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, 2002
                                       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)

                 40 Aluf David Street, Ramat - Gan, 52232 Israel
                    (Address of principal executive offices)

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

         Title of Each Class           Name of Each Exchange on Which Registered
         -------------------           -----------------------------------------
              None                                 N/A

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
                                (Title of Class)

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
                 as of December 31, 2002.......................... 4,882,748

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>







                                TABLE OF CONTENTS
                                                                            Page
                                                                            ----

PART I........................................................................1

ITEM 1.    IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS..............1
ITEM 2.    OFFER STATISTICS AND EXPECTED TIMETABLE............................1
ITEM 3.    KEY INFORMATION....................................................1
            A. Selected Financial Data........................................1
            B. Capitalization and Indebtedness................................2
            C. Reasons for the Offer and Use of Proceeds......................2
            D. Risk Factors...................................................2
ITEM 4.    INFORMATION ON THE COMPANY........................................16
            A. History and Development of the Company........................16
            B. Business Overview.............................................18
            C. Organizational Structure......................................27
            D. Property, Plants and Equipment................................27
ITEM 5.    OPERATING AND FINANCIAL REVIEW AND PROSPECTS......................27
            A. Operating Results.............................................27
            B. Liquidity and Capital Resources...............................38
            C. Research and Development......................................39
            D. Trend Information.............................................40
ITEM 6.    DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES........................41
            A. Directors and Senior Management...............................41
            B. Compensation..................................................43
            C. Board Practices...............................................43
            D. Employees.....................................................48
            E. Share Ownership...............................................49
ITEM 7.    MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS.................52
            A. Major Shareholders............................................52
            B. Related Party Transactions....................................53
            C. Interests of Experts and Counsel..............................53
ITEM 8.    FINANCIAL INFORMATION.............................................54
            A. Consolidated Statements and Other Financial Information.......54
            B. Significant Changes...........................................55
ITEM 9.    THE OFFER AND LISTING.............................................55
            A. Offer and Listing Details.....................................55
            B. Plan of Distribution..........................................56
            C. Markets.......................................................56
            D. Selling Shareholders..........................................56
            E. Dilution......................................................56
            F. Expense of the Issue..........................................56
ITEM 10.   ADDITIONAL INFORMATION............................................57
            A. Share Capital - Treasury shares...............................57
            B. Memorandum and Articles of Association........................57
            C. Material Contracts............................................60
            D. Exchange Controls.............................................60
            E. Taxation......................................................60


                                       i

<PAGE>



            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.......................................................74
ITEM 15.   CONTROLS AND PROCEDURES...........................................74
ITEM 16.   RESERVED..........................................................74

PART III.....................................................................74

ITEM 17.   FINANCIAL STATEMENTS..............................................74
ITEM 18.   FINANCIAL STATEMENTS..............................................74
ITEM 19.   EXHIBITS..........................................................75

S I G N A T U R E S..........................................................77


                                       ii




<PAGE>


     The  statements  contained  in this  annual  report  that  are  not  purely
historical are forward-looking  statements. Such forward-looking statements also
include  statements  in  Item 4 -  "Information  on the  Company"  and  Item 5 -
"Operating and Financial Review and Prospects."  These statements  involve risks
and  uncertainties  and actual results could differ materially from such results
discussed in these  statements as a result of the risk factors set forth in this
annual report. All forward-looking statements included in this annual report are
based on  information  available  to us on the date  hereof,  and we  assume  no
obligation to update any such forward-looking statements.

                                     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,  2002  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, a member
of Ernst & Young  Global,  whose  report  with  respect to the three years ended
December 31, 2002 and as of December 31, 2001 and 2002 appears in this Report.



                                       1

<PAGE>

<TABLE>
<CAPTION>
Statement of Operations Data:
                                                       Year Ended December 31,
                                           --------------------------------------------------
                                            1998       1999       2000        2001       2002
                                            ----       ----       ----        ----       ----
                                                (in thousands, except per share data)

<S>                                        <C>        <C>        <C>         <C>        <C>
Revenues............................       $11,118    $12,780    $11,067     $10,725    $9,787
Cost of revenues....................         4,196      3,137      2,842       2,552     1,896
                                             -----      -----      -----       -----     -----
Gross profit........................         6,922      9,643      8,225       8,173     7,891
Selling and marketing, net..........         3,920      4,186      4,853       4,911     3,954
Research and development, net.......         2,657      3,491      4,039       3,562     2,127
General and administrative..........         1,893      1,593      1,845       1,943     1,858
In process research and development
  write-off.........................            --         --        945          --        --
                                               ---        ---        ---         ---       ---
Operating income (loss).............        (1,548)       373     (3,457)     (2,243)      (48)
Financial income, net...............           147         35        374         138       134
Other income (expenses).............            --      5,150      1,591        (654)     (140)
                                               ---      -----      -----        ----      ----
Income (loss) before taxes..........        (1,401)     5,558     (1,492)     (2,759)      (54)
Taxes on income (tax benefit).......            84      1,277       (155)         16        52

</TABLE>


                                       1
<PAGE>

<TABLE>
<CAPTION>

Statement of Operations Data:

                                                       Year Ended December 31,
                                           --------------------------------------------------
                                            1998       1999       2000        2001       2002
                                            ----       ----       ----        ----       ----
<S>                                         <C>        <C>       <C>         <C>         <C>
Net income (loss) before equity in
  earnings of affiliates and
  minority interest.................        (1,485)     4,281     (1,337)     (2,775)     (106)
Equity in earnings of affiliates                31        211         66         221       236
Minority interest in a subsidiary...           (23)        --         --          --        --
                                               ---        ---        ---         ---       ---
Net income (loss)...................       $(1,477)    $4,492    $(1,271)    $(2,554)     $130
                                           =======     ======    =======     =======      ====
Basic net earnings (loss) per share.        $(0.31)     $0.96     $(0.26)     $(0.53)    $0.03
                                            ======      =====     ======      ======     =====
Diluted net earnings (loss) per share       $(0.31)     $0.94     $(0.26)     $(0.53)    $0.03
                                            ======      =====     ======      ======     =====
</TABLE>

<TABLE>
<CAPTION>
Balance Sheet Data:
                                                            December 31,
                                           ---------------------------------------------------
                                             1998       1999       2000        2001      2002
                                             ----       ----       ----        ----      ----
<S>                                        <C>        <C>        <C>         <C>       <C>
Working capital.....................       $ 8,586    $13,701    $10,342     $ 9,060   $ 9,244
Total assets........................        15,889     21,615     21,812      18,095    17,707
Long-term loans.....................            12          8         84          13         8
Shareholders' equity................        12,972     17,557     16,497      13,856    14,013
</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.

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 1998, 2000, 2001 and 2002 and incurred
a small  operating  loss in the first quarter of 2003. We cannot assure you that
we will be able to achieve or sustain profitable operations in the future.

                                        2

<PAGE>




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;

     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.

                                        3

<PAGE>


     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 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

                                       4

<PAGE>


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 2000,  2001 and 2002, our three major OEMs,  Siemens Gmbh,
Philips  Communications  Systems B.V. and Ericsson,  generated 40.0%,  44.0% and
46.0% of our revenues respectively. The percentage of sales attributable to each
of these OEMs in the three years ended December 31, 2002 are as follows:

                                    2000          2001         2002
                                    ----          ----         ----
Siemens....................         22.0%         32.0%        36.0%
Philips....................         11.0%          8.0%         6.0%
Ericsson...................          7.0%          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 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
requirement  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

                                       5

<PAGE>


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  have no  present  agreements  with  respect  to any  future
acquisitions or investments.

We face risks associated with expanding our distribution.

     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  our  direct  sales  force or other  distribution  channels  could have a
material  adverse  effect  on our  business,  operating  results  and  financial
condition.

We are subject to risks associated with international operations.

     We are based in Israel and generate a large percentage of our sales outside
the United States. Our sales in the United States accounted for 46%, 61% and 66%
of our total  revenues for the years ended  December  31,  2000,  2001 and 2002,
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;

                                        6

<PAGE>




     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 United States 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.

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.

                                        7

<PAGE>


     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    (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.

                                       8

<PAGE>


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.

Recently  enacted and proposed  changes in securities  laws and  regulations are
likely to increase our costs.

     The  Sarbanes-Oxely  Act of 2002  that  became  law in July  2002  requires
changes  in  some of our  corporate  governance  and  securities  disclosure  or
compliance practices.  That act also requires the SEC to promulgate new rules on
a variety of subjects,  in addition to rule  proposals  already made, and Nasdaq
has proposed revisions to its requirements for companies that are Nasdaq-listed.
We expect these  developments  to increase our legal  compliance  costs, to make
some  activities  more  time-consuming  and may  make it  difficult  to  attract
qualified  independent  directors.  We are presently  evaluating  and monitoring
regulatory   developments  and  cannot  estimate  the  timing  or  magnitude  of
additional costs we may incur as a result.

Developments beyond our control may adversely affect us.

     Certain types of losses of a catastrophic  nature, such as losses resulting
from floods, thunderstorms, earthquakes and other "Acts of God," terrorism, work
stoppages,  regulatory  actions or other  unpredictable  developments could also
interrupt and adversely affect our

                                       9

<PAGE>


business  operations.  In  addition,  the  continuing  threat  of  severe  acute
respiratory syndrome,  or SARS, may adversely impact our business,  particularly
in Southeast  Asia. To date,  SARS has not had a material  adverse effect on our
business.  However,  any  future  spread  of SARS as well as  travel  and  other
restrictions imposed to combat SARS may adversely affect us.

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  44.8%  of our  outstanding  ordinary  shares  and  Isaac
Ben-Bassat,  one of our  directors,  is the  owner of  15.1% of our  outstanding
ordinary  shares.  As a result,  they  control and will  continue to control the
election of the entire Board of Directors  other than our two outside  directors
and generally direct our business and affairs.

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 the 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.

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
nonetheless directly affected by the political, economic and military conditions
affecting Israel. Any major hostilities  involving Israel or the interruption or
curtailment of trade between Israel and its present trading  partners could have
a material  adverse effect on our business,  financial  condition and results of
operations.  Since the  establishment of the State of Israel in 1948, a state of
hostility has existed,  varying in degree and intensity,  between Israel and the
Arab countries.  While Israel has entered into peace  agreements with both Egypt
and Jordan and  several  other  countries  had  announced  their  intentions  to
establish  trade and other  relations  with Israel,  Israel has not entered into
additional peace agreements.  There has been a significant  deterioration in the
relationship between Israel

                                       10

<PAGE>


and the  Palestinian  Authority  since  September  2000,  and the peace  process
between the parties has stagnated. Since the beginning of 2002, there has been a
marked acceleration in the number and frequency of hostile incidents,  including
numerous  lethal suicide attacks in Israeli.  In response,  the Israeli Army has
made incursions into Palestinian-controlled  cities and towns and refugee camps.
The continued  hostilities between the Palestinian  community and Israel and the
failure to settle the conflict has had and continues to have a material  adverse
effect on the Israeli economy and a material  adverse effect on our business and
us. Further  expansion of  hostilities  might require more  widespread  military
reserve  service by some of our  employees,  which may have a  material  adverse
effect on our business.


Most of our  directors,  officers and employees are obligated to perform  annual
military reserve duty in Israel.  We cannot assess the potential impact of these
obligations on our business.

     Our  directors,  officers  and  employees  who are male adult  citizens and
permanent residents of Israel under the age of 48 are, unless exempt,  obligated
to perform  annual  military  reserve  duty and are  subject to being  called to
active duty at any time under emergency circumstances. We cannot assess the full
impact of these  requirements on our workforce or business if conditions  should
change,  and we cannot predict the effect on us of any expansion or reduction of
these obligations.

Economic conditions in Israel have deteriorated.

     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 rate of economic growth in Israel deteriorated
in 2001 and 2002, the Israeli currency was devalued and the rate of inflation in
Israel increased. The new Israeli Government has proposed certain budgetary cuts
and other  changes  which  were  recently  adopted  by the  Israeli  Parliament.
However,  the impact on the Israeli economy of these and other measures that may
eventually be adopted is uncertain.  In addition,  certain credit  agencies have
stated that they are reviewing  Israel's  credit rating.  Should Israel's credit
rating be lowered,  the ability of the Israeli  government  to generate  foreign
financial and economic  assistance may be adversely  affected.  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.  The failure
to stabilize the economy in Israel may have a material adverse effect on us.

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

                                       11

<PAGE>


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 1997 and 1998, the rate of
devaluation  of the NIS against the dollar  exceeded  the rate of  inflation,  a
reversal from prior years. However, in 1999 and 2000 while the rate of inflation
was low,  there was a  devaluation  of the dollar  against the NIS. In the years
2001 and 2002 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. We cannot guarantee that we will enter into such transactions in the
future or that such measures will adequately protect us from serious harm due to
the impact of inflation in Israel.

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 some conditions,  including investing in some fixed assets from
our own equity.  In addition,  some of these  programs may restrict our right to
manufacture  products or transfer our 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.  We
do not expect to receive any grants during 2003.

We may be adversely affected by proposed tax reform in Israel.

     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.

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.

                                       12



<PAGE>




     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.

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 preformed by an independent consultant, we believe that we
were not a PFIC in either 2001 or 2002.

     United  States  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.

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;

                                       13

<PAGE>




     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.

Anti-takeover provisions could negatively impact our shareholders.

     Some of the provisions of Israeli law could:

     o    discourage potential acquisition proposals;

     o    delay or prevent a change in control over us; and

     o    limit the price that  investors  might be willing to pay in the future
          for our ordinary shares.

     Generally,  under Israeli  corporate  law, a merger must be approved by the
board of directors and the shareholders of each of the merging companies. If the
share capital of the  non-surviving  company  consists of more than one class of
shares, the approval of each class is also required. Further, if the company was
incorporated  before  February 1, 2000,  as we were,  the approval of the merger
requires a majority of 75% of the shareholders  present and voting at a meeting.
In certain cases,  court  approval is also required.  Under the Companies Law, a
merger may be  completed  only after 70 days have  elapsed from the date all the
necessary

                                       14

<PAGE>


approvals and the merger proposals have been submitted to the Israeli  Companies
Registrar.  The Companies Law also provides that an  acquisition  of shares of a
public  company  must be made by means of a tender offer if, as a result of such
acquisition,  the  purchaser  would  become  a 25% or  more  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 tender offer if, as a result of the
acquisition, the purchaser would become a 45% shareholder of the company, unless
someone else already holds a majority of the voting power of the company.  These
rules do not apply if the  acquisition  is made by way of a merger.  Regulations
promulgated under the Companies Law provide that, generally, these provisions do
not apply to companies  whose  shares are listed for trading  outside of Israel.
The  requirements  of  Israeli  corporate  law  generally  make  these  forms of
acquisition  significantly  more  difficult  than under United States  corporate
laws.

     Other  potential  means of acquiring a public Israeli company might involve
significant  obstacles,  such  as a  requirement  for  court  approval  for  the
acquisition.  In addition, a body of case law has not yet developed with respect
to the Companies Law. Until this happens, uncertainties will exist regarding its
interpretation.

     Finally,   Israeli   tax  law  treats   some   acquisitions,   particularly
stock-for-stock  swaps between an Israeli  company and a foreign  company,  less
favorably than United States tax law. Israeli tax law may, for instance, subject
a  shareholder  who  exchanges  his or her  shares in us for shares in a foreign
corporation to immediate taxation.

     These  provisions of Israeli  corporate  and tax law and the  uncertainties
surrounding such law may have the effect of delaying,  preventing or making more
difficult a merger or  acquisition  involving our company.  This could prevent a
change of control in our company and  depress the market  price of our  ordinary
shares that might otherwise rise as a result of such change of control.

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.


                                       15

<PAGE>



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 for an indefinite term. We are a public limited
liability  company  under the Israeli  Companies Law 1999 and operate under this
law and associated  legislation.  Our registered  offices and principal place of
business are located at 40 Aluf David Street, Ramat - Gan 52232, Israel, and our
telephone   number  is   972-3-671-0777.   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 55,000 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 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
64,000  extensions.  Various  modules  were  developed  to service  the needs of
different  vertical  markets such as our PMSi module for the hotel  industry and
Resolve for performing  tie-line  reconciliation  for 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

                                       16

<PAGE>


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.

     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.



                                       17


<PAGE>



B. BUSINESS OVERVIEW

Industry Background

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

     Telemanagement  solutions  have  evolved  from the  stand-alone  PC - based
telephone call  accounting  and billing  systems of the mid-1980's to local area
network or  LAN-based  systems  operating  in  Windows  98/2000  and  Windows NT
environments  offering call  accounting,  fraud  detection and fault  management
solutions for users with complex voice and data networks.

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

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

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

                                       18

<PAGE>


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.

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

                                       19

<PAGE>


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, Executone 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.

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.

     o    Support authorization and account codes.

                                       20

<PAGE>




     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

                                       21

<PAGE>


 would  want to view  the  activity  from a  central  site.  The  administrative
functions can also be performed remotely using Internet Explorer. Fully 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 not marketing  WinTRAK any longer, 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)

                                       22

<PAGE>


trouble  tickets,  and (iii) work  orders.  Each  provides  its own  choices and
reference numbering for easy tracking and assignment.  Both service requests and
trouble  tickets  provide  the  option of being  used  globally  for the  entire
organization, regardless of whether the item in service has been recorded in the
site database, or used for items within the current site.

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  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.

     An add-on module, Tie Line Reconciliation  (TLR), provides for the accurate
costing of calls in a private PBX network - 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  (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 PBX, the hotel system is able to
control the opening and closing of guest extensions on check in or out.

Customer Service and Installation

     We provide  customer  support to end-user  customers in the United  States,
Israel,  Hong  Kong,  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.

     Our support staff installs  products at end-user  locations from offices in
Israel,  the United States,  Hong Kong,  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

                                       23

<PAGE>


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, 2002. 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.

     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,
Lucent (EMEA), Nortel, Alcatel,  ECI/Tadiran,  Harris, NEC, Cisco, Executone and
Panasonic.  The  percentage  of sales  attributable  to our  three  largest  OEM
customers Siemens,  Philips and Ericsson,  in the three years ended December 31,
2002 are as follows:

                                    2000         2001         2002
                                    ----         ----         ----
Siemens....................         22.0%        32.0%        36.0%
Philips....................         11.0%         8.0%         6.0%
Ericsson...................          7.0%         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

                                       24

<PAGE>


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.  According to the terms of our exclusive distributor agreement
with  Pfordt,  we are  entitled to license and sell our  products to global OEMs
operating  in  Germany,  subject  to the  payment of a 10% fee to Pfordt on such
revenues.

     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 and Hong Kong Telecom.

     Strategic  Relationships.  As part of our marketing strategy, we attempt to
develop and establish new strategic  relationships  with  manufacturers  of data
communication  systems and IP based  equipment as means of entering new markets.
We have a strategic partnership with XACCT Technologies,  a market leader in the
emerging IP mediation  market.  We are also  continuing  our  relationship  with
RADVision, a recognized IP technology leader.  Together with RADVision,  we will
offer a solution  consisting of  RADVision's  NGK-100  Gatekeeper,  voted as the
industry's  most  intelligent  gatekeeper,   and  our  advanced  Web-based  call
management solution. We joined Check Point Software's Open Platform for Security
(OPSEC)  alliance.  This  will  provide  information  technology  managers  with
valuable information  regarding all outgoing and incoming traffic from the Check
Point(TM)  VPN-1/FireWall-1(R).  The  integrated  system grants  managers a more
comprehensive  view,  analysis and control over all of an enterprise's voice and
data activities. We also signed an agreement with Cisco, pursuant to which Cisco
will use our VoIP solution in their CallManager call processing  software, a key
component of Cisco's AVVID  (Architecture for Voice, Video and Integrated Data).
It provides validated reports on call records,  start time, duration, and origin
and final  destination.  Additional  features  include  the  ability to allocate
usage-sensitive  call costing and,  using an  integrated  fraud  module,  detect
unauthorized or inappropriate system access.

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

     Israeli  Government Grants.  The Israeli  Government,  through the Fund for
Encouraging  Marketing  Activities,  awards  grants  to  Israeli  companies  for
overseas marketing expenses,  including expenses for maintaining  warehouses and
branches, advertising, catalogs,

                                       25

<PAGE>


exhibitions and surveys,  at the maximum rate of 33% of such expenses up to $1.2
million  per year.  Although we  received  grants in 1997 and 1999,  we have not
received  any grants  since  2000.  Beginning  in 1991,  such  grants  have been
dollar-linked  and are  required to be repaid by  royalties  on any  increase in
export  sales at the rate of 3% of  increased  sales.  There can be no assurance
that these grants will continue to be awarded in the future.

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.

                                       26

<PAGE>




C.   ORGANIZATIONAL STRUCTURE

     Our wholly owned subsidiaries in the United States,  Hong Kong, Holland 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.

D.   PROPERTY, PLANTS AND EQUIPMENT

     Our executive  offices and research and development  facilities are located
at 40 Aluf David Street, Ramat-Gan,  Israel, where we occupy approximately 6,500
square feet. The lease, which expires on December 31, 2003, has an annual rental
of approximately $87,000.

     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 for
an  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
        --------------------------------------------

A.   OPERATING RESULTS

     The following  discussion and analysis  should be read in conjunction  with
our Financial Statements and notes thereto included elsewhere in this Report.

     Our  consolidated  financial  statements  are  stated in U.S.  dollars  and
prepared in accordance  with  generally  accepted  accounting  principles in the
United States.  Transactions and balances originally denominated in U.S. dollars
are  presented at their  original  amounts.  Transactions  and balances in other
currencies are remeasured  into U.S.  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 United States  dollars.  In addition,  a
substantial  portion of our costs are incurred in United States  dollars.  Since
the United States dollar is the primary currency of the economic  environment in
which we and certain of our subsidiaries  operate,  the dollar is our functional
and  reporting  currency  and,  accordingly,  monetary  accounts  maintained  in
currencies  other than the dollar are remeasured using the foreign exchange rate
at the balance sheet date.  Operational  accounts and non-monetary balance sheet
accounts are measured and recorded at the exchange rate in effect at the date of
the transaction.  The effects of foreign currency  remeasurement are reported in
financial  expenses.  For  affiliates and certain  subsidiaries,  the functional
currency has been determined to be the local currency, and therefore, assets and
liabilities are translated at year-end  exchange rates;  statement of operations
items  are  translated  at  average  rates  prevailing  during  the  year.  Such
translation  adjustments are recorded as a separate  component of  shareholders'
equity, accumulated other comprehensive income (loss).

                                       27

<PAGE>




Critical Accounting Policies

     The preparation of financial  statements  requires us to make estimates and
assumptions  that affect the reported  amounts of assets and liabilities and the
disclosure of contingent liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period. On an
on-going basis, we evaluate our estimates and judgments, including those related
to revenue  recognition,  bad debts and intangible assets. We base our estimates
and  judgments on  historical  experience  and on various other factors that are
believed to be reasonable under the circumstances, the results of which form the
basis for making  judgments  about the carrying values of assets and liabilities
that are not readily apparent from other sources. Under different assumptions or
conditions, actual results may differ from these estimates.

     The following critical accounting policies,  among others described in Note
2 to our Financial Statements,  are the basis for our more significant judgments
and estimates used in the preparation of our consolidated financial statements.

     Other  Assets  and  Goodwill.  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  assets were
amortized until December 31, 2001, over 10 and 4 years, respectively.  According
to SFAS No.  142,  the net  carrying  amount of  distributor  relationships  and
assembled workforce were subsumed into goodwill at January 1, 2002.

     Goodwill  represents  excess of the cost over the net assets of an acquired
business.  Goodwill  from  acquisitions  completed  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  attributable to each of the reporting
units is tested for  impairment  by comparing  the fair value of each  reporting
unit with its carrying  value.  Fair value is determined  using  discounted cash
flows.  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.
Based on an external  study'  prepared by a certified  consultant ,no impairment
was required in 2002.

     As for the  application  of SFAS No. 142, we  evaluated  our  goodwill  and
intangibles  acquired prior to June 30, 2001 using the criteria of SFAS No. 142,
which  resulted  in the net  carrying  amount of $  1,872,000  related  to other
intangibles  to be subsumed into goodwill at January 1, 2002.  Such  intangibles
consist of assembled  workforce,  with an original  cost of $848,000  (amortized
cost of  $495,000),  and  distributors'  relationship  with an original  cost of
$1,653,000  (amortized cost of $1,377,000)  being subsumed into goodwill.  As of
December 31,

                                       28

<PAGE>


2002,  $2,017,000 and $800 of the goodwill  balance are attributable to our U.S.
and South America's reporting units, respectively.

     Revenue  Recognition.  We  and  our  subsidiaries  generate  revenues  from
licensing  the rights to use our software  products  directly to  end-users  and
indirectly  through  resellers  and OEM's  (who are  considered  by us to be end
users).   A  portion   of  our  sales  to   end-user   customers   is  based  on
self-installation.  We also  generate  revenues  from sales of  maintenance  and
support.  Revenues from software  license  agreements  are  recognized  when all
criteria outlined in Statement of Position 97-2 "Software Revenue  Recognition,"
as amended,  or SOP 97-2, 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.  Our
customers do not have the right to return products to us.

     Where software arrangements involve multiple elements, revenue is allocated
to each element based on vendor  specific  objective  evidence,  or VSOE, of the
relative  fair market value of each element in the  arrangement,  in  accordance
with the "residual  method"  prescribed by SOP 98-9  "Modification  of SOP 97-2,
Software Revenue Recognition with Respect to Certain  Transactions." The VSOE we
use to allocate  the sales prices to services  and  maintenance  is based on the
price  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  element when (i) there is VSOE of the fair values
of all the undelivered  elements,  and (ii) all revenue recognition  criteria of
SOP 97-2, as amended, are satisfied.  Under the residual method, any discount in
the arrangement is allocated to the delivered element.

     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 services contracts but not yet recognized as revenues.

     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 have been capitalized. During 2002 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 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, 2002.

                                       29

<PAGE>




Results of Operations

     The  following  table  sets  forth,  for the  periods  indicated,  selected
financial  information  with  respect  to  our  operations  as a  percentage  of
revenues:

                                                      Year Ended December 31,
                                                    --------------------------
                                                     2000      2001      2002
                                                     ----      ----      ----
Revenues........................................... 100.0%    100.0%    100.0%
Cost of revenues ..................................  25.7      23.8      19.4
                                                     ----      ----      ----
Gross profit.......................................  74.3      76.2      80.6
Selling and marketing, net.........................  43.9      45.8      40.4
Research and development, net......................  36.5      33.2      21.7
General and administrative.........................  16.7      18.1      19.0
In process research and development write-off......   8.5        --        --
                                                      ---       ---       ---
Operating loss..................................... (31.3)    (20.9)     (0.5)
Financial income, net..............................   3.4       1.3       1.4
Other income (expenses)............................  14.4      (6.1)     (1.5)
                                                     ----      ----      ----
Loss before taxes.................................. (13.5)    (25.7)     (0.6)
Taxes on income (tax benefit)......................  (1.4)      0.2       0.5
                                                     ----       ---       ---
Net loss before equity in earnings of affiliate.... (12.1)    (25.9)     (1.1)
Equity in earning of affiliate.....................   0.6       2.1       2.4
                                                      ---       ---       ---
Net income (loss).................................. (11.5)%   (23.8)%     1.3%
                                                    =====     =====       ===

Year Ended December 31, 2002 Compared to Year Ended December 31, 2001

     Revenues.  Revenues  consist  primarily of products sales and revenues from
services, including service center income, project development,  maintenance and
support.  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,  such as PBX systems.  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  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,  or OCS) and (iii) warranty and support costs for up to one
year for  end-users.  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.  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.

                                       30

<PAGE>




     Selling  and  Marketing,   Net.  Selling  and  marketing  expenses  consist
primarily  of  costs  relating  to  promotion,   advertising,  trade  shows  and
exhibitions, sales compensation, sales support, and travel expenses. 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 U.S.  and were able to maintain  our sales to existing  OEM
customers.  We believe that our selling and  marketing  expenses in 2003 for our
current products should be very similar to 2002.

     Research and Development,  Net.  Research and development  expenses consist
primarily of salaries of employees  engaged in on-going research and development
activities  and  other  related  costs.  Grants  from  the  OCS are  applied  as
reductions to total research and development costs. 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 consist
primarily  of  compensation  costs  for  administration,   finance  and  general
management  personnel and office maintenance and administrative  costs.  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.  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 $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 Earnings of Affiliate. We recognize income and loss from
the  operations of our 50%-owned  affiliate,  Jusan S.A. In 2002 and in 2001, we
recognized income of $236,000 and $221,000 respectively.

                                       31

<PAGE>




     Net Income (Loss).  In 2002 we recorded net income of $130,000 or $0.03 per
ordinary  share  on a fully  diluted  basis  as  compared  to a net loss of $2.6
million or $(0.53) per ordinary share on a fully diluted basis in 2001 after the
capital loss of $741,000.

Year Ended December 31, 2001 Compared to Year Ended December 31, 2000

     Revenues.  Revenues  decreased  3.6% to $10.7  million  in 2001 from  $11.1
million in 2000 as a result of the global recession and the decline in worldwide
sales of telecommunication products, especially PBX systems. In 2001, our wholly
owned  U.S.  subsidiary,  MTS  IntegraTRAK,  accounted  for  61.0% of our  total
revenues.

     Cost of Revenues.  Cost of revenues decreased 9.0% to $2.55 million in 2001
from $2.8 million in 2000,  principally  as a result of the overall  decrease in
sales and the overall  increase in sales of software  products that have a lower
cost than products with hardware components.

     Gross margin. Gross profit as a percentage of revenues,  increased slightly
to 76.2% in 2001 from 74.3% in 2000 due to the changing nature of our sales.

     Selling and  Marketing,  Net.  Selling  and  marketing  expenses  increased
insignificantly  by 1% to $4.9  million in 2001 from $4.85  million in 2000.  In
2001,  we were able to maintain  our sales to existing  OEM  customers  and also
succeeded in reaching  agreements with new strategic  partners.  During 2001, we
increased our overseas  marketing  efforts,  particularly  in the U.S.  where we
improved our marketing  deployment in the U.S.  market  through our wholly owned
subsidiary, MTS IntegraTRAK.

     Research and Development, Net. Net research and development costs decreased
11.0% to $3.56  million  in 2001 from  $4.0  million  in 2000,  as a result of a
downsizing  process  that we  implemented  during the last  quarter of 2001.  We
received  royalty-bearing  grants  totaling  $990,000  in 2001  from  the OCS as
compared to $1.25 million in 2000.

     General and Administrative.  General and administrative  expenses increased
4.9% to $1.94  million in 2001 from  $1.85  million  in 2000,  principally  as a
result of the  inclusion  of a full year of  expenses  associated  with our U.S.
based  subsidiary,  IntegraTRAK,  that we  acquired  in April  2000,  and  costs
associated with the recruitment of new management personnel during 2001.

     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 $138,000 in 2001 as compared to financial  income of $374,000 in 2000.
This decrease was  principally  due to lower interest rates in both the U.S. and
in Israel during 2001 and the  fluctuation of different  currencies  against our
reporting currency, the U.S. dollar.

     Other  Income  (Expenses).   During  November  2000,  we  sold  our  office
condominium space in New York City for $2.1 million.  We reported a capital gain
of $1.2 million from the

                                       32

<PAGE>


sale and the tax liability  resulting from the sale was approximately  $201,000.
During 2001 we recorded a capital loss of $741,000  ($606,000  after tax) from a
permanent  value  depreciation  of the  NICE  Systems  Ltd.  securities  that we
acquired as part of the  consideration we received from the sale of STS Software
Ltd. to NICE Systems Ltd.

     Taxes on Income.  In 2001 our taxes on income was  $16,000 as compared to a
tax  benefit  of  $155,000  in 2000.  The tax  benefit  in 2000 was  principally
attributable to deferred tax losses that we recognized and is net of the capital
gains tax we incurred in connection  with the sale of our  condominium  space in
New York City.

     Equity Interest in Earnings of Affiliate. We recognize income and loss from
the operations of our 50%-owned  affiliate,  Jusan S.A. and until July 2000 from
our investment in Silverbyte. In July 2000, we sold a 31% interest in Silverbyte
and since that date this investment has been accounted for according to the cost
method  and we no  longer  recognize  any  equity  income or loss.  In 2001,  we
recognized  income of $221,000  from our  affiliate,  Jusan S.A.  and in 2000 we
recognized  income  of  $66,000  from  our  equity  interests  in both of  these
affiliates.

     Net Loss.  In 2001 we  recorded a net loss of $2.6  million or $(0.53)  per
ordinary  share on a fully  diluted  basis  after the  capital  loss of $741,000
relating to our  securities  holdings in NICE  Systems Ltd. as compared to a net
loss of $1.27 million or $(0.26) per ordinary share on a fully diluted basis for
the year  ended  December  31,  2000.  Our net loss in 2000  includes a one time
write-off  of  $945,000  of  in-process  research  and  development  expenses in
connection with our acquisition of IntegraTRAK.

Quarterly Results of Operations

     The  following  tables  set forth  certain  unaudited  quarterly  financial
information  for the two  years  ended  December  31,  2002.  The  data has been
prepared  on  a  basis  consistent  with  our  audited  consolidated   financial
statements   included  elsewhere  in  this  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
                                -------------------------------------------------------------------------------
                                                 2001                                   2002
                                --------------------------------------  ---------------------------------------
                                Mar. 31,  Jun. 30,  Sept.30,  Dec. 31,  Mar. 31,  Jun. 30,  Sept. 30,  Dec. 31,
                                --------  --------  --------  --------  --------  --------  ---------  --------
                                                                  (in thousands)

<S>                              <C>      <C>       <C>       <C>       <C>       <C>        <C>       <C>
Revenues.....................    $2,983   $2,977    $2,132    $2,633    $2,581    $2,494     $2,196    $2,516
Cost of revenues.............       676      695       487       694       569       407        475       445
                                    ---      ---       ---       ---       ---       ---        ---       ---
Gross profit.................     2,307    2,282     1,645     1,939     2,012     2,087      1,721     2,071
                                  -----    -----     -----     -----     -----     -----      -----     -----
Selling and marketing, net...     1,295    1,312     1,180     1,124     1,014     1,071        970       899
Research and development, net     1,241      751       852       718       605       539        497       486
General and administrative....      457      468       501       517       460       473        459       466
Operating expenses............    2,993    2,531     2,533     2,359     2,079     2,083      1,926     1,851
                                  -----    -----     -----     -----     -----     -----      -----     -----
Operating income (loss).......     (686)    (249)     (888)     (420)      (67)        4       (205)      220
Financial income
  (expense), net..............      (12)      19        73        58         3       101         42       (12)
Other income (loss)...........     (741)      82        42       (37)       17        (5)       (71)      (81)
                                   ----       --        --       ---        --        --        ---       ---
</TABLE>


                                       33
<PAGE>

<TABLE>
<CAPTION>
                                                              Three months ended
                                -------------------------------------------------------------------------------
                                                 2001                                   2002
                                --------------------------------------  ---------------------------------------
                                Mar. 31,  Jun. 30,  Sept.30,  Dec. 31,  Mar. 31,  Jun. 30,  Sept. 30,  Dec. 31,
                                --------  --------  --------  --------  --------  --------  ---------  --------
                                                                  (in thousands)

<S>                              <C>       <C>       <C>       <C>       <C>       <C>        <C>       <C>
Income (loss) before taxes....   (1,439)    (148)     (773)     (399)      (47)      100       (234)      127
Taxes on income (tax benefit)       (59)      11        10        54        --        65        (51)       38
                                    ---       --        --        --        --        --        ---        --
Net income (loss) before
  equity in earnings
  (loss) of affiliate.........   (1,380)    (159)     (783)     (453)      (47)       35       (183)       89
Equity in results of
affiliate.....................       45       58        61        57        38        84         84        30
                                     --       --        --        --        --        --         --        --
Net income (loss).............  $(1,335)   $(101)    $(722)    $(396)      $(9)     $119       $(99)    $ 119
                                =======    =====     =====     =====       ===      ====       ====     =====

Revenues......................    100.0%   100.0%    100.0%    100.0%    100.0%    100.0%     100.0%    100.0%
Cost of revenues..............     22.7     23.3      22.8      26.4      22.0      16.3       21.6      17.7
                                   ----     ----      ----      ----      ----      ----       ----      ----
Gross profit..................     77.3     76.7      77.2      73.6      78.0      83.7       78.4      82.3
                                   ----     ----      ----      ----      ----      ----       ----      ----
Selling and marketing, net....     43.4     44.1      55.3      42.7      39.3      42.9       44.2      35.7
Research and development,
   net .......................     41.6     25.2      40.0      27.3      23.4      21.6       22.6      19.3
General and administrative....     15.3     15.7      23.5      19.6      17.8      19.0       20.9      18.5
Operating expenses............    100.3     85       118.8      89.6      80.5      83.5       87.7      73.5
                                  -----     --       -----      ----      ----      ----       ----      ----
Operating income (loss).......    (23.0)    (8.3)    (41.6)    (16.0)     (2.5)      0.2       (9.3)      8.8
Financial income
  (expense), net..............    (0.4)      0.6       3.4       2.2       0.1       4.1        1.9      (0.5)
Other income (loss)...........   (24.8)      2.8       2.0      (1.4)      0.7      (0.2)      (3.2)     (3.2)
                                 -----       ---       ---      ----       ---      ----       ----      ----
Income (loss) before taxes....   (48.2)     (4.9)    (36.2)    (15.2)     (1.7)      4.1      (10.6)      5.1
Taxes on income (tax benefit).    (2.0)      0.4       0.5       2.1        --      (2.6)       2.3      (1.5)
                                  ----       ---       ---       ---        --      ----        ---      ----
Net income (loss) before
  equity in earnings of
  affiliate...................   (46.2)     (5.3)    (36.7)    (17.3)     (1.7)      1.5       (8.3)      3.6
                                 -----      ----     -----     -----      ----       ---       ----       ---
Equity in earnings  of
  affiliate...................     1.5       1.9       2.9       2.2       1.5       3.4        3.8       1.2
                                   ---       ---       ---       ---       ---       ---        ---       ---
Net income (loss).............   (44.7%)    (3.4%)   (33.8%)   (15.1%)    (0.2%)     4.9%      (4.5%)     4.8%
                                 =====      ====     =====     =====      ====       ===       ====       ===
</TABLE>

Effective Corporate Tax Rate

     Our income in Israel prior to March 31, 1996, was taxed in the framework of
C.  Mer's tax  status.  Commencing  April 1,  1996,  our  income  has been taxed
separately.  C. Mer was granted the status of an "Approved Enterprise" under the
Law for the Encouragement of Capital Investments, 1959, or the "Investment Law",
with respect to four enlargement  projects. In accordance with the provisions of
the  Investment  Law, C. Mer chose to enjoy  "alternative  benefits,"  wherein a
company  waives  the  receipt of grants in return  for a tax  exemption.  Income
derived from an "Approved  Enterprise" is tax-exempt for a period of two to four
years, commencing with the year it first earns taxable income, and is subject to
corporate tax at the rate of 25% for additional  periods of three to five years.
Income derived from C. Mer's first "Approved  Enterprise" program was tax-exempt
for a four-year  period ended December 31, 1992 and was subject to a reduced tax
rate of 25% for a  three-year  period ended  December 31, 1995.  C. Mer's second
"Approved  Enterprise"  program  was  tax-exempt  for a four-year  period  ended
December 31, 1995 and a reduced tax rate of 25% for the three-year  period ended
December 31, 1998. The third "Approved  Enterprise" program entitled C. Mer to a
tax-exemption  for a four-year  period ended December 31, 1996 and a reduced tax
rate of 25%

                                       34

<PAGE>


for the  three-year  period  ended  December  31,  1999.  The  fourth  "Approved
Enterprise"  program entitled C. Mer to a tax exemption for the four-year period
ended December 31, 1999 and a reduced tax rate of 25% for the three-year  period
ending December 31, 2002. C. Mer transferred these Approved  Enterprise programs
to us. The fifth "Approved  Enterprise"  program  entitled us to a tax exemption
for a two-year  period ending December 31, 1999 and will entitle us to a 25% tax
rate for the five-year  period  ending  December 31, 2004.  The sixth  "Approved
Enterprise"  program entitles us to a tax exemption for a two-year period and is
subject to tax rate of 25% for five-year period. The benefits in respect of this
program have not yet commenced.  Should we and our Israeli  subsidiaries  derive
income from sources  other than the Approved  Enterprise  programs,  such income
will be subject to tax at regular  rates,  which is currently 36%. Our effective
tax rates in Israel were 30%, 25% and 25% during the years 2000,  2001 and 2002,
respectively.

     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.

     During year 2000, we sold our condominium  office space in New York, and as
a result we  submitted  a combined  tax  report  for our two U.S.  subsidiaries,
enabling us to reduce our tax expense by approximately $300,000 in year 2000.

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

     Since the majority of our sales are denominated  and paid in U.S.  dollars,
we believe that inflation and fluctuations in the U.S. dollar exchange rate have
no  material  effect on our  sales.  Inflation  and U.S.  dollar  exchange  rate
fluctuations,  however, have some influence on our expenses and, as a result, on
our net income. 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
dollar.  In 2000, 2001 and 2002 the rate of inflation in Israel was 0%, 1.4% and
6.5%,  respectively,  while the rate of  devaluation  was (2.7%),  9.3 and 7.3%,
respectively.   Inflation  in  Israel  will  have  a  negative   effect  on  our
profitability,  since a  significant  portion of our  expenditures  is  employee
compensation-related.  Salaries  in  Israel  are paid in NIS,  most of which are
adjusted to a limited  extent to reflect  changes in the CPI in Israel.  Some of
our other NIS-based  expenses are either  currently  adjusted to U.S. dollars or
are adjusted to the CPI.

     During  calendar years 1997 through 2002,  Israel's gross domestic  product
increased (decreased) by 2.7%, 2.0%, 6.4%, (0.85%) and (1.0%), respectively. The
Israeli Government's  monetary policy contributed to relative price and exchange
rate stability during most of these years despite  fluctuating rates of economic
growth and a high rate of unemployment.

     The  following  table  sets  forth,  for  the  periods  indicated,  certain
information  with  respect  to 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 such devaluation:

                                       35

<PAGE>


                              Israeli    Israeli     Israeli    Israeli annual
                             Consumer    annual       annual       inflation
                               Price    inflation  devaluation   adjusted for
                               Index      rate         rate      devaluations
                               -----      ----         ----      ------------
Year ended December 31,    (1987 basis)     %            %             %
-----------------------    ------------   ----         ----          ----
1996......................     346.4       10.6         3.7          6.6
1997......................     370.7        7.0         8.8         (1.7)
1998......................     402.6        8.6        17.6         (7.7)
1999......................     408.0        1.33       (0.17)        1.3
2000......................     408.0        0          (2.7)         0
2001......................     413.8        1.4         9.3         (7.2)
2002......................     440.65       6.5         7.3         (0.7)

Conditions in Israel

     We are incorporated under the laws of, and our principal  executive offices
and  manufacturing  and research and development  facilities are located in, the
State of Israel.  Accordingly,  we are directly affected by political,  economic
and military conditions in 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 the
continued  state of  hostility,  varying  in degree  and  intensity,  has led to
security and economic problems for Israel.  Since September 2000, there has been
significant increase in violence, primarily in the West Bank and Gaza Strip, and
more recently  there has been a marked  deterioration  in the relations  between
Israel and the Palestinian  Authority and Israel has experienced  many terrorist
incidents within its borders. As a result, peace negotiations between Israel and
representatives of the Palestinian  Authority have been sporadic and have failed
to result in peace.

     Several  countries  continue  to  restrict  business  with  Israel and with
companies having operations in Israel.  Although we are precluded from marketing
our products to these countries,  we believe that in the past these restrictions
have not had a material  adverse  effect on us. In addition,  as a result of the
hostilities  between Israel and the Palestinian  Authority,  most Arab countries
with which Israel had commercial and trading  agreements have publicly announced
the  halt of  these  agreements.  Also,  as a  result  of the  Israeli  military
activities in the West Bank during April 2002,  several European countries began
to boycott  Israeli  firms.  We do not believe that these  measures  will have a
material adverse affect on us. However,  restrictive laws, policies or practices
directed  towards Israel or Israeli  businesses  could have an adverse impact on
our business.

     In  addition,  some of our  employees in Israel are subject to being called
upon to  perform  military  service  in Israel,  and their  absence  may have an
adverse effect upon our operations.

                                       36

<PAGE>


Generally,  unless exempt, male adult citizens and permanent residents of Israel
under the age of 54 are  obligated to perform up to 37 days of military  reserve
duty annually and all such  residents are subject to being called to active duty
at any time under  emergency  circumstances.  In  addition,  due to the  current
hostilities between the State of Israel and the Palestinian  Authority,  the MOD
has issued emergency orders to recruit a large number of reserve soldiers. While
we have operated effectively under these requirements since we began operations,
we cannot  assess the full  impact of these  requirements  on our  workforce  or
business if conditions should change,  and we cannot predict the effect on us of
any expansion or reduction of these obligations.

     To date,  no executive  officer or key employee was  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.  The Israeli  Government has intervened in various  sectors of
the economy by utilizing fiscal and monetary  policies,  import duties,  foreign
currency  restrictions  and  controls  of wages,  prices  and  foreign  currency
exchange rates. The Israeli Government has periodically  changed its policies in
all these areas.

     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, during 2001 and 2002, the Israeli rate of economic
growth has  deteriorated,  the NIS has been devaluated and the rate of inflation
has increased.  The Israeli  Parliament has recently  adopted certain  budgetary
cuts  and  other  changes  proposed  by the new  Israeli  government,  including
increasing  the value  added tax rate by 1% to 18%.  However,  the impact on the
Israeli  economy of these and other  economic  measures  that may  eventually be
adopted is uncertain. In addition, certain credit agencies have stated that they
are reviewing Israel's credit rating. Should such agencies lower Israel's credit
rating,  the ability of the Israeli government to generate foreign financial and
economical  assistance may be adversely affected.  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.

Trade Agreements

     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 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  U.S.,  Australia,  Canada  and  Japan.  These
preferences  allow Israel to export  products  covered by such  programs  either
duty-free or at reduced tariffs.

                                       37

<PAGE>




     Israel and the European Union Community concluded a Free Trade Agreement in
July 1975 which confers  certain  advantages on Israeli exports to most European
countries  and  obligates  Israel to lower its  tariffs  on  imports  from these
countries over a number of years. In 1985,  Israel and the U.S.  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, which includes  Austria,  Finland,  Iceland,
Liechtenstein,  Norway,  Sweden and  Switzerland,  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.

B.   LIQUIDITY AND CAPITAL RESOURCES

     On December  31, 2002,  we had $9.1  million in cash and cash  equivalents,
$1.2 million in  marketable  securities  and working  capital of $9.2 million as
compared to $6 million in cash and cash equivalents,  $1.9 million in short-term
bank deposits, $2.1 million in marketable securities and $9.1 million in working
capital on December 31,  2001.  The  increase in cash and cash  equivalents  and
working  capital  is  mainly  due to our  downsizing  efforts.  During  2002  we
continued our stock buy back program, purchasing 261,100 ordinary shares through
December  31,  2002 at a cost of  $330,000,  an average  of $1.26 per share.  We
anticipate  that the  repurchase  program will  continue in 2003. 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 90 to
100 days  after  shipment.  Any  material  change in the  aging of our  accounts
receivable could have an adverse effect on our working capital.  During 2002, we
were able to improve our operating cash flow by reducing our operating expenses.

     The  decrease  in  inventory  for the  year  ended  December  31,  2002 was
primarily  due to our efforts to reduce  inventories  in light of the  difficult
economic  conditions  prevailing  worldwide.  The  net  accounts  receivable  at
year-end December 31, 2002 did not change significantly compared to December 31,
2001.  The  allowance  for  doubtful  accounts  was  $837,000 and $356,000 as of
December 31, 2001 and 2002,  respectively,  the significant change is attributed
to bad debts  recognition  in 2002.  As of  December  31,  2002,  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.

                                       38

<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
and ISO 9000-3 (software development) certified.

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

     On December 31, 2002,  we employed 27 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 2000, 2001 and 2002, our research and
development  expenditures  were $5.3  million,  $4.6  million and $2.1  million,
respectively,  for which  the Chief  Scientist  reimbursed  approximately  $1.25
million in 2000 and $0.99  million  in 2001.  We did not  receive  any grants in
2002. During 2000, we recorded an in process research and development  write-off
of $945,000, as a result of the acquisition of the assets of IntegraTRAK Inc.

     Under research and  development  agreements with the Chief Scientist we are
required  to pay  royalties  on our  sales of  products  developed  with  grants
received from the Chief Scientist, 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 Chief Scientist  royalties on all call accounting  product sales at the
applicable  rates at the time of  payment.  Under this  agreement  and  existing
regulations, we are required to pay royalties at a rate of 3%-5% of our software
sales.

     We have expensed  royalties relating to the repayment of such grants in the
amount of $217,000,  $176,000  and  $132,000,  for the years ended  December 31,
2000, 2001 and 2002, respectively.

     As of December 31, 2002, we had a contingent obligation to pay royalties in
the amount of approximately $7.67 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 2003.

                                       39

<PAGE>




Manufacturing

     Our manufacturing operations are performed by third-party contractors.  The
contractors also perform quality assurance activities on our behalf.  Quality is
monitored at each stage of the  production  process,  including the selection of
component  suppliers and supplies,  the assembly of finished  products and final
testing,  packaging and shipping.  We also perform testing and quality assurance
procedures  with respect to the  components,  which are  incorporated,  into our
products. Our facilities are ISO-9001 certified.

     Certain components and subassemblies  included in our products are obtained
from a single  source or a limited group of suppliers  and  subcontractors.  Our
reliance on a limited group of suppliers  involves  several  risks,  including a
potential  inability  to obtain  adequate  supplies  of certain  components  and
reduced  control over pricing and timely  delivery of  components.  Although the
timeliness,  quality and pricing of deliveries  to date from our suppliers  have
been acceptable and we believe that  additional  sources of supply are available
should one or more of our suppliers  are unable to meet our needs,  there can be
no assurance that supplies will be available on an acceptable basis.

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.

Cautionary Statement Regarding Forward-Looking Statements

     This  Annual   Report  on  Form  20-F  contain   various   "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.
Such forward-looking  statements reflect our current view with respect to future
events and financial  results.  Forward-looking  statements  usually include the
verbs "anticipates,"  "believes,"  "estimates,"  "expects,"  "intends," "plans,"
"projects,"  "understands"  and other verbs  suggesting  uncertainty.  We remind
shareholders  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.

     We have  attempted to identify  additional  significant  uncertainties  and
other factors  affecting  forward-looking  statements in a Risk Factors  section
which appears in Item 3 - Key Information.

                                       40


<PAGE>



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..............    55   Chairman of the Board
   Shai Levanon...........    45   President and Chief Executive Officer
   Yossi Brikman..........    45   Chief Financial Officer and General Manager
                                      Israel Operations
   Richard Bruyere........    39   Chief Operating Officer MTS IntegraTRAK Inc.
   Alon Aginsky...........    40   Director
   Isaac Ben-Bassat.......    49   Director
   Dr. Yehoshua Gleitman..    53   Director
   Steven J. Glusband.....    56   Director
   Prof. Nava Pliskin.....    55   Director

     Messrs. Mer, Aginsky, Ben-Bassat and Glusband will serve as directors until
our 2003 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. Mr. Jacob Reshef and Mr. Eitan Metuki were
tendered their resignation as our directors effective November 2002.

     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 since 1988. Mr. Mer holds
a B.Sc.  degree in Computer  Sciences and  Mathematics  from the Technion Israel
Institute for Technology.

     Shai Levanon has served as President and Chief Executive Officer since July
2, 2001. Prior to joining us and since October 1999, Mr. Levanon served as Chief
Executive  Officer of Cellonet  Interactive  Mobile  Commerce,  a company  which
developed and marketed  mobile  commerce  products.  From 1995 until 1997 he was
Vice President for Marketing and Sales at Advanced Vision  Technology,  a public
traded company on the Neuer Market in Germany.  From 1992 until 1994 Mr. Levanon
served as Vice  President  of Sales for NICE  Systems  Corporation,  an  Israeli
company, which develops multimedia digital recording solutions, applications and
related professional services for business interaction  management and is traded
on Nasdaq. From 1990 until 1992 he served as International Marketing Manager for
Orisol Ltd., an Israeli  manufacturing company for vision-based  equipment.  Mr.
Levanon  holds a B.Sc.  in Electronic  Engineering  from Tel Aviv  University in
Israel.

                                       41

<PAGE>


     Yossi Brikman has been our Vice President and Chief Financial Officer since
January 1998. Since March 2000 Mr. Brikman has also served as 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 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 a newly formed large  systems group of C. Mer. 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 since 1988. 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.  He was Chief Executive Officer
of  Ampal-American  Israel  Corporation  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 in  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.

                                       42



<PAGE>




     Prof. Nava Pliskin has served as an outside director since July 2001. Prof.
Pliskin has been an Associate  Professor since 1995, in the areas of Information
Systems (IS) and  Information  Technology  (IT), at the Department of Industrial
Engineering  and  Management  Ben-Gurion  University  in  Israel.  She has  been
affiliated with Ben-Gurion University in various positions since 1985, receiving
tenure in 1992.  In  addition,  she was a Thomas Henry  Carroll Ford  Foundation
Visiting  Associate  Professor at the Harvard  Business  School in 1996-1997 and
Visiting Faculty Member at Suffolk University 1989-1991.  She has 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, 2002.

                                               Salaries, fees,       Pension,
                                               commissions and    retirement and
                                                  bonuses       similar benefits
                                               ---------------  ----------------
All directors and executive officers
as a group, consisting of fifteen (15 persons)   $714,465           $120,271

     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, 2002, we paid each
of our  independent  directors an annual fee of  approximately  $8,400 and a per
meeting  attendance fee of $300. Under the Companies Law, our board of directors
must  approve all  compensation  arrangements  with  office  holders who are not
directors.  Directors'  compensation  arrangements  also require audit committee
approval before board and shareholder approval.

     As of December 31, 2002,  our directors and executive  officers as a group,
consisting  of 15 persons,  held  options to purchase  an  aggregate  of 357,657
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.  The  Board is  currently  composed  of 8
directors.  All 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  as detailed
below) may be  reelected  upon  completion  of their term of office.  All of our
current directors were elected by our shareholders at our annual general meeting
of shareholders of July 2002.

                                       43

<PAGE>




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.

     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  outside
directors are to be appointed, all current members of the Board of Directors are
of the same  gender,  then at least one  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. 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 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 three
independent  directors  on our  Board of  Directors  and to  establish  an 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.

                                       44

<PAGE>

Mr. Alon Aginsky  qualifies as an  independent  director  under the Nasdaq Stock
Market requirements.

Approval of Related Party Transactions Under Israeli Law

     The  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 " -- Directors  and Senior  Management"  above is an office  holder.
Under the 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.

     The  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 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.

                                       45

<PAGE>


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  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  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  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.

Indemnification of Directors and Officers

     The  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 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.  Under a
proposed  amendment to our Articles of Association  that will be voted on at our
next Annual General Meeting of Shareholders to be held in July 2003,  subject to
any

                                       46

<PAGE>


restrictions  imposed  by  corporate  law,  we will be  able  to  enter  into an
insurance  contract for the liability of any of our office  holders with respect
to:

     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
          respect  of an act  performed  by him in  his  capacity  as an  office
          holder.

     In addition, we may indemnify an office holder against:

     o    a financial liability imposed on him in favor of another person by any
          judgment,  including a settlement or an arbitrator's award approved by
          a court in respect of an act  performed  in his  capacity as an office
          holder; and

     o    reasonable litigation expenses, including attorneys' fees, expended by
          such office  holder or charged to him by a court,  in  proceedings  we
          institute  against  him or  instituted  on our  behalf  or by  another
          person,  or in a criminal  charge from which he was acquitted,  all in
          respect of an act performed in his capacity as an office holder.

     These provisions are  specifically  limited in their scope by the Companies
Law, which provides that a company may not indemnify 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,  indemnification  of, and  procurement  of
insurance  coverage  for,  our  office  holders  must be  approved  by our audit
committee  and our board of directors  and, in specified  circumstances,  by our
shareholders.

     At our next Annual General  Meeting of Shareholders to be held in July 2003
we will ask our  shareholders  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.

Audit Committee

     Our audit  committee  is currently  composed of Prof.  Nava  Pliskin,  Alon
Aginsky and Dr. Yehoshua Gleitman.  Our audit committee generally meets at least
four times each year. The  responsibilities of the audit committee include:  (i)
examining  the manner in which  management  ensures and monitors the adequacy of
the nature, extent and effectiveness of accounting and internal control systems;
(ii) reviewing prior to publication  the statutory  accounts and other published
financial statements and information; (iii) monitoring relationships with our

                                       47

<PAGE>


independent  auditors,  ensuring that there are no  restrictions on the scope of
the statutory audit,  making  recommendations  on the auditors,  appointment and
dismissal,   and   reviewing   the   activities,   findings,   conclusions   and
recommendations  of  the  independent  auditors;   (iv)  reviewing  arrangements
established by management for compliance with regulatory and financial reporting
requirements; and (v) reviewing the scope and nature of the work of the internal
auditing unit.

     The audit  committee  is  authorized  generally to  investigate  any matter
within the scope of its  responsibilities  and has the power to obtain  from the
internal  auditing  unit,  our  independent  auditors  or any other  officer  or
employee any information that is relevant to such investigations.

     The Israeli  Companies Law provides that public  companies  must appoint an
audit  committee.  The  responsibilities  of the audit  committee  also  include
approving  related-party  transactions  as  required  by law.  Under the Israeli
Companies Law, an audit  committee  must consist of at least three members,  and
include all of the company's  outside  directors.  However,  the chairman of the
board of directors,  any director employed by the company or providing  services
to the company on a regular basis, any controlling  shareholder and any relative
of a  controlling  shareholder  may not be a member of the audit  committee.  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 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. Our internal auditor complies with
the requirements of the Companies Law.

D.   EMPLOYEES

     On December  31, 2002,  we and our  consolidated  subsidiaries  employed 90
persons includes 27 persons in research and development,  31 persons in training
and  technical  support,  15  persons in  marketing  and sales and 17 persons 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

                                       48

<PAGE>


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 2002, payments to the National Insurance Institute
amounted to approximately 14.5% of wages, of which approximately  two-thirds was
contributed by employees with the balance contributed by the employer.

     Pursuant to Israeli law, we are legally required to pay severance  benefits
upon 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 23, 2003
regarding  the  beneficial  ownership  of our  ordinary  shares  by  each of our
directors and members of our management bodies.

                                             Number of       Percentage of
                                          Ordinary Shares     Outstanding
                                           Beneficially        Ordinary
Name                                         Owned(1)          Shares(2)
----                                         --------          ---------
Chaim Mer..............................  2,089,778 (3)(4)        44.8%
Shai Levanon...........................     65,000 (5)            1.4%
Yossi Brikman..........................    110,000 (5) (8)        2.4%
Richard Bruyere........................     10,333 (5)             *
Alon Aginsky...........................      6,667 (5)             *
Isaac Ben-Bassat.......................    689,214 (6)           15.1%
Dr. Yehoshua Gleitman..................       --                   --
Steven J. Glusband.....................     10,000 (5)(7)          *
Prof. Nava Pliskin.....................       --                   --
----------
*  Less than 1%.

(1)  Beneficial  ownership is  determined  in  accordance  with the rules of the
     Securities

                                       49

<PAGE>


     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 4,565,138  ordinary  shares  (excluding
     384,610 shares held in treasury) issued and outstanding as of May 31, 2003.

(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  shares
     through their controlling  interest in Mer Services Ltd., 95 shares through
     their  controlling  interest in Mer & Co. (1982) Ltd. and 46 shares through
     their controlling interest in C. Mer Industries Ltd.

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

(5)  Subject to currently exercisable stock options.

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

(7)  Includes 9,000 shares subject to currently exercisable stock options.

(8)  Includes 43,000 shares subject to currently exercisable stock options

Stock Option Plans

     Israel's  securities  laws  provide  that an "offer" of  securities  to the
"public"  requires  the  publication  of a  prospectus  that  meets the  Israeli
prospectus  requirements  and which has been  approved by the Israel  Securities
Authority in accordance with Israeli law. Israel's securities laws do not define
the terms "offer" or "public." The Israel  Securities  Authority has  informally
taken the position that the grant of options in any 12 month period to more than
35  Israeli  resident  employees  of an  Israeli  company  is an  "offer" to the
"public" within the meaning of Israel's  securities laws. An action initiated by
another company which challenges this  interpretation  of the Israel  Securities
Authority is currently pending in the District Court of Tel-Aviv.

     In an effort to provide an  incentive  to our  employees,  we have  granted
options to more than 35 Israeli resident employees.  We do not believe that such
grants violate Israel's  securities  laws.  Should a court determine in favor of
the position of the Israel Securities Authority,  we may be deemed to have acted
in contravention of Israel's securities laws.

                                       50

<PAGE>




1996 Stock Option Plan

     Under our 1996 Stock  Option  Plan,  as amended,  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,  which has the  authority  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 provisions 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 in the 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.  These 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 2002,  no options were granted  under our 1996 Plan,  and no options
were exercised into ordinary  shares.  At December 31, 2002,  there were 132,950
options outstanding at an average exercise price of $3.32 per share.

Section 102 Stock Option Plan

     Under our Section 102 Stock Option Plan, as amended, options to purchase up
to  1,500,000   ordinary  shares  may  be  granted  to  our  Israeli  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 Plan will terminate in 2006, unless earlier terminated by
the Board of Directors.

     The exercise prices of options granted under the 102 Plan are determined by
the Board of  Directors  at the time of the  grant,  and the  options so granted
generally expire no later than ten years from the date of grant.

     Pursuant to Section 102 of the Israel  Income Tax  Ordinance  and the rules
promulgated  thereunder  (including the requirement  that the options and/or the
resulting shares be deposited

                                       51

<PAGE>


with a trustee  for at least two years),  the tax on the benefit  arising to the
employee from the grant and exercise of options as well as from the allotment of
ordinary  shares  under  these  options is  deferred  until the  transfer of the
options  and/or  ordinary  shares to the  employee's  name or upon sale of those
options and/or  ordinary  shares.  We will be allowed to claim as an expense for
tax purposes the amounts credited to the employees as a benefit upon sale of the
shares  allotted  under the Section 102 Plan at a price  exceeding  the exercise
price, at such time as the related capital gains tax is payable by the employee.

     During 2002,  options to purchase an aggregate  of 35,000  ordinary  shares
were granted  under our Section 102 Plan at an average  exercise  price of $1.19
per share and no options were exercised into ordinary shares. The exercise price
for all of the  grants  was the  fair  market  value on the  date of  grant.  At
December 31, 2002, there were 624,630 options  outstanding under the Section 102
Plan at an exercise price of $3.32 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 have an exercise price
of $4.95 per  ordinary  share for warrants  exercised  until  February  2004 and
$5.625 per ordinary share for warrants exercised during the period February 2004
through February 2006.


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

A.   MAJOR SHAREHOLDERS

     The  following  table sets forth  certain  information  as of June 23, 2003
regarding  the  beneficial  ownership  by all  shareholders  known  to us to own
beneficially 5.0% or more of our ordinary shares:

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

Chaim Mer and Dora Mer.............      2,089,778 (3)(4)         44.8%
Isaac Ben-Bassat...................        689,214                15.1%
                                        ----------                -----
        Total......................       2,778,992               59.9%
                                          =========               =====
-----------

(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

                                       52

<PAGE>


     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 4,565,138  ordinary  shares  (excluding
     384,610  shares held in  treasury)  issued and  outstanding  as of June 23,
     2003.

(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  shares
     through their controlling  interest in Mer Services Ltd., 95 shares through
     their  controlling  interest in Mer & Co. (1982) Ltd. and 46 shares through
     their controlling interest in C. Mer Industries Ltd.

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

     As of June 22, 2003 there were 31 holders of record of our ordinary shares,
of which 12 record holders holding  approximately 39% of our ordinary shares had
registered   addresses  in  the  United  States.  We  believe  that  there  were
approximately 554 beneficial holders of our ordinary shares on June 19, 2003.

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,  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%.

     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.





                                       53

<PAGE>




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 of our Financial Statements.

Legal Proceedings

Tax assessment

     In April  2000,  we  received a demand  for a tax  payment in the amount of
approximately NIS 6,000,000 ($1,250,000) for the period of 1997 to 1999 from the
tax  authorities  in Israel.  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 and,
therefore, no provision was provided.

Claims and demands

     On June 4, 2001 a claim was filed in the District Court of Tel Aviv against
us and the former  directors of S.T.S.  asserting  various  claims in connection
with the sale of S.T.S to NICE  Systems  Ltd.  The amount of the lawsuit was NIS
4,800,000 (approximately  $1,000,000).  On March 10, 2003, the District Court in
Tel-Aviv  issued a judgment  validating  the  parties'  agreement to dismiss the
complaint  against us and the former  directors of S.T.S.  and waived all of the
plaintiffs' claims against the defendants in connection with the complaint.

Dividend Distribution

     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 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.

                                       54

<PAGE>




B.   SIGNIFICANT CHANGES

     None.

ITEM 9. THE OFFER AND LISTING
        ---------------------

A.   OFFER AND LISTING DETAILS

Yearly Stock Information

     Since our public  offering in May 1997,  our shares have been listed on the
Nasdaq  Stock  Market.  The  following  table sets forth the annual high and low
market prices in U.S.  dollars of our ordinary  shares since our initial  public
offering.

                                     High       Low
                                     ----       ---
          2002...................   $1.65     $0.75
          2001...................    4.63      0.90
          2000...................   17.75      2.50
          1999...................    7.13      1.25
          1998...................    4.50      1.28
          1997...................    9.25      2.75

Quarterly Stock Information

     The following table sets forth for the three-year period ended December 31,
2002 the range of high ask and low bid prices in U.S.  dollars  of our  ordinary
shares for each full financial quarter.


2002                          High       Low
----                          ----       ---
First Quarter...........     $1.65     $0.98
Second Quarter..........      1.05      0.91
Third Quarter...........      1.00      0.80
Fourth Quarter..........      1.23      0.75

2001
----
First Quarter...........     $4.63     $1.63
Second Quarter..........      2.70      1.50
Third Quarter...........      2.03      1.00
Fourth Quarter..........      1.85      0.90




                                       55

<PAGE>


2000
----
First Quarter...........    $17.50     $6.00
Second Quarter..........     12.25      4.63
Third Quarter...........      6.75      4.50
Fourth Quarter..........      6.38      2.50

Monthly Stock Information

     The following  table sets forth for six months ended  December 31, 2002 the
range of high ask and low bid  prices in U.S.  dollars  of our  ordinary  shares
during each such month.

                             High       Low
                             ----       ---
July.....................   $0.99      $0.80
August...................    1.00       0.81
September................    0.95       0.80
October..................    0.90       0.75
November.................    0.90       0.78
December.................    1.23       0.85


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.

D.   SELLING SHAREHOLDERS

     Not applicable.

E.   DILUTION

     Not applicable.

F.   EXPENSE OF THE ISSUE

     Not applicable.

                                       56


<PAGE>

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

A.   SHARE CAPITAL - TREASURY SHARES

     During the years  2000,  2001 and 2002,  we  purchased  11,252,  54,665 and
195,183  ordinary  shares in  consideration  of $40,000,  $118,000 and $172,000,
respectively,  according to our stock repurchase  program,  which authorized our
officers to repurchase up to 300,000 of our ordinary  shares and was approved by
our board of  directors.  The  repurchased  shares were held as treasury  shares
until they were cancelled on May 2003.

     In April 2003 our board of directors  increased  the number of shares to be
repurchased under our stock repurchase  program from 300,000 to 600,000 ordinary
shares.  We plan to repurchase  additional  shares from time to time in the open
market subject to, among other things,  general market conditions and the market
price of our ordinary shares, as well as the provisions of Israeli corporate law
and U.S. securities law.


B.   MEMORANDUM AND ARTICLES OF ASSOCIATION

Purposes and Objects of the Company

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

     On February 1, 2000, the Israeli Companies Law, 1999-5759, or the 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
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  Israel  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 6B.  Directors,  Senior  Management and Employees -
Compensation."

     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.

                                       57

<PAGE>




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.

     Ordinary shares. 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 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  6A.
Directors, Senior Management and Employees - Election of Directors."

                                       58

<PAGE>




     Rights to share in the company's  profits.  Our shareholders have the right
to share in our  profits  distributed  as a  dividend  and any  other  permitted
distribution. See "Item 10B. 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 the  company.  Under  our  memorandum  of
association and the 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 6A.
"Directors and Senior Management - Approval of Related Party  Transactions Under
Israeli Law."

Changing Rights Attached to Shares

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

Annual and Extraordinary Meetings

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

                                       59

<PAGE>


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
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  Companies  Law and  regulations  promulgated
thereunder.  See also "Item 6A.  Directors,  Senior  Management  and Employees -
Directors and Senior Management - 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  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

                                       60

<PAGE>


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 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

                                       61

<PAGE>


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 package of benefits. Under the alternative package
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
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  distributed  income earned in the benefit period and to
income (distributed or not) earned in the benefit period is as follows:

                                                            The company
            For a company with foreign investment of        tax rate is
            ----------------------------------------        -----------
            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  (15%),  if the dividend 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
package of benefits,  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.

     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  was  granted  approved  enterprise  status  with  respect  to five
investment  projects and chose the  alternative  package with respect to each of
these  projects.  Subsequent  to our  incorporation,  C.  Mer  transferred  four
continuing approved programs to us. A fifth and sixth

                                       62

<PAGE>


program were also granted  approval to us. See "Operating and Financial Review -
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, 2002.

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,  research and development  programs which meet specified  criteria and are
approved by a  governmental  committee of the Chief  Scientist  are eligible for
grants of up to 50% of the project's expenditure,  as determined by the research
committee,  in exchange for the payment of  royalties  from the sale of products
developed in  accordance  with the program.  Regulations  promulgated  under the
Research  Law  generally  provide  for the  payment  of  royalties  to the Chief
Scientist of 3%-5% on sales of products and services derived from our technology
developed using these grants until 100% to 150% of the U.S.  dollar-linked grant
is repaid. Effective for grants received from 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  also  require that the
manufacture of products developed with government grants be performed in Israel.
However, under the regulations  promulgated under the Research Law, in the event
that any of the  manufacturing  is  performed  outside  Israel  if  approval  is
received  from the  Chief  Scientist  for  such  foreign  manufacturing  and the
identity of the  foreign  manufacturers,  we may be  required  to pay  increased
royalties.  If the  manufacturing  volume that is performed outside of Israel is
less than  50%,  the total  amount  to be repaid to the Chief  Scientist  may be
adjusted to 120% of the grant.  If the  manufacturing  volume that is  performed
outside of Israel is between  50% and 90%,  the total  amount may be adjusted to
150% of the grant and if it is more than 90%,  the total  amount may be adjusted
to 300% of the grant. The technology  developed  pursuant to the Chief Scientist
grants may not be transferred  to third parties  without the prior approval of a
governmental  committee under the Research Law. Such approval,  however,  is not
required for the export of any products developed using the grants.  Approval of
the transfer of technology may be granted in specific circumstances, only if the
recipient  abides  by  the  provisions  of  the  Research  Law  and  regulations
promulgated  thereunder,  including the restrictions on the transfer of know-how
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 funds  generally  available  for grants from the Chief  Scientist  were
reduced for 1998, and the Israeli authorities have indicated that the government
may further reduce or abolish grants from the Chief Scientist in the future.  We
are not expecting to receive any more grants

                                       63

<PAGE>


during year 2003. We agreed to pay royalties to the Chief  Scientist on sales of
the products  developed from research and development  projects that were funded
by the Chief  Scientist  up to the amount of funding  that we  received.  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 150% of the
grant received,  linked to the exchange rate of the U.S. dollar.  As of December
31,  2002,  we had a  contingent  obligation  to pay  royalties in the amount of
approximately  $7,667,000.  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:

     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; and

     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 Conditions

     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

                                       64

<PAGE>


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  traded  securities are normally exempt from
          tax for individuals and are taxable for companies. However, 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%.

     Under  current law,  sales of our  ordinary  shares 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
capital gains.

     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 sale,  exchange or disposition of ordinary  shares by a person who
qualifies  as a  resident  of  the  United  States  within  the  meaning  of the
U.S.-Israel  Tax Treaty and who is  entitled to claim the  benefits  afforded to
such person by the U.S.-Israel  Tax 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

                                       65

<PAGE>


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  U.S.-Israel  Tax
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 U.S.-Israel Tax 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 and 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 in a treaty between Israel and the shareholder's  country of residence.
Under the U.S.-Israel Tax 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.

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.

                                       66

<PAGE>


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 (the "Code"),  Treasury  regulations  promulgated  thereunder,
judicial and  administrative  interpretations  thereof,  and the U.S.-Israel Tax
Treaty,  all as in effect on the date  hereof  and all of which are  subject  to
change either prospectively or retroactively.  This summary does not address all
tax  considerations  that may be  relevant  with  respect  to an  investment  in
ordinary shares. This summary does not account for the specific circumstances of
any particular investor, such as:

     o    broker-dealers,

     o    financial institutions,

     o    certain insurance companies,

     o    investors liable for alternative minimum tax,

     o    tax-exempt organizations,

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

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

     o    investors  that  actually  or  constructively  own  10% or more of our
          voting shares, and

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

     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:

     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;

                                       67

<PAGE>




     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. 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

                                       68

<PAGE>


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

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

     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
(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 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 tax legislation,  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 reduced
rate on capital gains applies to sales and exchanges on or after May 6, 2003 and
the reduced rates on dividend  income to dividends  received  after December 31,
2002. The

                                       69

<PAGE>


rate  reduction  does not apply to  dividends  received  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 ("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 either  2001 or
2002.

     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"  (a  "QEF  election")  or to  "mark-to-market"  your
ordinary shares, as described below,

     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  charge would be imposed with respect
          to the resulting tax liability allocated to each such year,

     o    gain  recognized  upon the  disposition  of ordinary  shares  would be
          taxable as ordinary income, 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.

                                       70

<PAGE>




     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.

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.

                                       71

<PAGE>





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 United States 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 are referred to in this annual
report,  may also be inspected at our offices  located at 40 Aluf David  Street,
Ramat - Gan, 52232 Israel.

I.   SUBSIDIARY INFORMATION

     Not applicable.

                                       72

<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 U.S. dollars and
bear annual interest of 1.2% to 2.0%,  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
U.S. 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 U.S.  dollar,  with all other
variables  held  constant on the expected  sales,  would result in a decrease in
expected  2003  sales of  $500,000  or an  increase  in  expected  2003 sales of
$500,000.  In 2003 we entered  into a  commitment  to purchase  dollars and sell
euros having a value of Euro 400,000.



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

     Not applicable.

                                     PART II


ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
         -----------------------------------------------

     None.

                                       73

<PAGE>




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

     Not applicable.

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

     Within the 90 days prior to the date of the filing of this  annual  report,
we carried out an evaluation,  under the supervision and with the  participation
of our senior  management,  including Chief  Executive  Officer Shai Levanon and
Chief Financial  Officer Yossi Brikman,  of the  effectiveness of the design and
operation of our disclosure controls and procedures pursuant to Rule 13(a)-14(c)
of the Securities  Exchange Act of 1934.  Disclosure controls and procedures are
designed to ensure that the material  financial  and  non-financial  information
required  to be  disclosed  in this Form 20-F  filed  with the SEC is  recorded,
processed,  summarized  and reported  timely.  In designing and  evaluating  the
disclosure controls and procedures,  management recognized that any controls and
procedures,  no  matter  how  well  designed  and  operated,  can  provide  only
reasonable,  rather than  absolute,  assurance of achieving the desired  control
objectives,  and  management  necessarily  was required to apply its judgment in
evaluating the  cost-benefit  relationship of possible  controls and procedures.
Based  upon that  evaluation,  our  management,  including  the Chief  Executive
Officer and Chief Financial Officer,  concluded that our 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. Therefore, no corrective actions were taken.

ITEM 16. Reserved
         --------

                                    PART III


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

     The  Company  has  elected  to furnish  financial  statements  and  related
information specified in Item 18.

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

Consolidated Financial Statements.

Index to Consolidated Financial Statements.

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

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

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

                                       74

<PAGE>




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

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

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

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

          *10.1     Purchase  and  Assignment  Agreement,  dated March 31, 1996,
                    between C. Mer  Industries  Ltd.,  MER & Co. (1982) Ltd. and
                    the Registrant

          *10.2     1996 Employee Stock Option Plan

          *10.3     Section 102 Stock Option Plan

          *10.4     Form of Underwriter's Warrant

         **10.5     Form of Financial Consulting Agreement

           23.1     Consent of Kost Forer & Gabbay

           99.1     Certification by Chief Executive Officer Pursuant to Section
                    302 of the Sarbanes-Oxley Act of 2002.

           99.2     Certification by Chief Financial Officer Pursuant to Section
                    302 of the Sarbanes-Oxley Act of 2002.

           99.3     Certification  by Chief  Executive  Officer  Pursuant  to 18
                    U.S.C.  Section 1350, As Adopted  Pursuant to Section 906 of
                    the Sarbanes-Oxley Act of 2002.

           99.4     Certification  by Chief  Financial  Officer  Pursuant  to 18
                    U.S.C.  Section 1350, As Adopted  Pursuant to Section 906 of
                    the Sarbanes-Oxley Act of 2002.

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

                                       75

<PAGE>




     *    Incorporated by reference to our  registration  statement on Form F-1,
          registration number 333-05814,  filed with the Securities and Exchange
          Commission.

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


                                       76

<PAGE>






             MER TELEMANAGEMENT SOLUTIONS LTD. AND ITS SUBSIDIARIES


                        CONSOLIDATED FINANCIAL STATEMENTS


                             AS OF DECEMBER 31, 2002


                            U.S. DOLLARS IN THOUSANDS




                                      INDEX


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

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




                               - - - - - - - - - -

                                      F-1

<PAGE>


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





                         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,  2001  and  2002,  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, 2002. 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  auditing  standards  generally
accepted in the 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, 2001 and 2002, and the consolidated  results
of their  operations  and their  cash  flows for each of the three  years in the
period  ended  December 31,  2002,  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
Tel-Aviv, Israel                                   KOST FORER & GABBAY
February 3, 2003                            A Member of Ernst & Young Global

                                      F-2

<PAGE>




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


                                                              December 31,
                                                          ----------------------
                                                          2001             2002
                                                          ----             ----
    ASSETS

 CURRENT ASSETS:
 Cash and cash equivalents                            $ 5,987       $    9,062
 Short-term bank deposits                               1,942                -
 Marketable securities (Note 3)                         2,098            1,153
 Trade receivables (net of allowance for
  doubtful accounts of $ 837 and $ 356 as of
  December 31, 2001 and 2002, respectively)             1,172            1,259
 Other accounts receivable and prepaid
  expenses (Note 4)                                       952              511
 Inventories (Note 5)                                     322              240
                                                          ---              ---

 Total current assets                                  12,473           12,225
 -----                                                 ------           ------


 LONG-TERM INVESTMENTS:
 Investments in an affiliate (Note 6)                   1,092            1,335
 Long-term loans, net of current
  maturities (Note 7)                                      97               86
 Severance pay fund                                       651              545
 Other investments (Note 8)                               389              368
                                                          ---              ---
 Total long-term investments                            2,229            2,334
 -----                                                  -----            -----

 PROPERTY AND EQUIPMENT, NET (Note 9)                     816              602
                                                          ---              ---

 OTHER ASSETS:
 Goodwill (Note 10a)                                      153            2,025
 Other intangible assets, net (Note 10b)                2,345              360
 Deferred income taxes (Note 14)                           79              161
                                                           --              ---
 Total other assets                                     2,577            2,546
 -----                                                  -----            -----


 Total assets                                         $18,095          $17,707
 -----                                                =======          =======





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)

                                                                December 31,
                                                          ----------------------
                                                           2001             2002
                                                           ----             ----
    LIABILITIES AND SHAREHOLDERS' EQUITY

 CURRENT LIABILITIES:
 Current maturities of long-term loans (Note 12)         $  58           $    8
 Trade payables                                            499              350
 Accrued expenses and other liabilities (Note 11)        1,859            1,439
 Deferred revenues                                         997            1,184
                                                           ---            -----

 Total current liabilities                               3,413             2,981
 -----                                                   -----             -----

 LONG-TERM LIABILITIES:
 Long-term loans, net of current
  maturities (Note 12)                                      13                8
 Accrued severance pay                                     813              705
                                                           ---              ---

 Total long-term liabilities                               826              713
 -----                                                     ---              ---

  CONTINGENT LIABILITIES AND COMMITMENTS (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, 2001 and 2002; Issued: 4,882,748 shares as of
   December 31, 2001 and 2002; Outstanding: 4,816,831
   and 4,621,648 shares as of December 31, 2001 and
   2002, respectively                                       15               15
 Additional paid-in capital                             12,846           12,846
 Treasury shares                                          (158)            (330)
 Accumulated other comprehensive loss                     (410)            (211)
 Retained earnings                                       1,563            1,693
                                                         -----            -----

 Total shareholders' equity                             13,856           14,013
 -----                                                  ------           ------
 Total liabilities and shareholders' equity            $18,095          $17,707
 -----                                                 =======          =======



The  accompanying  notes  are an  integral  part of theinancial
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,
                                                          --------------------------------------------
                                                              2000            2001            2002
                                                          -------------   -------------   ------------
 <S>                                                        <C>             <C>             <C>
 Revenues (Note 17):
   Product sales                                            $   9,414       $   7,843       $   7,397
   Services                                                     1,653           2,882           2,390
                                                          -------------   -------------   ------------

 Total revenues                                                11,067          10,725           9,787
                                                          -------------   -------------   ------------

 Cost of revenues:
   Product sales                                                2,520           1,909           1,655
   Services                                                       322             643             241
                                                          -------------   -------------   ------------

 Total cost of revenues                                         2,842           2,552           1,896
                                                          -------------   -------------   ------------

 Gross profit                                                   8,225           8,173           7,891
                                                          -------------   -------------   ------------

 Operating expenses:
   Research and development, net (Note 18a)                     4,039           3,562           2,127
   Selling and marketing                                        4,853           4,911           3,954
   General and administrative                                   1,845           1,943           1,858
   In process research and development write-off                  945               -               -
                                                           -------------  -------------   ------------

 Total operating expenses                                      11,682          10,416           7,939
                                                           -------------  -------------   ------------

 Operating loss                                                (3,457)         (2,243)            (48)
 Financial income, net (Note 18b)                                 374             138             134
 Other income (expenses), net (Note 18c)                        1,591            (654)           (140)
                                                           -------------  -------------   ------------

 Loss before taxes on income                                   (1,492)         (2,759)            (54)
 Taxes on income (tax benefit) (Note 14)                         (155)             16              52
                                                           -------------  -------------   ------------

                                                               (1,337)         (2,775)           (106)
 Equity in earnings of affiliates                                  66             221             236
                                                           -------------  -------------   ------------

 Net income (loss)                                           $ (1,271)       $ (2,554)      $     130
                                                           =============  =============   ============

 Basic and diluted net earnings (loss) per share             $  (0.26)       $  (0.53)      $    0.03
                                                          =============  =============   ============

 Weighted average number of shares used in computing
 basic and diluted net earning (loss) per share             4,866,640       4,826,126       4,709,796
                                                          =============  =============   ============
</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
                                                    Additional                 other                      Total          Total
                                          Share      paid-in    Treasury    comprehensive  Retained    comprehensive  shareholders'
                                         capital     capital     shares        loss        earnings     income(loss)     equity
                                       ----------- ----------- ----------- -------------- ----------- -------------- --------------
 <S>                                    <C>          <C>        <C>           <C>           <C>            <C>          <C>
 Balance as of January 1, 2000          $   15       $12,228    $    -        $  (74)       $ 5,388                     $ 17,557
   Exercise of warrants, net            *)   -           204         -             -              -                          204
   Exercise of options, net             *)   -           314         -             -              -                          314
   Purchases of treasury shares              -             -       (40)            -              -                          (40)
   Amortization of compensation
    related to options
    granted to a director for
    consulting services                      -            90         -             -              -                           90
   Other comprehensive loss:
    Unrealized losses on available
      for sale marketable securities         -             -         -          (175)             -        $  (175)         (175)
    Foreign currency translation
      adjustments                            -             -         -          (182)             -           (182)         (182)
                                                                                                      --------------
   Total other comprehensive loss                                                                             (357)
   Net loss                                  -             -         -             -         (1,271)        (1,271)       (1,271)
                                       ----------- ----------- ----------- -------------- ----------- --------------    ------------
                                                                                                           $(1,628)
   Total comprehensive loss                                                                           ==============
 Balance as of December 31, 2000            15        12,836       (40)         (431)         4,117                       16,497
   Exercise of options, net             *)   -            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
                                       =========== =========== =========== ============== ===========                   ============
 Accumulated unrealized losses from
   available-for-sale
   marketable securities                                                      $ (106)
 Accumulated foreign currency
   translation adjustments                                                      (105)
                                                                           --------------
                                                                              $ (211)
                                                                           ==============
</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,
                                                          --------------------------------------------
                                                              2000            2001            2002
                                                          -------------   -------------   ------------
 <S>                                                       <C>              <C>              <C>
 Cash flows from operating activities:
 -------------------------------------
 Net income (loss)                                         $(1,271)         $(2,554)         $   130
 Adjustments 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                        (289)             279              140
   Gain on sale of interest in an affiliate                    (73)               -                -
   Loss (gain) on sale of property and equipment            (1,223)              51                6
   Loss from impairment of investment in warrants                -              375                -
   Equity in earnings of affiliates                            (66)            (221)            (236)
   Proceeds from (investment in) trading securities,
      net                                                      (94)               -               81
   Depreciation and amortization                             1,028            1,110              501
   Amortization of compensation related to options
    granted to a director for consulting services               90                -                -
   In-process research and development write-off               945                -                -
   Deferred income taxes, net                                 (310)             (20)              29
   Accrued severance pay, net                                   (1)              57               (2)
   Decrease (increase) in trade receivables                  1,411              269              (87)
   Decrease in other accounts receivable and prepaid
    expenses                                                   455              673              215
   Decrease in inventories                                      46              220               82
   Decrease in trade payables                                 (370)            (169)            (149)
   Decrease in accrued expenses and other liabilities       (1,748)            (623)            (419)
   Increase (decrease) in deferred revenues                  1,059             (173)             187
   Other                                                        (5)               -               11
                                                          -------------   -------------   ------------
 Net cash provided by (used in) operating activities          (416)            (726)             489
                                                          -------------   -------------   ------------

 Cash flows from investing activities:
 -------------------------------------
 Changes in related parties account, net                      (117)              50              108
 Proceeds from sale of property and equipment                2,003               45               26
 Investment in short-term bank deposit                        (156)          (7,528)               -
 Proceeds from realization of short-term bank deposits       1,988            7,448            1,942
 Purchase of property and equipment                           (173)            (226)            (166)
 Investment in available for sale marketable
   securities                                               (4,208)            (401)          (1,512)
 Investment in held-to-maturity marketable securities            -                -             (476)
 Proceeds from sale of available-for-sale marketable
   securities                                                1,106            1,631            2,508
 Proceeds from redumption of held-to-maturity
   marketable securities                                         -                -              201
 Payment for acquisition of IntegraTRAK (a)                 (3,100)               -                -
 Dividend from an affiliate                                    115               56              190
 Other investments                                            (220)               -                -
 Other                                                         (26)               -              (12)
                                                          -------------   -------------   ------------
 Net cash provided by (used in) investing activities        (2,788)           1,075            2,809
                                                          -------------   -------------   ------------
</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,
                                                          --------------------------------------------
                                                              2000            2001            2002
                                                          -------------   -------------   ------------
 <S>                                                       <C>              <C>              <C>
 Cash flows from financing activities:
 -------------------------------------
 Changes in related parties, net                                 -                -                4
 Repayment of long-term loans                                  (61)             (91)             (55)
 Proceeds from exercise of options and warrants, net           518               10                -
 Purchase of treasury shares                                   (40)            (118)            (172)
                                                          -------------   -------------   ------------

 Net cash provided by (used in) financing activities           417             (199)            (223)
                                                          -------------   -------------   ------------

 Increase (decrease) in cash and cash equivalents           (2,787)             150            3,075
 Cash and cash equivalents at the beginning of the
   year                                                      8,624            5,837            5,987
                                                          -------------   -------------   ------------

 Cash and cash equivalents at the end of the year          $ 5,837          $ 5,987          $ 9,062
                                                          =============   =============   ============

 Supplemental disclosure of cash flows activities:
 -------------------------------------------------
   Cash paid during the year for:
   Interest                                                $    56          $    45          $    10
                                                          =============   =============   ============
   Income taxes                                            $   257          $     8          $    58
                                                          =============   =============   ============

 Non cash investing transactions:
 --------------------------------
   Notes receivable from realization of an affiliate       $   75
                                                          =============

   Long-term loan from realization of an affiliate         $   52
                                                          =============
</TABLE>


                                                           December 31,
                                                               2000
                                                         ----------------
 (a) Payment for acquisition of IntegraTRAK:
     ---------------------------------------
        Estimated fair value of assets acquired and
          liabilities  assumed at the
         date of acquisition:
        Working capital deficiency (excluding cash
         and cash equivalents)                           $(1,524)
        Property and equipment                               497
        Goodwill *)                                          180
        In process research and development                  945
        Developed technology                                 710
        Assembled and trained workforce *)                   848
        Distributor relationship *)                        1,653
        Long-term liabilities                               (209)
                                                         -------
                                                         $ 3,100
                                                         =======
*) See Note 10a.

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

                                      F-8

<PAGE>





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

NOTE 1:-    ORGANIZATION AND OPERATIONS

          a.   MER  Telemanagement  Solutions  Ltd. ("the Company" or "MTS") was
               incorporated on December 27, 1995. The Company designs, develops,
               markets and supports a  comprehensive  line of  telecommunication
               management solutions that enable business organizations and other
               enterprises  to  more  effectively  manage  their   communication
               resources.  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 and packaged  computer  software of
               tracking  telephone calls and costs and also provides  consulting
               and  maintenance  support for its services.  As for the Company's
               subsidiaries, see Note 19.

               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.

               MTS 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 2000,  2001 and 2002,  two major
               customers  generated 33%, 40% and 42% of the Company's  revenues,
               respectively (see Note 17b).

               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.

               The Company's shares are listed for trade on the Nasdaq SmallCapl
               Market.

          b.   Acquisition of IntegraTRAK, Inc.:

               On April 24, 2000, the Company acquired in cash substantially all
               of the assets and assumed  certain  liabilities  of  IntegraTRAK,
               Inc.   ("IntegraTRAK")  a  privately  held  company  IntegraTRAK,
               develops,   markets  and  sells  packaged  computer  software  of
               tracking  telephone calls and costs, and software that assists in
               the management of telecommunication  equipment.  IntegraTRAK also
               provides  consulting  service bureau and maintenance  support for
               its services.

               The  acquisition  was treated on the basis of the purchase method
               of  accounting  and  accordingly,  the  purchase  price  has been
               allocated  according to the fair value of the assets acquired and
               liabilities assumed of IntegraTRAK. The operations of IntegraTRAK
               are  included  in the  consolidated  statements  from the  second
               quarter of 2000.

                                       F-9


<PAGE>

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

NOTE 1:-    ORGANIZATION AND OPERATIONS (Cont.)

               In connection with IntegraTRAK acquisition,  The Company recorded
               in the  second  quarter of 2000,  a one-time  expense of $ 945 to
               write-off   software   acquired   from   IntegraTRAK   for  which
               technological  feasibility has not yet been  established.  As for
               intangible assets related to the acquisition, see Note 10.

               The  following  represents  the  unaudited  pro forma  results of
               operations  for the year ended  December 31, 2000,  assuming that
               the acquisition occurred on January 1, 2000.

                                                              Year ended
                                                           December 31, 2000
                                                           -----------------

               Revenues                                      $   13,680
                                                           =================

               Net income (loss)                             $     (349)
                                                           =================

               Basic net earnings (loss) per share           $    (0.07)
                                                           =================

               Diluted net earnings (loss) per share         $    (0.07)
                                                           =================

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.

          b.   Financial statements in U.S. dollars:

               The majority of the Company's and its subsidiaries' sales is made
               outside  Israel  in U.S.  dollars  ("dollars").  In  addition,  a
               substantial  portion of the Company's 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 the Company 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.

                                      F-10

<PAGE>


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

NOTE 2:-    SIGNIFICANT ACCOUNTING POLICIES (Cont.)

               The financial statements of certain subsidiaries and an affiliate
               whose functional currency is not the dollar, have been translated
               into  U.S.   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).

          c.   Principles of consolidation:

               The consolidated financial statements include the accounts of the
               Company  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.   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
               U.S.  dollars and bear  interest at an average rate of 1.9%.  The
               short-term  deposits  are  presented  at  their  cost,  including
               accrued interest.

          f.   Marketable securities:

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

               Management  determines  the  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).

                                      F-11


<PAGE>


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

NOTE 2:-    SIGNIFICANT ACCOUNTING POLICIES (Cont.)

               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).

          g.   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.

          h.   Investments in affiliates and other companies:

               Investments  in  privately  held  companies  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 are presented using the equity method of accounting. 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 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"
               ("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 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, 2002, no  impairment  losses have been
               identified.

          i.   Property and equipment:

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

                                                           %
                                         ------------------------------------

    Computers and peripheral equipment                    33
    Office furniture and equipment                      6 - 20
    Motor vehicles                                        15
    Leasehold improvements               Over the term of the lease agreement



                                      F-12

<PAGE>


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

NOTE 2:-    SIGNIFICANT ACCOUNTING POLICIES (Cont.)

          j.   Impairment of long-lived assets:

               Long-lived  assets  of  the  Company  and  its  subsidiaries  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, 2002 no  impairment
               was required.

          k.   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  attributable  to each of the reporting  units is tested
               for impairment by comparing the fair value of each reporting unit
               with  its  carrying  value.   Fair  value  is  determined   using
               discounted  cash  flows.   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.  The  Company has
               selected  December  31 as the  date it will  perform  its  annual
               goodwill  impairment tests. As of December 31, 2002 no impairment
               was required. As for application of SFAS No. 142, see Note 10a.

               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.


                                      F-13

<PAGE>


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

NOTE 2:-    SIGNIFICANT ACCOUNTING POLICIES (Cont.)

               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.  Research and development grants
               amounted  to $  1,249,  $ 990 and $ 1 in  2000,  2001  and  2002,
               respectively.

          n.   Income taxes:

               The Company and its  subsidiaries  account 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 and its subsidiaries generate 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  and its  subsidiaries  also  generate
               revenues from rendering maintenance, service bureau and support.

               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 does not grant a right of return to its customers.

               Where software 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.  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.

                                      F-14

<PAGE>


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

NOTE 2:-    SIGNIFICANT ACCOUNTING POLICIES (Cont.)

               Revenues from  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 and support costs:

               The Company provides free warranty and support 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, 2002 amounted to of $ 22.

            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:

                                      F-15

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

NOTE 2:-    SIGNIFICANT ACCOUNTING POLICIES (Cont.)

                                                   Year ended December 31,
                                            ------------------------------------
                                                2000        2001          2002
                                            -----------   ---------    ---------
     Net income (loss), as reported         $   (1,271)   $ (2,554)    $    130
     Deduct: Total stock-based
     compensation  expense determined
     under fair value method for all
     awards, net of related
     tax effect                                   (733)       (769)        (177)
                                            -----------   ---------   ----------
     Pro forma net loss                     $   (2,004)   $ (3,323)    $    (47)
                                            ===========   =========    =========
     Basic and diluted net earnings
     (loss) per    share, as reported       $   (0.26)    $  (0.53)    $   0.03
                                            ===========   =========    =========
     Basic and diluted net loss per
     share, pro forma                       $   (0.42)    $  (0.68)    $  (0.01)
                                            ===========   =========    =========

               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:

                                                    Year ended December 31,
                                           -------------------------------------
                                              2000          2001         2002
                                           -----------   -----------  ----------
         Average risk-free interest rates     6%            3.5%         2%
         Average expected life (in years)     2             4            4
         Volatility                          49%           87.2%        66.8%

               The Company applies  Statement of Financial  Accounting  Standard
               No. 123  "Accounting  for  Stock-Based  Compensation"  ("SFAS No.
               123") and EITF 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.

          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, 2000,  2001
               and  2002  amounted  to  approximately  $ 27,  $ 189  and $  104,
               respectively.

                                      F-16
<PAGE>




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

NOTE 2:-    SIGNIFICANT ACCOUNTING POLICIES (Cont.)

          s.   Fair value of financial instruments:

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

               The  carrying  amounts of cash and cash  equivalents,  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.

               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.

               The trade  receivables  of the Company and its  subsidiaries  are
               mainly  derived  from sales to  customers  in the U.S. and Europe
               (see Note 17c). 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.

                                      F-17


<PAGE>


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

NOTE 2:-    SIGNIFICANT ACCOUNTING POLICIES (Cont.)

          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  1,315,152,  1,227,141  and 757,580 for the years ended
               December 31, 2000, 2001 and 2002, respectively.

          v.   Reclassification:

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

          w.   Impact of recently issued accounting standards:

               In June 2002, the FASB issues  Statement of Financial  Accounting
               Standard No. 146,  "Accounting for Costs  Associated with Exit or
               Disposal   Activities"   ("SFAS  No.   146"),   which   addresses
               significant  issue regarding the  recognition,  measurement,  and
               reporting of costs associated with exit and disposal  activities,
               including  restructuring  activities.  SFAS No. 146 requires that
               costs  associated with exit or disposal  activities be recognized
               when they are incurred rather than at the date of a commitment to
               an exit or disposal plan.  SFAS No. 146 is effective for all exit
               or disposal  activities  initiated  after  December 31, 2002. The
               Company  does not expect the  adoption  of SFAS No. 146 to have a
               material  impact  on  its  results  of  operations  or  financial
               position.

               In November  2002,  the FASB issued FASB  Interpretation  No. 45,
               "Guarantor's   Accounting   and   Disclosure   Requirements   for
               Guarantees,  Including  Indirect  Guarantees of  Indebtedness  of
               Others,  an  interpretation of FASB Statements No. 5, 57, and 107
               and Rescission of FASB Interpretation No. 34" ("FIN No. 45"). FIN
               No. 45 elaborates on the disclosures to be made by a guarantor in
               its interim and annual financial statements about its obligations
               under certain  guarantees  that it has issued.  It also clarifies
               that a guarantor is required to recognize,  at the inception of a
               guarantee,  a  liability  for the fair  value  of the  obligation
               undertaken  in  issuing  the  guarantee.  FIN  No.  45  does  not
               prescribe a specific  approach  for  subsequently  measuring  the
               guarantor's  recognized  liability  over the term of the  related
               guarantee. It also incorporates,  without change, the guidance in
               FASB Interpretation No. 34, "Disclosure of Indirect Guarantees of
               Indebtedness   of  Others,"  which  is  being   superseded.   The
               disclosure  provisions  of FIN No. 45 are effective for financial
               statements of interim or annual  periods that end after  December
               15,  2002,  and  the  provisions  for  initial   recognition  and
               measurement  are effective on a prospective  basis for guarantees
               that are issued or modified after December 31, 2002, irrespective
               of a  guarantor's  year-end.  The  Company  does not  expect  the
               adoption  of FIN No. 45 to have a material  impact on its results
               of operations or financial position.

                                      F-18


<PAGE>


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

NOTE 3:-    MARKETABLE SECURITIES

          The following is a summary of the  Company's  investment in marketable
     securities:
<TABLE>
<CAPTION>
                                           December 31, 2001                        December 31, 2002
                                    ----------------------------------  ----------------------------------------------
                                                   Gross     Estimated                 Gross      Gross      Estimated
                                     Amortized  unrealized fair market  Amortized  unrealized  unrealized  fair market
                                       cost       losses      value       cost        gains      losses      value
                                    ----------  ---------- ----------   ---------  ----------  ----------  -----------
 <S>                                <C>         <C>        <C>           <C>         <C>         <C>        <C>
 Held-to-maturity corporate debt    $     -     $     -    $      -      $  275      $    26     $    -     $   301
 Available-for-sale:
   Mutual funds                       1,947         (67)      1,880         566            -        (49)        517
   Equity securities                    160         (36)        124         418            -        (57)        361
                                        ---         ---         ---         ---           --        ---         ---
                                      2,107        (103)      2,004       1,259           26       (106)      1,179
   Trading securities                    94           -          94           -            -          -           -
                                         --          --          --          --           --         --          --
                                    $ 2,201     $  (103)    $ 2,098      $1,259      $    26     $ (106)    $ 1,179
                                    =======     =======     =======      ======      =======     ======     =======
</TABLE>

               The gross realized gains (losses) on sales of  available-for-sale
               securities   totaled   $  31  and  $  (128)  in  2001  and  2002,
               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  $ 72  and  $  (3)  in  2001  and  2002,
               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,  2002,  by
               contractual maturity, are shown below.

                                                       December 31, 2002
                                                -------------------------------
                                                  Amortized          Market
                                                    cost              value
                                                --------------   --------------

          Matures in one year                     $  275            $  301
          Equity securities and mutual funds         984               878
                                                --------------   --------------

          Total                                   $1,259            $1,179
                                                ==============   ==============

                                   F-19

<PAGE>



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

NOTE 4:-    OTHER ACCOUNTS RECEIVABLE AND PREPAID EXPENSES

                                                              December 31,
                                                       ------------------------
                                                          2001        2002
                                                       ----------  ----------

     Receivable from the Government of Israel for
       grants and participations                        $ 73        $  -
     Related parties                                     108           -
     Government authorities                              224         288
     Prepaid expenses                                    175          91
     Deferred income taxes                               144          33
     Other                                               228          99
                                                       ------      -------
                                                        $952        $511
                                                       ======      =======


NOTE 5:-    INVENTORIES

              Raw materials                            $131         $118
              Finished products                         191          122
                                                       ------    ---------

                                                       $322         $240
                                                       ======    =========


NOTE 6:-    INVESTMENTS IN AFFILIATE

    Investment in Jusan S.A.:
      Equity, net                                   $ 1,057      $ 1,300
      Goodwill                                           35           35
                                                  ----------    ---------
                                                    $ 1,092      $ 1,335
                                                  ==========    =========
    Dividend received from Jusan S.A.
      during the year:                              $    56      $   190
                                                  ==========    =========

                            F-20


<PAGE>



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

NOTE 7:-    LONG-TERM LOANS

          a.   Composed as follows:

                                                       December 31,
                                               --------------------------
                                                    2001          2002
                                               ------------  ------------
     Loans to others in NIS - unlinked (1)       $    179      $    140
     Less - current maturities (2)                     82            54
                                               ------------  ------------
                                                 $     97      $     86
                                               ============  ============

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

               (2)  Included in other receivables and prepaid expenses.


          b.   As of December 31,  2002,  the  aggregate  annual  maturities  of
               long-term loans are as follows:

                   First year (current maturities)       $ 54
                   Second year                             54
                   Third year                              32
                                                          ----

                                                          $140
                                                          ====


NOTE 8:-    OTHER INVESTMENTS
                                                              December 31,
                                                        ---------------------
                                                          2001        2002
                                                        --------    ---------
              Long-term deposits (1)                      $ 42        $ 21
              Investment in other companies (2)            347         347
                                                        --------    ---------
                                                          $389       $ 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.

                                      F-21

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

NOTE 9:-    PROPERTY AND EQUIPMENT, NET
                                                         December 31,
                                                   ---------------------------
                                                     2001            2002
                                                   -----------   -------------
        Cost:
          Computers and peripheral equipment       $2,177          $2,387
          Office furniture and equipment              585             492
          Motor vehicles                              180             107
          Leasehold improvements                      151             191
                                                   --------       --------
                                                    3,093           3,177
                                                   --------        --------
        Accumulated depreciation:
          Computers and peripheral equipment        1,733           2,116
          Office furniture and equipment              358             310
          Motor vehicles                               91              66
          Leasehold improvements                       95              83
                                                   --------        --------
                                                     2,277          2,575
                                                   --------        --------
          Depreciated cost                         $   816         $   602
                                                   ========        ========

          Depreciation  expenses for the years ended December 31, 2000, 2001 and
          2002 were $ 305, $ 488 and $ 348, respectively.


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,
               2002, $ 2,017 and $ 8 of the goodwill  balance are  attributed to
               the  Company's  U.S.  and  South   America's   reporting   units,
               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 (Cont.)

               The  results of  operations  presented  below for the three years
               ended December 31, 2000, 2001 and 2002, respectively, reflect the
               operations   had  the  Company   adopted   the   non-amortization
               provisions of SFAS No. 142 effective January 1, 2000:

<TABLE>
<CAPTION>
                                                                         December 31,
                                                         ---------------------------------------------
                                                              2000           2001            2002
                                                         --------------  -------------   -------------
                  <S>                                       <C>            <C>             <C>
                  Reported net income (loss)               $   (1,271)     $   (2,554)     $      130
                  Goodwill amortization                           303             431               -
                                                         --------------  -------------   -------------
                  Adjusted net income (loss)               $     (968)     $   (2,123)     $      130
                                                         ==============  =============   =============
                  Basic and diluted net earnings (loss)
                   per share:
                  Reported net earnings (loss) per
                   share                                   $    (0.26)    $    (0.53)     $      0.03
                  Goodwill amortization                          0.06           0.09                -
                                                         --------------  -------------   -------------
                  Adjusted basic and diluted net
                   earnings (loss) per share               $    (0.20)     $   (0.44)     $      0.03
                                                         ==============  =============   =============
</TABLE>

          b.   Other intangibles consist of the following:

<TABLE>
<CAPTION>
                                        December 31, 2001                  December 31, 2002
                                ---------------------------------- -----------------------------------
                                  Gross                   Other       Gross                    Other
                                carrying   Accumulated  intangibles, carrying   Accumulated  intangibles,
                                 amount    amortization    net        amount    amortization    net
                                ---------- -----------  ---------- -----------  ------------ ----------
            <S>                 <C>          <C>          <C>          <C>        <C>          <C>
            Distributor
              relationship      $1,653       $(276)       $1,377       $  -       $   -        $  -
            Assembled
              workforce            848        (353)          495          -           -           -
            Developed
              technology           710        (237)          473        750        (390)        360
                                ---------- -----------  ---------- ----------- ------------ ----------
                                $3,211       $(866)       $2,345       $750       $(390)       $360
                                ========== ===========  ========== =========== ============ ==========
</TABLE>

               Developed  technology  amortization  expenses for the years ended
               December  31,  2000,  2001 and 2002,  were $ 95, $ 142 and $ 153,
               respectively.  The expected  amortization expenses for 2003, 2004
               and 2005 are $ 153, $ 153 and $ 54, respectively.

NOTE 11:-   ACCRUED EXPENSES AND OTHER LIABILITIES

                                                         December 31,
                                                -------------------------------
                                                     2001             2002
                                                --------------   --------------

              Employees and payroll accruals        $  400           $  550
              Income tax payable                         5               26
              Accrued expenses                         873              422
              Customer advances                        581              437
              Related parties                            -                4
                                                --------------   --------------
                                                    $1,859           $1,439
                                                ==============   ==============


                                      F-23

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

NOTE 12:-   LONG-TERM LOANS
                                                         December 31,
                                                 -----------------------------
                                                     2001            2002
                                                 -------------   -------------

             Loan from others (1)                     $71             $16
             Less - current maturities                 58               8
                                                 -------------   -------------

                                                      $13             $ 8
                                                 =============   =============

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

NOTE 13:-   CONTINGENT LIABILITIES AND COMMITMENTS

          a.   Lease commitments:

               1.   The  facilities  of the  Company  and its  subsidiaries  are
                    rented under operating leases for periods ending in 2004.

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

                       2003     $    320
                       2004          155
                                -----------
                                $    475
                                ===========

                    Rent  expenses for the years ended  December 31, 2000,  2001
                    and  2002,  were  approximately  $  507,  $ 576  and $  446,
                    respectively.

          b.   Royalty commitments:

               1.   The Company is committed  to pay  royalties to the Office of
                    the Chief  Scientist of the Ministry of Trade ("OCS") of the
                    Government  of Israel on  proceeds  from  sales of  products
                    resulting  from the  research  and  development  projects in
                    which the Government  participated 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
                    revenues  of the  Company,  up to  100%-150%  of the  grants
                    received linked to the dollar.  As of December 31, 2002, the
                    Company has a contingent  obligation to pay royalties in the
                    amount of $ 7,667.  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 $ 217, $ 176 and $
                    132 for the years ended  December 31,  2000,  2001 and 2002,
                    respectively.

                                      F-24

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


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

               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,  2002,  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,
                    2002.

               3.   According to an agreement  effective  February 1999 with the
                    Company's distributor,  Pfordt,  elektronik GmbH the Company
                    is committed to pay a 10% commission on its  transactions in
                    Germany which are not executed through Pfordt.

          c.   Claims and demands:

               1.   On June 4, 2001 a claim was filed in the  District  Court of
                    Tel Aviv  against the Company  and the former  directors  of
                    S.T.S.  asserting various claims in connection with the sale
                    of S.T.S to NICE  Systems Ltd. The amount of the lawsuit was
                    NIS (New Israeli  shekel) 4,800  thousand  (approximately  $
                    1,000 thousand).

                    On March 10, 2003, the District  Court in Tel-Aviv  issued a
                    judgment  validating  the parties'  agreement to dismiss the
                    complaint  against the Company and the former  directors  of
                    S.T.S.,  waived all of the  plaintiffs'  claims  against the
                    defendants in connection  with the complaint,  with no costs
                    ordered.

               2.   Regarding the demand from the tax authorities in Israel, see
                    Note 14e.


NOTE 14:-   TAXES ON INCOME

          a.   Tax  benefits  under  the Law for the  Encouragement  of  Capital
               Investments, 1959 ("the Law"):

               The Company was  granted the status of an  "Approved  Enterprise"
               under the Law in respect of six expansion projects.  According to
               the  provisions  of  the  Law,  the  Company   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 three  expansion  programs  which are assigned to the Company
               are as follows:

               1.   The first program entitled the Company to tax-exemption  for
                    a four-year period ended December 31, 1999 and is subject to
                    a reduced  tax rate of 25% for a  three-year  period  ending
                    December 31, 2002.

                                      F-25

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

NOTE 14:-   TAXES ON INCOME (Cont.)

               2.   The second program entitled the Company 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.

               3.   The third program  entitles the Company 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 the
               Company'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 the  Company  may be required to refund the
               amount of the benefits,  in whole or in part, including interest.
               As of December 31, 2002,  management believes that the Company is
               meeting all of the aforementioned conditions.

               The tax-exempt income  attributable to the "Approved  Enterprise"
               amounting to $ 2,250 as of December  31, 2002 can be  distributed
               to shareholders without subjecting the Company to taxes only upon
               the  complete   liquidation  of  the  Company.  The  Company  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 the Company's "Approved Enterprise".

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

               Should the Company 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 the  Company 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

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,  the  Company  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:

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

          d.   Tax loss carryforward:

               The Company's  subsidiaries  in Asia and Israel have  estimated a
               total amount of available  carryforward  tax losses of $ 60 and $
               4, 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 the  Company  and its  Israeli  subsidiary,  which can be used
               indefinitely, amounted to approximately $ 1,335.

          e.   Tax assessment:

               In April  2000,  the tax  authorities  in  Israel  issued  to the
               Company a demand for a tax payment,  for the period of 1997-1999,
               in the amount of approximately NIS 6,000 ($ 1,250).

               The Company has appealed to the Israeli district court in respect
               of the abovementioned tax demand. Based on the opinion of its tax
               counsel, the Company believes that certain defenses can be raised
               against the demand of the tax  authorities.  The Company believes
               that the outcome of this matter will not have a material  adverse
               effect on its financial  position or results of  operations  and,
               therefore, no provision was provided.


                                      F-27

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

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:

<TABLE>
<CAPTION>
                                                                                 December 31,
                                                                         -----------------------------
                                                                             2001            2002
                                                                         -------------   -------------
                 <S>                                                        <C>             <C>
                 Tax loss carryforwards of the Company and its
                   subsidiaries                                             $ 575           $ 364
                 Allowances for doubtful accounts and provisions for
                   employee benefits                                          132             92
                 In respect of marketable securities                          (24)            29
                 Capitalized software and other intangible assets             125             93
                 Other                                                       (139)           (140)
                                                                         -------------   -------------
                 Net deferred tax asset before valuation allowance            669             438
                 Valuation allowance                                         (446)           (244)
                                                                         -------------   -------------
                 Net deferred income taxes                                  $ 223           $ 194
                                                                         =============   =============
                 Presented as follows:
                   Current assets - foreign                                 $  14           $  21
                                                                         =============   =============
                   Current assets - domestic                                $ 130           $  12
                                                                         =============   =============
                   Other assets - domestic                                  $  79           $ 161
                                                                         =============   =============
</TABLE>

               The  Company  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 in its subsidiaries 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

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,
                                                               ---------------------------------------
                                                                  2000          2001         2002
                                                               ------------  -----------  ------------
                <S>                                             <C>           <C>          <C>
                Loss before taxes as reported in the
                statements
                 of operations                                  $ (1,492)     $ (2,759)    $    (54)
                                                               ============  ===========  ============
                Tax rates                                             36%           36%          36%
                                                               ============  ===========  ============
                Theoretical tax benefit                         $   (537)     $   (993)    $    (19)
                Increase in taxes resulting from:
                Effect of different tax rates and "Approved
                Enterprise" benefit                                  456           396          200
                Tax adjustment in respect of inflation in
                Israel and others                                   (163)          193          (61)
                Utilization of carryforward tax losses for
                 which valuation allowance was provided              (26)            -         (246)
                Non-deductible expenses and tax exempt income        (88)          (43)         (24)
                Taxes in respect of previous years                   (88)            -            -
                Deferred taxes for which valuation allowance
                was provided                                         291           463          202
                                                               ------------  -----------  ------------
                Taxes on income (tax benefit) as reported in
                the statements of operations                    $   (155)     $     16     $     52
                                                               ============  ===========  ============


          h.   Income (loss) before income taxes is
                 comprised as follows:

                 Domestic                                        $(1,281)     $ (1,772)    $   (841)
                 Foreign                                            (211)         (987)         787
                                                                -----------  -----------   -----------
                                                                 $(1,492)     $ (2,759)    $    (54)
                                                                ===========  ===========   ===========

          i.   The provisions for income tax expense
                 (benefit) are comprised as follows:

                 Current taxes                                   $   243      $     36     $     23
                 Deferred taxes                                     (310)          (20)          29
                 Taxes in respect of previous years                  (88)            -            -
                                                                -----------  -----------   -----------

                                                                 $  (155)     $    16      $     52
                                                                ===========  ===========   ===========

                 Domestic                                        $  (353)     $   (42)     $     29
                 Foreign                                             198           58            23
                                                                ----------  -----------   ------------

                                                                $   (155)     $    16      $     52
                                                                ===========  ===========   ===========
</TABLE>

                                      F-29

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

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.

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 Mr.  Mer's  monthly  salary from $ 5 to $ 7 per month
               and the grant of options to purchase 98,824 ordinary shares.  The
               options  were granted to Mr. Mer 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.

               Ms.  Dora Mer,  the wife of Chaim  Mer,  provides  ongoing  legal
               services to the Company and  receives a monthly  retainer of $ 5.
               The conditions of retaining the services of Ms. Mer were approved
               by the Company's board of directors and audit committee.

               The Company'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 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 2001 and 2002,  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,
               2001 and 2002.


                                      F-30

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

NOTE 15:-   RELATED PARTIES TRANSACTIONS (Cont.)

          c.   Transactions with related parties were as follows:

                                                  Year ended December 31,
                                            ------------------------------------
                                              2000         2001          2002
                                            ----------  -----------   ----------
   Sales through a related parties           $    23      $    58     $      65
                                            ==========  ===========   ==========
   Amounts charged by related parties:
     Cost of revenues                        $   107      $    62     $     239
     Research and development                     26           58             8
     Selling and marketing                         -            -             2
     General and administrative                    -            -             4
                                            ----------  -----------   ----------
                                             $   133      $   120     $     253
                                            ==========  ===========   ==========
   Amounts  charged  by MTS  Integra
     TRAK and MTS Asia to related parties:
     Selling and marketing                   $    59      $    44     $       2
                                            ==========  ===========   ==========
     Repayments to the related parties, net  $    (8)     $   (10)    $    (172)
                                            ==========  ===========   ==========


          d.   Amounts due from an affiliate:

                                                       December 31,
                                               ------------------------------
                                                   2001             2002
                                               -------------    -------------
                 Jusan S.A                     $      5         $     10
                                               =============    =============

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 the Company and the right to receive cash  dividends,  if
                    declared.

               b.   Share Option Plan:

                    The Company has authorized, through its 1996 Incentive Share
                    Option plan,  the grant of options to officers,  management,
                    employees and directors of the Company or any  subsidiary of
                    up to 1,900,000 of the Company'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.   The  Incentive   Share  Option  Plan  will
                    terminate in 2006,  unless canceled earlier by the Company's
                    board of directors.

                    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.


                                      F-31

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

NOTE 16:-   SHAREHOLDERS' EQUITY (Cont.)

          As of December 31, 2002,  1,001,170  options are  available for future
          grant.

          Summary  of  the  Company's   stock   options   activity  and  related
          information for the years ended December 31, is as follows:
<TABLE>
<CAPTION>
                                                      Options                                 Weighted
                                                     available     Number      Options         average
                                                     for grant   of options   exercisable   exercise price
                                                    ------------ -----------  ----------- ----------------
                  <S>                                <C>         <C>            <C>            <C>
                  Options  exercisable  at
                    January 1, 2000                                             665,755        $  2.46
                                                                              ===========
                  Balance on January 1, 2000          687,239    1,062,761                     $  2.85
                    Shares authorized                 150,000            -                     $     -
                    Options granted                  (415,524)     415,524                     $  6.19
                    Options forfeited                  25,883      (25,883)                    $  5.07
                    Options exercised                       -     (137,250)                    $  2.5
                                                    ------------ -----------                  ---------
                  Options  exercisable at
                   December 31, 2000                                            778,325        $  3.02
                                                                              ===========
                  Balance on December 31, 2000        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 31, 2001                                           800,887        $  4.48
                                                                              ===========
                  Balance on December 31, 2001        531,609    1,227,141                     $  3.74
                    Options granted                   (35,000)      35,000                     $  1.2
                    Options forfeited (1)             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
                                                    ============ ===========                  =========
</TABLE>

          (1)  All of  the  options  granted  during  1996  (part  of  the  1996
               incentive option plan) that were not exercised or forfeited until
               2002, were terminated and became available for future grants.

          The options  outstanding  as of December 31, 2002 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           2002      life (in years)   price     exercisable       options
                ---------------   -------------  ------------  ------------ ------------- -------------
                <S>                  <C>              <C>        <C>           <C>            <C>
                $ 0.93 - 1.3          34,500          3.08       $1.19               -        $  -
                $ 1.9 - 2.5          473,406          1.84       $2.12         287,764        $  2.17
                $ 4.0625 - 4.5        17,000          1.19       $4.17          14,332        $  4.1
                $ 5.5 - 5.75          39,000          1.46       $5.63          26,001        $  5.63
                $ 5.9375 - 6.0375    170,924          1.97       $5.98         162,541        $  5.99
                $ 7.0625              22,750          1.33       $7.0625        12,006        $  7.0625
                                  -------------                             -------------
                                     757,580                     $3.32         502,644        $  3.76
                                  =============                ============ ===========     ===========
</TABLE>

                                      F-32

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

NOTE 16:-   SHAREHOLDERS' EQUITY (Cont.)

          c.   The weighted  average fair value of options  granted during 2000,
               2001 and 2002,  whose exercise price equals the fair value of the
               stock on the date of  grant,  was $ 6.189,  $ 2.05 and $ 1.20 per
               option, respectively. All options were granted at fair value.

               The total compensation expenses, net of tax, that would have been
               included  in the  statements  of  operations  for the years ended
               December 31, 2000, 2001 and 2002 had the Company adopted SFAS No.
               123 is $ 733, $ 769 and $ 177, respectively.

          d.   Underwriters' warrants:

               In  connection  with the May 1997 initial  public  offering,  the
               Company  issued  its  underwriters,  at  the  par  value  of  the
               underlying  shares,  warrants (the  "Underwriters'  Warrants") to
               purchase 120,000 ordinary  shares.  The Underwriter  Warrants are
               exercisable  for four years  commencing  May 20,  1998,  at $ 7.8
               (130% of the May 1997  offering  price) per Ordinary  share.  The
               Underwriter's Warrants contain anti-dilution protection. In 2000,
               450 warrants were exercised.  The Underwriter's  warrants expired
               in 2002.

          e.   In June 1998, the Company  granted 75,000 warrants to consultants
               for a price of $ 0.005 per  warrant to purchase  75,000  ordinary
               shares of the Company,  at an exercise price of $ 4.00 per share.
               The warrants are exercisable for five years commencing June 1998.
               In 2000, 50,000 warrants were exercised.

          f.   In January 2000, the Company  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).

          g.   On February 7, 2001,  the Company  issued  five-year  warrants to
               purchase  25,000  ordinary shares of the Company to Investec Bank
               (Mauritius)  Ltd. in connection with certain  financial  services
               performed on the Company'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.

          h.   Treasury shares:

               During  the years  2000,  2001 and 2002,  the  Company  purchased
               11,252,  54,665 and 195,183 treasury shares in consideration of $
               40,  $ 118  and $  172,  respectively,  according  to  the  stock
               repurchase  program,  which authorized the Company's  officers to
               repurchase up to 300,000  ordinary  shares of the Company and was
               approved by the Company's board of directors.

          i.   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.

                                      F-33


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

NOTE 17:-   SEGMENTS, CUSTOMERS AND GEOGRAPHIC INFORMATION

          a.   MTS  operates  in  one  industry  segment,  the  development  and
               marketing of a comprehensive line of telecommunication management
               solutions.  The  Company  operates  in four  geographical  areas.
               Operations in Israel include  research and  development,  selling
               and marketing.  Operations in the United States,  Brazil and Asia
               include   selling  and  marketing.   The  data  is  presented  in
               accordance  with Statement of Financial  Accounting  Standard No.
               131,  "Disclosure  About  Segments of an  Enterprise  and Related
               Information"  ("SFAS No.  131").  The  following  is a summary of
               operations  within  geographic areas based on the location of the
               selling entity:
<TABLE>
<CAPTION>
                                                         Year ended December 31, 2002
                                        ----------------------------------------------------------------
                                                                               Adjustments
                                                  United              South        and
                                        Israel    States     Asia    America   eliminations Consolidated
                                        --------- --------  -------- --------- ------------ ------------
            <S>                          <C>       <C>        <C>     <C>       <C>          <C>
            Sales to unaffiliated
              customers                  $2,541    $6,449     $469    $ 328     $     -      $ 9,787
            Transfers between
              geographic areas            1,806         -        -        -      (1,806)           -
                                        --------- --------  -------- --------- ------------ ------------
            Total sales                  $4,347    $6,449     $469    $ 328     $(1,806)     $ 9,787
                                        ========= ========  ======== ========= ============ ============
            Depreciation and
              amortization expenses      $  299    $  167     $ 21    $  14     $     -      $    501
                                        ========= ========  ======== ========= ============ ============
            Operating income (loss)      $ (995)   $  795     $(60)   $ 201     $    11      $    (48)
                                        ========= ========  ======== ========= ============
            Financial income, net                                                                 134
            Other expenses                                                                       (140)
                                                                                            ------------
            Loss before taxes on
              income                                                                          $   (54)
                                                                                            ============
            Tax expenses                  $   29   $    -     $  -    $  23     $     -       $    52
                                        ========= ========  ======== ========= ============ ============
            Net income (loss)             $ (361)  $  682     $(60)   $(131)    $     -       $   130
                                        ========= ========  ======== ========= ============ ============

            Identifiable long lived
              assets                      $  624   $2,302     $ 29    $  32     $     -       $ 2,987
                                        ========= ========  ======== ========= ============
            Non-identifiable assets                                                            14,720
                                                                                            ------------
            Total assets at December
              31, 2002                                                                        $17,707
                                                                                            ============
</TABLE>

                                      F-34

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

NOTE 17:-   SEGMENTS, CUSTOMERS AND GEOGRAPHIC INFORMATION (Cont.)
<TABLE>
<CAPTION>

                                                           Year ended December 31, 2001
                                          ---------------------------------------------------------------
                                                                                Adjustments
                                                    United              South       and
                                          Israel    States     Asia    America  eliminations Consolidated
                                          -------- --------- --------- -------- ------------ ------------
            <S>                           <C>      <C>        <C>       <C>       <C>         <C>
            Sales to unaffiliated
              customers                   $ 3,310  $ 6,496    $  500    $  419    $     -     $ 10,725
            Transfers between
              geographic areas                661        -         -         -       (661)           -
                                          -------- --------- --------- -------- ------------ ------------
            Total sales                   $ 3,971  $ 6,496    $  500    $  419    $  (661)    $ 10,725
                                          ======== ========= ========= ======== ============ ============
            Depreciation and
              amortization expenses       $   421  $   645    $   42    $    2    $     -     $  1,110
                                          ======== ========= ========= ======== ============ ============
            Operating income (loss)       $(1,465) $  (752)   $  (39)   $  (73)   $    86     $ (2,243)
                                          ======== ========= ========= ======== ============
            Financial income, net                                                                  138
            Other expenses                                                                        (654)
                                                                                             ------------
            Loss before taxes on income                                                       $ (2,759)
                                                                                             ============
            Tax expenses (income)         $   (42) $     -    $    -    $   58    $     -     $     16
                                          ======== ========= ========= ======== ============ ============
            Net loss                      $(1,423) $  (930)   $  (35)   $ (166)   $     -     $ (2,554)
                                          ======== ========= ========= ======== ============ ============
            Identifiable long lived
              assets                      $   809  $ 2,437    $   35    $   33    $     -     $  3,314
                                          ======== ========= ========= ======== ============
            Non-identifiable assets                                                             14,781
                                                                                             ------------
            Total assets at December
              31, 2001                                                                        $ 18,095
                                                                                             ============
</TABLE>

                                      F-35

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

NOTE 17:-   SEGMENTS, CUSTOMERS AND GEOGRAPHIC INFORMATION (Cont.)
<TABLE>
<CAPTION>
                                                          Year ended December 31, 2000
                                         ----------------------------------------------------------------
                                                                                Adjustments
                                                    United             South        and
                                          Israel    States    Asia    America   eliminations Consolidated
                                         --------- --------- -------- --------- ------------ ------------
            <S>                          <C>       <C>       <C>       <C>        <C>        <C>
            Sales to unaffiliated        $ 4,647   $ 5,029   $   922   $  469     $     -    $  11,067
            customers
            Transfers between
            geographic areas                 968        19         -        -        (987)           -
                                         --------- --------- -------- --------- ------------ ------------
            Total sales                  $ 5,615   $ 5,048   $   922   $  469     $  (987)   $  11,067
                                         ========= ========= ======== ========= ============ ============
            Depreciation and
            amortization   expenses      $   815   $   159   $    34   $   20     $     -    $   1,028
                                         ========= ========= ======== ========= ============ ============
            Operating income (loss)      $(2,193)  $(1,280)  $    57   $  (32)    $    (9)   $  (3,457)
                                         ========= ========= ======== ========= ============
            Financial income, net                                                                  374
            Other income                                                                         1,591
                                                                                             ------------
            Loss before taxes on income                                                      $  (1,492)
                                                                                             ============
            Tax expenses (income)        $  (353)  $   201   $     -   $   (3)    $     -    $    (155)
                                         ========= ========= ======== ========= ============ ============
            Net income (loss)            $  (871)  $  (443)  $    64   $  (21)    $     -    $  (1,271)
                                         ========= ========= ======== ========= ============ ============
            Identifiable long lived
            assets                       $ 1,210   $ 2,987   $    65   $   32     $     -    $   4,294
                                         ========= ========= ======== ========= ============
            Non-identifiable assets                                                             17,518
                                                                                             ------------
            Total assets at December
            31, 2000                                                                         $  21,812
                                                                                             ============
</TABLE>

                                      F-36

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

NOTE 17:-   SEGMENTS, CUSTOMERS AND GEOGRAPHIC INFORMATION (Cont.)

          b.   Major customers as a percentage of total revenues:

                                        Year ended December 31,
                               ------------------------------------------
                                  2000           2001            2002
                               ------------   ------------    -----------
                                                   %
                               ------------------------------------------
                  Philips            11              8               6
                  Siemens            22             32              36

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

                                            Year ended December 31,
                                   ------------------------------------------
                                      2000           2001            2002
                                   ------------   ------------    -----------

           Israel                    $    791     $      358      $      217
           United States                5,039          6,496           6,449
           Austria                        154             24               -
           Germany                      1,352          1,355           1,130
           Holland                      1,460          1,009             756
           Europe (excluding
             Austria, Germany
             and Holland)                 719            448             296
           Asia                           922            500             469
           South America                  469            419             328
           Other                          161            116             142
                                   ------------   ------------    -----------
                                     $ 11,067       $ 10,725      $    9,787
                                   ============   ============    ===========


NOTE 18:-   SELECTED STATEMENTS OF OPERATIONS DATA

          a.   Research and development, net:

                                              Year ended December 31,
                                     ------------------------------------------
                                        2000            2001           2002
                                     ------------    -----------    -----------

   Total costs                         $  5,288        $  4,552     $    2,128
   Less - grants and participations      (1,249)           (990)            (1)
                                     ------------    -----------    -----------

                                       $  4,039        $  3,562     $    2,127
                                     ============    ===========    ===========

                                      F-37

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

NOTE 18:-   SELECTED STATEMENTS OF OPERATIONS DATA (Cont.)

          b.   Financial income, net

<TABLE>
<CAPTION>
                                                                     Year ended December 31,
                                                            ------------------------------------------
                                                               2000           2001           2002
                                                            -----------    ------------   ------------
                   <S>                                      <C>            <C>            <C>
                   Financial expenses:

                   Interest expenses                        $     (219)    $     (232)    $     (205)
                   Other expenses                                    -             (9)            (7)
                   Foreign currency translation
                   differences                                     (52)           (81)             -
                                                            -----------    ------------   ------------

                                                                  (271)          (322)          (212)
                                                            -----------    ------------   ------------
                   Financial income:

                   Interest income                                 645            403            310
                   Other income                                      -             57              1
                   Foreign currency translation
                   differences                                       -              -             35
                                                            -----------    ------------   ------------

                                                                   645            460            346
                                                            -----------    ------------   ------------

                   Financial income, net                    $      374     $      138     $      134
                                                            ===========    ============   ============

          c.   Other income (expenses):

                   Loss from impairment of investments
                   in  warrants                             $        -     $     (375)    $        -
                   Gain on sale of an interest in
                   affiliate                                        73              -              -
                   Gain on sale of property and
                   equipment                                     1,223              -              -
                   Gain (loss) on marketable
                   securities, net                                 289           (279)          (140)
                   Other                                             6              -              -
                                                            -----------    ------------   ------------

                                                            $    1,591     $     (654)    $     (140)
                                                            ===========    ============   ============
</TABLE>

                                      F-38

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

NOTE 19:-   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 Brasil Ltd. (a subsidiary of Bohera B.V.)            100%               Brazil

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

</TABLE>



                              - - - - - - - - - - -

                                      F-39

<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.
                                            (REGISTRANT)



                                            By:    /s/Chaim Mer
                                                   ------------
                                                   Chaim Mer
                                                   Chairman of the Board



                                            By:    /s/Shai Levanon
                                                   ---------------
                                                   Shai Levanon
                                                   Chief Executive Officer




                                            By:    /s/Yossi Brikman
                                                   ----------------
                                                   Yossi Brikman
                                                   Chief Financial Officer




Dated: June 25, 2003

                                       77

<PAGE>




                                  EXHIBIT INDEX

Exhibit No.  Description of Exhibit
-----------  ----------------------

   *3.1      Memorandum of Association of the Registrant
   *3.2      Articles of Association of the Registrant
   *4.1      Specimen of Ordinary Share Certificate
  *10.1      Purchase and Assignment Agreement, dated March 31, 1996, between C.
             Mer Industries Ltd., MER & Co. (1982) Ltd. and the Registrant
  *10.2      1996 Employee Stock Option Plan
  *10.3      Section 102 Stock Option Plan
  *10.4      Form of Underwriter's Warrant
 **10.5      Form of Financial Consulting Agreement
   23.1      Consent of Kost Forer & Gabbay
   99.1      Certification by Chief Executive Officer Pursuant to Section 302 of
             the Sarbanes-Oxley Act of 2002.
   99.2      Certification by Chief Financial Officer Pursuant to Section 302 of
             the Sarbanes-Oxley Act of 2002.
   99.3      Certification  by Chief  Executive  Officer  Pursuant to 18
             U.S.C.  Section 1350, As Adopted Pursuant to Section 906 of
             the Sarbanes-Oxley Act of 2002.
   99.4      Certification  by Chief  Financial  Officer  Pursuant to 18
             U.S.C.  Section 1350, As Adopted Pursuant to Section 906 of
             the Sarbanes-Oxley Act of 2002.

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

     *    Incorporated by reference to our  registration  statement on Form F-1,
          registration number 333-05814,  filed with the Securities and Exchange
          Commission.

     **   Filed as exhibit  10.5 to our Annual  Report on Form 20-F for the year
          ended December 31, 2001 and incorporated herein by reference.