options are available for future
               grant.

               Summary of MTS's stock options  activity and related  information
               for the three years ended December 31, is as follows:

<TABLE>
<CAPTION>
                                                                                            Weighted
                                                      Options      Number                   average
                                                     available   of options    Options      exercise
                                                     for grant   outstanding  exercisable    price
                                                    ------------ -----------  ----------- -------------
                  <S>                                <C>         <C>            <C>           <C>
                  Options  exercisable  at January                              778,325       $   3.02
                  1, 2001                                                     ===========
                  Balance on January 1, 2001          447,598    1,315,152                    $   3.88
                    Options granted                  (436,405)     436,405                    $   2.05
                    Options forfeited                 520,416     (520,416)                   $   2.74
                    Options exercised                       -       (4,000)                   $   2.5
                                                    ------------ -----------              -------------
                  Options  exercisable at December                              800,887       $   4.48
                  31, 2001                                                    ===========
                    Balance on December 31, 2001      531,609    1,227,141                    $   3.74
                    Options granted                   (35,000)      35,000                    $   1.2
                    Options forfeited                 504,561     (504,561)                   $   4.19
                                                    ------------ -----------              -------------
                  Options  exercisable at December                              502,644       $   3.76
                  31, 2002                                                    ===========
                    Balance on December 31, 2002    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                              355,413       $   3.68
                  31, 2003                                                    =========== =============
                  Balance on December 31, 2003        826,776      798,641                    $   2.85
                                                    ============ ===========              =============
</TABLE>

                                      F-32

<PAGE>

                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)

NOTE 16:- SHAREHOLDERS' EQUITY (Cont.)

               The  options  outstanding  as of  December  31,  2003  have  been
               separated into ranges of exercise prices, as follows:
<TABLE>
<CAPTION>
                                    Options       Weighted                                   Weighted
                                  outstanding      average      Weighted                     average
                                     as of        remaining      average                   exercise price
                     Exercise     December 31,   contractual    exercise      Options      of exercisable
                      price           2003      life (in years)  price     exercisable       options
                  --------------- -------------  ------------  ------------ ------------- -------------
                  <S>                <C>            <C>        <C>             <C>            <C>
                  $ 0.93 - $ 1.3      32,500        2.08       $1.19            10,830        $1.19
                      $ 1.844        250,000        4.92       $1.844                -        $   -
                  $ 1.9 - $ 2.05     239,967        1.38       $1.96           192,213        $1.95
                  $ 2.9 - $ 2.95     117,500        4.93       $2.91                 -        $   -
                      $ 4.5            2,000        1.08       $4.5              1,333        $4.5
                      $ 5.5           19,000        0.58       $5.5             19,000        $5.5
                  $ 5.9375 - $ 6     116,724        1.00       $5.99           115,749        $5.99
                      $ 7.0625        20,950        0.33       $7.0625          16,288        $7.0625
                                  -------------                             -------------
                                     798,641                   $2.85           355,413        $3.68
                                  =============                ========     ============= ==========
</TABLE>


          c.   The weighted  average fair value of options  granted  during 2001
               and 2002, whose exercise price equals the fair value of the stock
               on  the  date  of  grant,  was $  2.05  and $  1.20  per  option,
               respectively.

               During  2003,  the  Company  granted  434,500  options,  of  such
               options,  117,500  options  were  granted at a  weighted  average
               exercise  price of $ 2.91 per share (the fair market value of the
               shares on the date of grant) and 317,000  options with a weighted
               average  exercise price of $ 1.45 were granted at exercise prices
               below the fair value of the shares on the date of grant.

               The Company has recorded deferred stock compensation  expense for
               options issued with an exercise price below the fair market value
               of the shares; 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 was recognized during 2003.

               During 2003, the Company  reduced  the  exercise  price of 83,000
               options  to  zero   resulting  in  a   compensation   expense  of
               approximately $ 153.

          d.   In January  2000,  MTS granted  98,824  options to Mr. Chaim Mer,
               chairman of the Company,  having an exercise  price of $ 6.00 per
               share.  These options were granted in lieu of Mr. Mer's salary ($
               7 per month) in 2000. The options are  exercisable for five years
               commencing January 1, 2000 (see Note 15).

          e.   On February 7, 2001,  MTS issued  five-year  warrants to purchase
               25,000 ordinary shares of MTS to Investec Bank  (Mauritius)  Ltd.
               in connection with certain financial  services performed on MTS's
               behalf.  The warrants have an exercise  price of $ 4.95 per share
               for warrants  exercised until February 2004 and $ 5.625 per share
               for warrants exercised until February 2006. The fair value of the
               warrants,  at the date of the grant, using a Black-Scholes option
               pricing  model  was  immaterial  and  therefore  no  compensation
               expenses were recorded.


                                      F-33

<PAGE>


                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)

NOTE 16:- SHAREHOLDERS' EQUITY (Cont.)

          f.   Treasury shares:

               During  the years  2001,  2002 and 2003,  the  Company  purchased
               54,665, 195,183 and 130,510 treasury shares in consideration of $
               118,  $ 172  and $  147  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 the year, MTS cancelled $458 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 17:- SELECTED STATEMENTS OF OPERATIONS DATA

          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.


          a.   Major customers as a percentage of total revenues:

                                                 Year ended December 31,
                                         ---------------------------------------
                                            2001           2002          2003
                                         -----------   ------------   ----------
                                                            %
                                         ---------------------------------------

                 Philips                       8              6              7
                 Siemens                      32             36             40

          b.   The following is a summary of revenues  within  geographic  areas
               based on end customer location and long-lived assets:

                                              Year ended December 31,
                                     -----------------------------------------
                                         2001           2002          2003
                                     ------------   ------------   -----------
      Revenues from sales:
      --------------------
       Israel                        $      358     $      217      $    186
       United States                      6,496          6,449         4,917
       Germany                            1,355          1,130         1,826
       Holland                            1,009            756           924
       Europe (excluding Austria,
         Germany and Holland)               448            296           516
       Asia                                 500            469           364
       South America                        419            328           368
       Austria                               24              -             -
       Others                               116            142           129
                                     ------------   ------------   -----------
                                      $  10,725     $    9,787      $  9,230
                                     ============   ============   ===========


                                      F-34

<PAGE>

                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)

NOTE 17:- SELECTED STATEMENTS OF OPERATIONS DATA (Cont.)


                                             Year ended December 31,
                                     ----------------------------------------
                                        2001           2002          2003
                                     -----------   ------------   -----------
      Long-lived assets:
      ------------------
        Israel                       $      809     $      624      $     394
        United States                     2,437          2,302          2,268
        Holland                              10             10              8
        Asia                                 35             29             16
        South America                        23             22             27
                                     -----------   ------------   -----------
                                     $    3,314     $    2,987      $   2,713
                                     ===========   ============   ===========

          c.   Research and development, net:

       Total costs                    $   4,552      $   2,128      $   1,825
       Less - grants and
         participations                    (990)            (1)             -
                                     -----------   ------------    ----------
                                      $   3,562      $   2,127      $   1,825
                                     ===========   ============    ==========

          d.   Financial income, net

       Financial expenses:
       Interest expenses             $     (232)    $     (205)     $      (64)
       Other expenses                        (9)            (7)              -
       Foreign currency translation
       differences                          (81)             -             (11)
                                     ------------   ------------    -----------
                                           (322)          (212)            (75)
                                     ------------   ------------    -----------
       Financial income:
       Interest income                      403            310             186
       Other income                          57              1              13
       Foreign currency translation
       differences                            -             35               -
                                     ------------   ------------    -----------
                                            460            346             199
                                     ------------   ------------    -----------
       Financial income, net         $      138     $      134      $      124
                                     ============   ============    ===========

          e.   Other income (expenses):

        Loss from impairment of
         investments in warrants     $     (375)    $        -      $        -
        Gain (loss) on marketable
        securities, net                    (279)          (140)              6
                                     ------------   ------------    -----------
                                     $     (654)    $     (140)     $        6
                                     ============   ============    ===========

                                      F-35

<PAGE>

                                               MER TELEMANAGEMENT SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)

NOTE 18:- SUBSIDIARIES AND AFFILIATES

<TABLE>
<CAPTION>
                                                                  Percentage of      Jurisdiction of
                                                                    ownership         incorporation
                                                                 ----------------    ----------------
            <S>                                                       <C>            <C>
            Subsidiaries:
            -------------

            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 Bohera B.V.)            100%               Brazil

            Affiliate:
            ----------

            Jusan S.A. (a  subsidiary of Jaraga B.V.)                  50%                Spain

</TABLE>

NOTE 19:- SUBSEQUENT EVENTS (UNAUDITED)

     In March 2004,  MTS  IntegraTRAK  was named as a  defendant  in a complaint
     filed in the United  States  District  Court for the  Northern  District of
     Georgia,  Atlanta Division,  captioned Telemate.net Software, Inc. v. James
     A. Myers, Total Wire Software Company,  Inc. and MTS IntegraTRAK,  Inc. The
     plaintiff  alleges  among  other  things  federal  copyright  infringement,
     federal   unfair   competition,   common   law   unfair   competition   and
     misappropriation  of trade  secrets  in  connection  with  MTS  IntegraTRAK
     license of software from James A. Myers.  In a related  action in the State
     Court of Fulton  County,  State of  Georgia,  captioned  James A.  Myers v.
     Telemate.net  Software,  Inc.  v. MTS  IntegraTRAK,  Inc.  and  Total  Wire
     Software Company,  Inc., Telemate filed a third-party complaint against MTS
     IntegraTRAK based on the same license,  claiming  misappropriation of trade
     secrets.  The  plaintiff is seeking an injunction  against MTS  IntegraTRAK
     future sales of the product,  damages,  an  accounting of any sales of such
     product,  and  attorneys'  fees. MTS  IntegraTRAK  has not responded to the
     complaints as yet, but believes that it has good and valid defenses that it
     will assert.

                              - - - - - - - - - - -


                                      F-36






<PAGE>






                                   JUSAN, S.A.


                              FINANCIAL STATEMENTS


                             AS OF DECEMBER 31, 2003


                               EUROS IN THOUSANDS




                                      INDEX


                                                                        Page
                                                                    ------------

Report of Independent Auditors                                          F-38

Balance Sheets                                                          F-39

Statements of Income                                                    F-40

Statements of Changes in Shareholders' Equity                           F-41

Statements of Cash Flows                                                F-42

Notes to Financial Statements                                        F-43-F-51




                               - - - - - - - - - -


                                      F-37

<PAGE>


ERNST & YOUNG

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






                         REPORT OF INDEPENDENT AUDITORS

                             To the Shareholders of

                                   JUSAN, S.A.


      We have audited the accompanying balance sheets of JUSAN, S.A. ("the
Company") as of December 31, 2003 and 2002, and the related statements of
income, changes in shareholders' equity and cash flows for each of the two years
in the period ended December 31, 2003. 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 audit.


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


      In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of the Company as of December
31, 2003 and 2002, and the results of its operations and its cash flows for each
of the two years in the period ended December 31, 2003, in conformity with
accounting principles generally accepted in the United States.






                                            /s/ Kost Forer Gabbay and Kasierer
 Tel-Aviv, Israel                             KOST FORER GABBAY & KASIERER
 January 14, 2004                           A Member of Ernst & Young Global


                                      F-38

<PAGE>





                                                                     JUSAN, S.A.
BALANCE SHEETS
--------------------------------------------------------------------------------
Euros in thousands

<TABLE>
<CAPTION>

                                                                                 December 31,
                                                                        ------------------------------
                                                                            2002             2003
                                                                        -------------    -------------
 <S>                                                                <C>               <C>
    ASSETS
 CURRENT ASSETS:
 Cash and cash equivalents                                          (euro)   338      (euro)  953
 Short-term bank deposits                                                    402              450
 Trade  receivables  (net of allowance
   for doubtful accounts of 6
   euros as of  December  31, 2002 and
   2003 and provision for
   returns of 7 euros as of December 31, 2003)                             1,578            1,732
 Other accounts receivable and prepaid expenses (Note 3)                     262              240
 Inventories (Note 4)                                                        900              793
                                                                        -------------    -------------
 Total current assets                                                      3,480            4,168
 -----                                                                  -------------    -------------

 PROPERTY AND EQUIPMENT, NET (Note 5)                                        118               78
                                                                        -------------    -------------
 Total assets                                                       (euro) 3,598      (euro)4,246
 -----                                                                  =============    =============

    LIABILITIES AND SHAREHOLDERS' EQUITY

 CURRENT LIABILITIES:
 Short-term bank debt (Note 6)                                      (euro)    16      (euro)   38
 Trade payables                                                              623              795
 Accrued expenses and other liabilities (Note 7)                             386              408
 Deferred revenues                                                           126              232
                                                                        -------------    -------------
 Total current liabilities                                                 1,151            1,473
 -----                                                                  -------------    -------------

 COMMITMENTS (NOTE 8)

 SHAREHOLDERS' EQUITY (Note 11):
 Share capital -
   15,052  Ordinary  shares  of (euro) 0.0042
   par  value  (Authorized,
   issued and outstanding) as of
   December 31, 2002 and 2003                                                 63               63
 Retained earnings                                                         2,384            2,710
                                                                        -------------    -------------

 Total shareholders' equity                                                2,447            2,773
 -----                                                                  -------------    -------------

 Total liabilities and shareholders' equity                         (euro) 3,598      (euro)4,246
 -----                                                                  =============    =============

</TABLE>

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


                                      F-39

<PAGE>


                                                                     JUSAN, S.A.
STATEMENTS OF INCOME
--------------------------------------------------------------------------------
Euros in thousands (except share and per share data)

<TABLE>
<CAPTION>
                                                                    Year ended December 31,
                                                          --------------------------------------------
                                                              2001            2002            2003
                                                          -------------   -------------   ------------
                                                            Unaudited
                                                          -------------
 <S>                                                   <C>               <C>             <C>
 Revenues (Note 12):
   Product sales                                       (euro)5,227       (euro)6,060     (euro)5,353
   Services                                                    986               819             707
                                                          -------------   -------------   ------------
 Total revenues                                              6,213             6,879           6,060
                                                          -------------   -------------   ------------
 Cost of revenues:
   Product sales                                             2,871             3,336           2,797
   Services                                                    737               658             538
                                                          -------------   -------------   ------------
 Total cost of revenues                                      3,608             3,994           3,335
                                                          -------------   -------------   ------------
 Gross profit                                                2,605             2,885           2,725
                                                          -------------   -------------   ------------
 Operating expenses:
   Research and development                                    325               470             425
   Selling and marketing                                       628               718             770
   General and administrative                                  852               892             882
                                                          -------------   -------------   ------------
 Total operating expenses                                    1,805             2,080           2,077
                                                          -------------   -------------   ------------
 Operating income                                              800               805             648
 Financial income, net (Note 13)                                 6                 7               9
                                                          -------------   -------------   ------------
 Income before taxes on income                                 806               812             657
 Income taxes (Note 9)                                         183               185             131
                                                          -------------   -------------   ------------
 Net income                                            (euro)  623         (euro)627       (euro)526
                                                          =============   =============   ============
 Basic and diluted net earnings per share              (euro) 41.4        (euro)41.7     (euro)34.95
                                                          =============   =============   ============
 Weighted  average  number of shares used in
 computing basic and diluted net earnings per share         15,052            15,052          15,052
                                                          =============   =============   ============
</TABLE>


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

                                      F-40

<PAGE>


                                                                     JUSAN, S.A.
--------------------------------------------------------------------------------
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Euros in thousands

<TABLE>
<CAPTION>
                                                                                           Total
                                                             Share        Retained     shareholders'
                                                            Capital       earnings        equity
                                                         ------------- -------------- ---------------
 <S>                                                     <C>          <C>            <C>
 Balance as of January 1, 2001 (unaudited)               (euro)63     (euro)1,934    (euro)1,997
   Dividends                                                    -            (120)          (120)
   Net income                                                   -             623            623
                                                         ------------- -------------- ---------------
 Balance as of December 31, 2001 (unaudited)                   63           2,437          2,500
   Dividends                                                    -            (680)          (680)
   Net income                                                   -             627            627
                                                         ------------- -------------- ---------------
 Balance as of December 31, 2002                               63           2,384          2,447
   Dividend paid                                                -            (100)          (100)
   Accrued dividend                                             -            (100)          (100)
   Net income                                                   -             526            526
                                                         ------------- -------------- ---------------
 Balance as of December 31, 2003                         (euro)63     (euro)2,710    (euro)2,773
                                                         ============= ============== ===============
</TABLE>




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

                                      F-41


<PAGE>


                                                                     JUSAN, S.A.
STATEMENTS OF CASH FLOWS
--------------------------------------------------------------------------------
Euros in thousands
<TABLE>
<CAPTION>
                                                                    Year ended December 31,
                                                          --------------------------------------------
                                                              2001            2002            2003
                                                          -------------   -------------   ------------
                                                            Unaudited
                                                          -------------
 <S>                                                     <C>              <C>             <C>
 Cash flows from operating activities:
 -------------------------------------
 Net income                                              (euro)   623     (euro)   627    (euro)   526
 Adjustments to reconcile net income to net cash
   provided by (used in) operating activities:
   Depreciation                                                    48               63              64
   Decrease (increase) in trade receivables                        71             (236)           (154)
   Decrease (increase) in other accounts receivable
    and prepaid expenses                                           31              (51)             22
   Decrease (increase) in inventories                             270             (252)            107
   Increase (decrease) in trade payables                          422             (264)            172
   Increase (decrease) in accrued expenses and other
    liabilities                                                   176             (218)            (78)
   Increase in deferred revenues                                    -              126             106
                                                          -------------   -------------    -----------
 Net cash provided by (used in) operating activities            1,641             (205)            765
                                                          -------------   -------------    -----------
 Cash flows from investing activities:
 -------------------------------------
 Investment in short-term bank deposits                        (1,103)             702             (48)
 Purchase of property and equipment                               (62)             (94)            (24)
                                                          -------------   -------------   ------------
 Net cash provided by (used in) investing activities           (1,165)             608             (72)
                                                          -------------   -------------   ------------
 Cash flows from financing activities:
 -------------------------------------
 Dividend paid                                                   (120)           (680)            (100)
 Short-term bank debt                                            (129)            (61)              22
                                                          -------------   -------------   ------------
 Net cash used in financing activities                           (249)           (741)             (78)
                                                          -------------   -------------   ------------
 Increase (decrease) in cash and cash equivalents                 227            (338)             615
 Cash and cash  equivalents  at the  beginning
   of the year                                                    449             676              338
                                                          -------------   -------------   ------------

 Cash and cash equivalents at the end of the year        (euro)   676     (euro)  338     (euro)   953
                                                          =============   =============   ============

Non-cash financing information:
-------------------------------
 Accrued dividend                                                   -               -     (euro)   100
                                                          =============   =============   ============
 Supplemental disclosure of cash flows activities:
 -------------------------------------------------
   Cash paid during the year for:
   Interest                                              (euro)     7     (euro)    9     (euro)     8
                                                          =============   =============   ============

   Income taxes                                          (euro)    82     (euro)  183     (euro)   184
                                                          =============   =============   ============
</TABLE>


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

                                      F-42

<PAGE>




                                                                     JUSAN, S.A.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
Euros in thousands

NOTE 1:- ORGANIZATION AND OPERATIONS

     a.   JUSAN,  S.A.  ("the  Company") was  incorporated  in Spain on June 19,
          1959.  The  Company  is  engaged  in  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 two major customers (see also Note 12a).


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.

     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-43

<PAGE>


                                                                     JUSAN, S.A.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
Euros in thousands

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)

     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.

          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 their estimated realizable value.


                                      F-44

<PAGE>


                                                                     JUSAN, S.A.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
Euros in thousands

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)

     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 as of December 31, 2003 in the amount of (euro)
          7 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.

          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 as
          of  December  31,  2003 in the  amount of (euro)  18 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.

                                      F-45

<PAGE>


                                                                     JUSAN, S.A.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
Euros in thousands

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)

     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.

     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 12a).  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.  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.

     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").

     n.   Reclassification:

          Certain amounts from prior years have been reclassified to conform the
          current year's  presentation.  The  reclassification  had no effect on
          previously reported net loss, shareholders' equity or cash flows.

                                      F-46

<PAGE>



                                                                     JUSAN, S.A.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
Euros in thousands

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)

     o.   Impact of recently issued accounting standards:

          In January  2003,  the  Financial  Accounting  Standards  Board issued
          Interpretation No. 46, Consolidation of Variable Interest Entities, an
          interpretation   of   Accounting   Research   Bulletin  No.  51  ("the
          interpretation").  In general,  a variable interest entity (VIE) is an
          entity  that has (1)  insufficient  amount of equity for the entity to
          carry on its principal  operations,  without  additional  subordinated
          financial  support from other parties,  (2) equity investors that as a
          group do not have the ability through voting or similar rights to make
          decisions  about the entity's  activities,  or (3) investors that as a
          group do not have the obligation to absorb the entity's losses or have
          the right to receive the  benefits of the entity.  The  interpretation
          requires the  consolidation of a VIE by the primary  beneficiary.  The
          primary  beneficiary  is the entity  that  absorbs a  majority  of the
          entity's expected losses, receives a majority of the entity's expected
          residual  returns,  or both, as a result of ownership,  contractual or
          other  financial  interests  in the entity.  Presently,  entities  are
          generally  consolidated  by  an  enterprise  that  has  a  controlling
          financial  interest through ownership of a majority voting interest in
          the entity.

          The  Company's  management  believes  that this  standard will have no
          effect on the Company.


NOTE 3:- OTHER ACCOUNTS RECEIVABLE AND PREPAID EXPENSES

                                                          December 31,
                                                 ------------------------------
                                                     2002             2003
                                                 -------------    -------------

              Government authorities                (euro)201        (euro)191
              Employee advances                            34               33
              Deposits                                     16               16
              Other                                        11                -
                                                 -------------    -------------
                                                    (euro)262        (euro)240
                                                 =============    =============


NOTE 4:-    INVENTORIES

              Raw materials                         (euro)551        (euro)489
              Work in progress                             38               23
              Finished products                           311              281
                                                 -------------    -------------
                                                    (euro)900        (euro)793
                                                 =============    =============

                                      F-47

<PAGE>

                                                                     JUSAN, S.A.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
Euros in thousands

NOTE 5:- PROPERTY AND EQUIPMENT, NET

                                                              December 31,
                                                   -----------------------------
                                                       2002             2003
                                                   -------------    ------------
     Cost:
       Computers and peripheral equipment         (euro) 140        (euro) 152
       Office furniture and equipment                    285               294
       Motor vehicles                                    100               103
       Leasehold improvements                            140               140
                                                   -------------   -------------
                                                         665               689
                                                   -------------   -------------
     Accumulated depreciation:
       Computers and peripheral equipment                 97               127
       Office furniture and equipment                    243               265
       Motor vehicles                                     67                79
       Leasehold improvements                            140               140
                                                   -------------   -------------
                                                         547               611
                                                   -------------   -------------
     Depreciated cost                             (euro) 118        (euro)  78
                                                   =============   =============

     Depreciation  expenses for the years ended December 31, 2001, 2002 and 2003
     were (euro) 48, (euro) 63 and (euro) 64, respectively.


NOTE 6:- SHORT-TERM BANK DEBT

     The Company has a short-term  bank debt in the amount of (euro)38,  bearing
     interest of 3.5%.


NOTE 7:- ACCRUED EXPENSES AND OTHER LIABILITIES

                                                         December 31,
                                                -------------------------------
                                                     2002             2003
                                                --------------   --------------

        Employees and payroll accruals         (euro)  53        (euro) 55
        Income tax payable                            184              131
        Government authorities                        131              104
        Accrued dividends                               -              100
        Warranty costs                                 18               18
                                                --------------   --------------
                                               (euro) 386       (euro) 408
                                                ==============   ==============

                                      F-48

<PAGE>

                                                                     JUSAN, S.A.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
Euros in thousands

NOTE 8:- CONTINGENT LIABILITIES AND COMMITMENTS

     The facilities of the Company are rented under operating leases for periods
     ending in 2006.

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

           2004      (euro) 140
           2005              92
           2006              35
                    ---------------
                     (euro) 267
                    ===============

     Rent  expenses  for years ended  December 31, 2001,  2002,  and 2003,  were
     approximately (euro) 141, (euro) 142 and (euro) 152, respectively.


NOTE 9:- 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,
                                                               ---------------------------------------
                                                                   2001         2002         2003
                                                               ------------  -----------  ------------
                                                                Unaudited
                                                               ------------
             <S>                                                <C>           <C>          <C>
             Income before taxes as reported
               in the statements of operations                  (euro)806     (euro)812    (euro)657
                                                               ============  ===========  ============
             Tax rates                                                 35%           35%          35%
                                                               ============  ===========  ============
             Theoretical tax benefit                            (euro)282     (euro)284    (euro)230
             Decrease in taxes resulting from:
             Tax deduction for development                            (99)          (99)         (99)
                                                               ------------  -----------  ------------
             Taxes on income (tax benefit) as reported
              in the statements of operations                   (euro)183     (euro)185    (euro)131
                                                               ============  ===========  ============
</TABLE>

     Under the  current  tax  legislation,  35% of  development  expense  can be
     deducted from the income tax with the limits of 45% of the  theoretical tax
     benefits. In 2001 and 2002 this limit was 35%.

     All the income before  income taxes is domestic.  Income taxes include only
     current tax expenses.

                                      F-49

<PAGE>





                                                                     JUSAN, S.A.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
Euros in thousands (except per share data)

NOTE 10:- RELATED PARTIES TRANSACTIONS

     The  balances  with and the revenues  derived from related  parties were as
     follows:

     a.   Payments to related parties:

                                        Year ended December 31,
                                 --------------------------------------
                                    2001         2002          2003
                                 -----------  -----------   -----------
                                 Unaudited
                                 -----------
          Wages                  (euro)295    (euro)274     (euro)308
                                 ===========  ===========   ===========

          In 2002 and 2003, the balance with personnel reflects short-term debt.

     b.   Transactions with related parties were as follows:

<TABLE>
<CAPTION>
                                                              Year ended December 31,
                                                      ----------------------------------------
                                                          2001          2002          2003
                                                      ------------  -------------  -----------
                                                       Unaudited
                                                      ------------
         <S>                                          <C>            <C>           <C>
         Sales through related parties                (euro)  -      (euro) -      (euro) 15
                                                      ============  =============  ===========
         Amounts charged by related parties:
           Cost of revenues                           (euro)117      (euro)80      (euro)205
                                                      ============  =============  ===========
</TABLE>

     c.   Amounts receivable from and payables to related parties:

                                                         December 31,
                                                 ------------------------------
                                                     2002             2003
                                                 -------------    -------------
          Receivables:
            Mer Telemagement Solutions             (euro)1        (euro)  9
                                                 =============    =============
          Payables:
            Beheer                                 (euro)-        (euro)128
                                                 =============    =============


NOTE 11:- 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.   Dividends:

          On October 31, 2003 the General  Meeting of  Shareholders  approved to
          pay  dividend of (euro) 200 ((euro)  13.29 per share) of which  (euro)
          100 has been paid during the year. The remaining  amount of (euro) 100
          is included in accrued expenses and other liabilities  include accrued
          dividend to one of the shareholders as of December 31, 2003.

                                      F-50

<PAGE>
                                                                     JUSAN, S.A.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
Euros in thousands

NOTE 11:- SHAREHOLDERS' EQUITY (Cont.)

     c.   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 can only be used to compensate  for
          losses or to increase capital.


NOTE 12:- SEGMENTS, CUSTOMERS AND GEOGRAPHIC INFORMATION

     a.   Major customers as a percentage of total revenues:

                                              Year ended December 31,
                                     ------------------------------------------
                                         2001          2002           2003
                                     ------------   -----------    ------------
                                      Unaudited
                                     ------------
                                                         %
                                     ------------------------------------------
          Adictis                           -              3%            13%
          Telefonica de Espana              7%             3%            10%


     b.   The following is a summary of revenues within  geographic  areas based
          on end customer location:

                                              Year ended December 31,
                                     ------------------------------------------
                                         2001          2002           2003
                                     ------------   -----------    ------------
                                      Unaudited
                                     ------------
          Spain                     (euro)4,016    (euro)4,335    (euro)3,360
          European Community              1,902          2,067          2,179
          Other                             295            477            521
                                     ------------   -----------    ------------
                                    (euro)6,213    (euro)6,879    (euro)6,060
                                     ============   ===========    ============


NOTE 13:- SELECTED STATEMENTS OF OPERATIONS DATA

            Financial income, net
                                               Year ended December 31,
                                      ------------------------------------------
                                          2001          2002           2003
                                      ------------   -----------    ------------
                                       Unaudited
                                      ------------
            Financial expenses:
            Interest expenses          (euro)  7      (euro)  9       (euro) 5
            Other expenses                    12             13              8
                                      ------------   -----------    ------------
                                              19             22             13
                                      ------------   -----------    ------------
            Financial income:
            Interest income                   25             29             22
                                      ------------   -----------    ------------
            Financial income, net       (euro) 6       (euro) 7       (euro) 9
                                      ============   ===========    ============



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


                                      F-51





<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/Yossi Brikman
                                                ----------------
                                                Yossi Brikman
                                                Chief Financial Officer



Dated: June 24, 2004

                                       79