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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, 2004



OR



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



For the transition period from
 to



Commission File Number 0-28986



TTI TEAM TELECOM INTERNATIONAL LTD.

(Exact name of Registrant as specified in its charter)



Israel

(Jurisdiction of incorporation or organization)



7 Martin Gehl Street

Kiryat Aryeh, Petach Tikva 49512 Israel

972-3-926-9700

(Address of principal executive offices)



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

None



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



Ordinary Shares, par value NIS 0.5 per share

(Title of Class)



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

None



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

11,872,938 Ordinary Shares, par value NIS 0.5 per share

6,636,389 Series A Convertible Preferred Shares, par value NIS 0.5 per share



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



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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                    |  | 3   
|       |  |         | 
|       |  |         |  | C. Reasons for the Offer and Use of Proceeds          |  | 3   
|       |  |         | 
|       |  |         |  | D. Risk Factors                                       |  | 3   
|       |  |         | 
|       |  | Item 4. |  | INFORMATION ON THE COMPANY                            |  | 18  
|       |  |         | 
|       |  |         |  | A. History and Development of the Company             |  | 18  
|       |  |         | 
|       |  |         |  | B. Business Overview                                  |  | 19  
|       |  |         | 
|       |  |         |  | C. Organizational Structure                           |  | 33  
|       |  |         | 
|       |  |         |  | D. Property, Plants and Equipment                     |  | 33  
|       |  |         | 
|       |  | Item 5. |  | OPERATING AND FINANCIAL REVIEW AND PROSPECTS          |  | 34  
|       |  |         | 
|       |  |         |  | A. Operating Results                                  |  | 34  
|       |  |         | 
|       |  |         |  | B. Liquidity and Capital Resources                    |  | 48  
|       |  |         | 
|       |  |         |  | C. Research and Development, Patents and Licenses     |  | 50  
|       |  |         | 
|       |  |         |  | D. Trend Information                                  |  | 51  
|       |  |         | 
|       |  |         |  | E. Off-Balance Sheet Arrangements                     |  | 51  
|       |  |         | 
|       |  |         |  | F. Tabular Disclosure of Contractual Obligations      |  | 52  
|       |  |         | 
|       |  | Item 6. |  | DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES            |  | 52  
|       |  |         | 
|       |  |         |  | A. Directors and Senior Management                    |  | 52  
|       |  |         | 
|       |  |         |  | B. Compensation                                       |  | 56  
|       |  |         | 
|       |  |         |  | C. Board Practices                                    |  | 57  
|       |  |         | 
|       |  |         |  | D. Employees                                          |  | 61  
|       |  |         | 
|       |  |         |  | E. Share Ownership                                    |  | 63  
|       |  |         | 
|       |  | Item 7. |  | MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS     |  | 65  



i



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|        |  |          |  |                                                            |  |   
|------- |  | -------- |  | ---------------------------------------------------------- |  | --
|        |  |          |  | A. Major Shareholders                                      |  | 65
|        |  |          | 
|        |  |          |  | B. Related Party Transactions                              |  | 69
|        |  |          | 
|        |  |          |  | C. Interests of Experts and Counsel                        |  | 72
|        |  |          | 
|        |  | Item 8.  |  | FINANCIAL INFORMATION                                      |  | 72
|        |  |          | 
|        |  |          |  | A. Consolidated Statements and Other Financial Information |  | 72
|        |  |          | 
|        |  |          |  | B. Significant Changes                                     |  | 74
|        |  |          | 
|        |  | Item 9.  |  | THE OFFER AND LISTING                                      |  | 74
|        |  |          | 
|        |  |          |  | A. Offer and Listing Details                               |  | 74
|        |  |          | 
|        |  |          |  | B. Plan of Distribution                                    |  | 74
|        |  |          | 
|        |  |          |  | C. Markets                                                 |  | 75
|        |  |          | 
|        |  |          |  | D. Selling Shareholders                                    |  | 75
|        |  |          | 
|        |  |          |  | E. Dilution                                                |  | 75
|        |  |          | 
|        |  |          |  | F. Expenses of the Issue                                   |  | 75
|        |  |          | 
|        |  | Item 10. |  | ADDITIONAL INFORMATION                                     |  | 75
|        |  |          | 
|        |  |          |  | A. Share Capital                                           |  | 75
|        |  |          | 
|        |  |          |  | B. Memorandum and Articles of Association                  |  | 75
|        |  |          | 
|        |  |          |  | C. Material Contracts                                      |  | 82
|        |  |          | 
|        |  |          |  | D. Exchange Controls                                       |  | 84
|        |  |          | 
|        |  |          |  | E. Taxation                                                |  | 84
|        |  |          | 
|        |  |          |  | F. Dividends and Paying Agents                             |  | 95
|        |  |          | 
|        |  |          |  | G. Statement by Experts                                    |  | 95
|        |  |          | 
|        |  |          |  | H. Documents on Display                                    |  | 95
|        |  |          | 
|        |  |          |  | I. Subsidiary Information                                  |  | 96
|        |  |          | 
|        |  | Item 11. |  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |  | 96
|        |  |          | 
|        |  | Item 12. |  | DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES     |  | 96
|        | 
|PART II |  | 96      
|        |  |          | 
|        |  | Item 13. |  | DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES            |  | 96



ii



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| |  |           |  |                                                                              |  |   
| |  | --------- |  | ---------------------------------------------------------------------------- |  | --
| |  |           | 
| |  | Item 14.  |  | MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS |  | 96
| |  |           | 
| |  | Item 15.  |  | CONTROLS AND PROCEDURES                                                      |  | 97
| |  |           | 
| |  | Item 16.  |  | Reserved                                                                     |  | 97
| |  |           | 
| |  | Item 16A. |  | AUDIT COMMITTEE FINANCIAL EXPERT                                             |  | 97
| |  |           | 
| |  | Item 16B. |  | CODE OF ETHICS                                                               |  | 97
| |  |           | 
| |  | Item 16C. |  | PRINCIPAL ACCOUNTANT FEES AND SERVICES                                       |  | 97
| |  |           | 
| |  | Item 16D. |  | EXEMPTIONS FROM LISTING STANDARDS FOR AUDIT COMMITTEES                       |  | 98
| |  |           | 
| |  | Item 16E. |  | PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS       |  | 98
| |  |           | 
| |  | Item 17.  |  | FINANCIAL STATEMENTS                                                         |  | 98
| |  |           | 
| |  | Item 18.  |  | FINANCIAL STATEMENTS                                                         |  | 98
| |  |           | 
| |  | Item 19.  |  | EXHIBITS                                                                     |  | 98



iii



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INTRODUCTION



Unless the context otherwise requires, all references in this annual report to TTI, us,
we, and our refer to TTI Team Telecom International Ltd.



Our consolidated financial statements are prepared in United States dollars and in accordance with generally accepted accounting principles in the United States. All references to dollars or
$ in this annual report are to United States dollars, and all references to Shekels or NIS are to New Israeli Shekels. On May 17, 2005, the exchange rate between the NIS and the dollar, as quoted by the Bank of
Israel, was NIS 4.373 to $1.00.



CAUTIONARY STATEMENT REGARDING
FORWARD-LOOKING STATEMENTS



Statements in this
annual report concerning our business outlook or future economic performance; further payments under contractual obligations, anticipated revenues, expenses or other financial items; and introductions and advancements in development of products, and
plans, and objectives related thereto; such as statements concerning assumptions made or expectations as to any future events, conditions, performance or other matters, are forward-looking statements within the meaning of Private
Securities Litigation Reform Act of 1995. In some cases, you can identify forward-looking statements by our use of words such as expect, anticipate, believe, intend, plan, seek
and estimate and similar expressions. Forward-looking statements are subject to risks, uncertainties and other factors which could cause actual results to differ materially from those in these statements. Factors that could cause or
contribute to these differences include, but are not limited to, those set forth under Item 3D - Risk Factors in this annual report as well as those discussed elsewhere in this annual report as well as our reports on Form 6-K submitted
to the Securities and Exchange Commission.



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 tables that
follow present portions of our financial statements and are not complete. The following selected financial data should be read together with our consolidated financial statements, notes to our consolidated financial statements and Item 5 -
Operating and Financial Review and



1



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Prospects included in this annual report. Historical results are not necessarily indicative of any results to be expected in any future period.



We derived the selected consolidated statements of operations data set forth
below for the years ended December 31, 2002, 2003 and 2004, and the selected consolidated balance sheet data as of December 31, 2003 and 2004, from our audited consolidated financial statements, which are included elsewhere in this annual report.
These consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (GAAP). We derived the consolidated statements of operations data for the years ended December
31, 2000 and 2001 and the selected consolidated balance sheet data as of December 31, 2000, 2001 and 2002 from audited consolidated financial statements that are not included in this annual report.



|                                                       |  |                            |        |      |   |        |  |   |         |   |  |      |         |   |  |   |         |  
|------------------------------------------------------ |  | -------------------------- | ------ | ---- | - | ------ |  | - | ------- | - |  | ---- | ------- | - |  | - | ------- | -
|                                                       |  | December 31 (in thousands) |       
|                                                       |  | 2000                       |        | 2001 |   | 2002   |  |   | 2003    |   |  | 2004 |        
|Statement of Income Data:                              |  |                            |        |      |   |        |  |   |         |   |  |      |         |   |  |   |         |  
|Revenues:                                              |  |                            |        |      |   |        |  |   |         |   |  |      |         |   |  |   |         |  
|Products                                               |  | $                          | 35,191 |      | $ | 53,547 |  | $ | 47,021  |   |  | $    | 33,831  |   |  | $ | 21,670  |  
|Services                                               |  |                            | 7,639  |      |   | 7,279  |  |   | 11,320  |   |  |      | 12,036  |   |  |   | 16,128  |  
|                                                       |  |                            |        |      |   |        |  |   |         |   |  |      |         |   |  |   |         |  
|Total revenues                                         |  |                            | 42,830 |      |   | 60,826 |  |   | 58,341  |   |  |      | 45,867  |   |  |   | 37,798  |  
|Cost of revenues:                                      |  |                            |        |      |   |        |  |   |         |   |  |      |         |   |  |   |         |  
|Products                                               |  |                            | 14,743 |      |   | 20,774 |  |   | 27,398  |   |  |      | 29,619  |   |  |   | 16,645  |  
|Services                                               |  |                            | 3,457  |      |   | 3,599  |  |   | 5,675   |   |  |      | 6,368   |   |  |   | 9,719   |  
|Impairment of capitalized software                     |  |                            |       |      |   |       |  |   |        |   |  |      | 5,864   |   |  |   | 3,597   |  
|                                                       |  |                            |        |      |   |        |  |   |         |   |  |      |         |   |  |   |         |  
|Total cost of revenues                                 |  |                            | 18,200 |      |   | 24,373 |  |   | 33,073  |   |  |      | 41,851  |   |  |   | 29,961  |  
|                                                       |  |                            |        |      |   |        |  |   |         |   |  |      |         |   |  |   |         |  
|Gross profit                                           |  |                            | 24,630 |      |   | 36,453 |  |   | 25,268  |   |  |      | 4,016   |   |  |   | 7,837   |  
|                                                       |  |                            |        |      |   |        |  |   |         |   |  |      |         |   |  |   |         |  
|Operating expenses:                                    |  |                            |        |      |   |        |  |   |         |   |  |      |         |   |  |   |         |  
|Research and development, net                          |  |                            | 4,709  |      |   | 6,281  |  |   | 7,958   |   |  |      | 10,318  |   |  |   | 10,744  |  
|Selling and marketing, net                             |  |                            | 8,454  |      |   | 12,206 |  |   | 17,725  |   |  |      | 19,465  |   |  |   | 19,220  |  
|General and administrative                             |  |                            | 3,708  |      |   | 5,236  |  |   | 6,980   |   |  |      | 6,333   |   |  |   | 6,636   |  
|goodwill write-off                                     |  |                            |       |      |   |       |  |   |        |   |  |      | 1,052   |   |  |   |        |  
|                                                       |  |                            |        |      |   |        |  |   |         |   |  |      |         |   |  |   |         |  
|Allowance for doubtful accounts and bad debt write-off |  |                            |       |      |   |       |  |   | 7,456   |   |  |      | 177     |   |  |   | (50     | )
|                                                       |  |                            |        |      |   |        |  |   |         |   |  |      |         |   |  |   |         |  
|Total operating expenses                               |  |                            | 16,871 |      |   | 23,723 |  |   | 40,119  |   |  |      | 37,345  |   |  |   | 36,550  |  
|                                                       |  |                            |        |      |   |        |  |   |         |   |  |      |         |   |  |   |         |  
|Operating income (loss)                                |  |                            | 7,759  |      |   | 12,730 |  |   | (14,851 | ) |  |      | (33,329 | ) |  |   | (28,713 | )
|Financial income, net                                  |  |                            | 2,578  |      |   | 2,365  |  |   | 3,412   |   |  |      | 2,793   |   |  |   | 1,326   |  
|                                                       |  |                            |        |      |   |        |  |   |         |   |  |      |         |   |  |   |         |  
|Income (loss) before income taxes                      |  |                            | 10,337 |      |   | 15,095 |  |   | (11,439 | ) |  |      | (30,536 | ) |  |   | (27,387 | )
|Income taxes (benefit)                                 |  |                            | 683    |      |   | 1,000  |  |   | (585    | ) |  |      | (456    | ) |  |   | 2,107   |  
|                                                       |  |                            |        |      |   |        |  |   |         |   |  |      |         |   |  |   |         |  
|Net income (loss)                                      |  | $                          | 9,654  |      | $ | 14,095 |  | $ | (10,854 | ) |  | $    | (30,080 | ) |  | $ | (29,494 | )
|                                                       |  |                            |        |      |   |        |  |   |         |   |  |      |         |   |  |   |         |  
|Basic net earnings (loss) per share                    |  | $                          | 0.88   |      | $ | 1.23   |  | $ | (0.92   | ) |  | $    | (2.53   | ) |  | $ | (2.48   | )
|                                                       |  |                            |        |      |   |        |  |   |         |   |  |      |         |   |  |   |         |  
|Diluted net earnings (loss) per share                  |  | $                          | 0.84   |      | $ | 1.20   |  | $ | (0.92   | ) |  | $    | (2.53   | ) |  | $ | (2.48   | )
|                                                       |  |                            |        |      |   |        |  |   |         |   |  |      |         |   |  |   |         |  
|Weighted average number of shares used in computing:   |  |                            |        |      |   |        |  |   |         |   |  |      |         |   |  |   |         |  
|Basic net earnings (loss) per share                    |  |                            | 11,027 |      |   | 11,490 |  |   | 11,853  |   |  |      | 11,872  |   |  |   | 11,873  |  
|                                                       |  |                            |        |      |   |        |  |   |         |   |  |      |         |   |  |   |         |  
|Diluted net earnings (loss) per share                  |  |                            | 11,525 |      |   | 11,722 |  |   | 11,853  |   |  |      | 11,872  |   |  |   | 11,873  |  
|                                                       |  |                            |        |      |   |        |  |   |         |   |  |      |         |   |  |   |         |  



2



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|                          |  |                            |        |      |   |         |  |      |         |      |   |        |  |   |       
|------------------------- |  | -------------------------- | ------ | ---- | - | ------- |  | ---- | ------- | ---- | - | ------ |  | - | ------
|                          |  | December 31 (in thousands)
|                          |  | 2000                       |        | 2001 |   | 2002    |  | 2003 |         | 2004
|Balance Sheet Data:       |  |                            |        |      |   |         |  |      |         |      |   |        |  |   |       
|Cash and cash equivalents |  | $                          | 18,509 |      | $ | 36,111  |  | $    | 33,972  |      | $ | 13,901 |  | $ | 5,472 
|Short term bank deposits  |  |                            | 6,582  |      |   | 193     |  |      | 1,229   |      |   | 4,365  |  |   | 4,426 
|Marketable securities     |  |                            | 24,100 |      |   | 18,182  |  |      | 12,889  |      |   | 15,767 |  |   | 10,572
|Working capital           |  |                            | 68,950 |      |   | 71,506  |  |      | 60,475  |      |   | 38,570 |  |   | 16,806
|Total assets              |  |                            | 91,420 |      |   | 115,597 |  |      | 104,465 |      |   | 76,606 |  |   | 46,497
|Shareholders equity      |  |                            | 78,206 |      |   | 94,885  |  |      | 86,268  |      |   | 55,789 |  |   | 26,293



B. Capitalization and Indebtedness



Not
applicable.



C. Reasons for Offer and Use of Proceeds



Not
applicable.



D. Risk Factors



You should carefully consider the
risks described below before making an investment decision regarding our ordinary shares. Our business, financial condition and results of operations could be materially adversely affected by any of these risks. The trading price of our ordinary
shares could decline due to any of these risks, and you may lose all or part of your investment.



Risks Relating to Our Business and Our Industry



If the general deterioration of the global economy and the slow-down of expenditures by communications service providers resume, our results of operations may be materially adversely affected.



Our business is dependent on current and anticipated market demand for our products. The
general deterioration of the global economy and economic uncertainty in the telecommunications market resulted in a curtailment of capital investment by communications service providers beginning towards the end of 2000. Many new and small
communications service providers have failed and existing service providers have been reducing or delaying expenditures on new equipment and applications. Many companies, including our current and potential customers, have postponed or decreased
further capital investment or have indicated to us that they intend to do so. Due to the past volatility of the market, it is difficult to predict the conditions of our market going forward. A continued decline in capital expenditures would reduce
our sales and could result in pressure on the



3



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price of our products, each of which would have a material adverse effect on our operating results. Recently, published studies indicate that future capital
expenditure will increase from its current low level that might result in an increased demand for OSS/BSS solutions. However, we are unable to predict the duration of this trend or the extent of any impact that it may have on our results of
operations. If this trend reverses and the slow-down in capital expenditures resumes, it would reduce our sales and could result in pressure on the price of our products, each of which would have a material adverse effect on our operating results.



Our customers are concentrated in the public carrier communications
industry and accordingly, trends in this industry could have a material adverse effect on our results of operations.



Our customers are concentrated in the public carrier communications market. Because of this concentration, we are especially susceptible to the recent downturn and
changes in the communications industry. The communications service provider industry is currently undergoing a period of consolidation due to the difficult market conditions. Consolidations of our prospective customers may delay or cause
cancellations of significant sales of our products, which could seriously harm our operating results.



The trends toward privatization and deregulation in the communications industry during the past decade have contributed to the overall growth in spending for telecommunications equipment during that period. Our
business, financial condition and results of operations will be harmed if these trends reverse or slow down materially.



We depend on a small number of customers for a large portion of our revenues and the loss of any one major customer would significantly decrease our revenues.



A large portion of our revenues is derived from substantial orders placed
by a relatively small number of customers. Our revenues from our five largest customers represented 48% of our total revenues in 2002, 40% of our total revenues in 2003 and 43% of our total revenues in 2004. Because of our dependence on a small
number of customers and large orders, if expected orders are not received, or orders are postponed, reduced or cancelled, our revenues and profitability will be significantly reduced.



Our profitability has been, and may continue to be, volatile, which could adversely affect the price of our ordinary shares.



We reported net losses of $10.9 million in 2002, $30.1 million in 2003
and $29.5 million in 2004. Although we have been profitable in the past, we may not be profitable or meet the level of expectations of the investment community in the future, which could have a material adverse impact on our share price. In
addition, our operating results may be adversely affected by timing of sales of our products or a shift in our mix of products and services.



We may need additional capital in the future and may not be able to secure adequate funds on terms acceptable to us.



In January 2005, we closed a private placement transaction in which we raised approximately
$14.6 million. Please see Item 4A  History and Development of the Company for more information regarding this transaction. Although we currently believe that we have sufficient capital to finance our operations for the next twelve
months, we may choose to raise additional capital. We have recently incurred operating losses that resulted in negative cash flow from operations and may do so in the future. If our cash flows are less than expected, we may need to raise additional
funds to respond to unforeseen technological or marketing hurdles, satisfy unforeseen liabilities, or take advantage of unanticipated opportunities. We may not be able to obtain funds at the time or times needed on terms



4



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acceptable to us, or at all. If we are unable to obtain adequate funds on acceptable terms, we may not be able to take advantage of market opportunities,
develop new products, or otherwise respond to competitive pressures.



Our
future operating results depend significantly on the continued market acceptance of our Netrac suite of products, and if these products do not continue to achieve or maintain market acceptance, we may have reduced revenues.



Revenues from licensing, servicing and supporting our Netrac suite of products account for a
substantial majority of our total revenues. Our future operating results will depend significantly on the continued market acceptance of our Netrac suite of products, and improvements to these products. Our products may not achieve or maintain
market acceptance. If they lose acceptance, we may have reduced revenues. This makes it difficult to rely on future revenues from these products.



Our products generally have long sales cycles and implementation periods over which we may not have control.



Prospective users of our products generally must make a significant commitment of resources.
Sales cycles of our products are often lengthy, generally ranging from six to 24 months. Our sales process is often subject to delays caused by lengthy approval processes that usually accompany significant expenditures. In addition, the time
required to implement our products can vary significantly with the needs of our customers and generally lasts for six to 24 months. The implementation process is also subject to delay. We cannot control these delays and cannot control the timing of
our sales revenue.



Our future success depends on our ability to keep pace
with technological changes and emerging industry standards.



The market
for our products is characterized by:



| |  |  | rapidly changing technologies;
| | - |  | ------------------------------



| |  |  | evolving industry standards;
| | - |  | ----------------------------



| |  |  | changing regulatory environments;
| | - |  | ---------------------------------



| |  |  | frequent new product introductions;
| | - |  | -----------------------------------



| |  |  | rapid changes in communications service providers requirements; and
| | - |  | --------------------------------------------------------------------



| |  |  | emergence of new types of networks.
| | - |  | -----------------------------------



In addition, the introduction of new technologies and new industry standards and practices can render our existing products obsolete and unmarketable. As a result, the
life cycles of our products are difficult to estimate and we could lose market acceptance and have reduced related revenues. Accordingly, our financial performance and growth is dependent on our ability to, among other things:



| |  |  | enhance our existing products;
| | - |  | ------------------------------



| |  |  | develop and introduce, on a timely and cost-effective basis, new products and product features that keep pace with technological developments and emerging industry standards,
including next-generation and third-generation networks;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | address the increasingly sophisticated needs of our customers;
| | - |  | --------------------------------------------------------------



5



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| |  |  | incorporate new technologies and new infrastructures; and
| | - |  | ---------------------------------------------------------



| |  |  | develop new interfaces between our products and complimentary products.
| | - |  | -----------------------------------------------------------------------



We may not be successful at these tasks. We may also experience difficulties that could delay or prevent the successful development, introduction and marketing of new
products and features. In addition, our new products and features may not meet the requirements of the marketplace and may not achieve market acceptance.



Our future operating results will depend significantly on the market acceptance of our next-generation operations support system, or NGOSS, family of products, and if
these products do not achieve market acceptance, our business and financial condition may be adversely affected.



We are in the process of developing and deploying our NGOSS family of products to support next-generation architectures and managed IP services. We have not yet fully
completed any next-generation products and we cannot assure you that our NGOSS family of products will receive market acceptance. If our NGOSS family of products does not receive market acceptance, we may not be able to recover significant resources
we invested in the development of these products and we may lose future revenues. As a result, our business, financial condition and results of operations may be adversely affected.



The development and roll-out of our NGOSS family of products may be difficult and costly, and we may not have enough resources to execute
our strategy.



We plan to continue devoting significant management and
financial resources to developing our NGOSS family of products and to expanding our customer base by targeting potential customers for our NGOSS products in markets that we have not previously served. We will be dependent on our ability to secure
enough funds, and if we will not be able to raise funds we may not be able to execute our strategy, which may leave us with low liquidity resources.



If the Internet or broadband communication services growth slows, demand for our NGOSS family of products may fall.



The success of our NGOSS family of products will depend heavily on the continued acceptance
of the Internet as a medium of commerce and communication, and the growth of broadband communication services. If use of the Internet or broadband communication services does not continue to grow or grows slower than expected, the market for
software that manages communications over the Internet may not develop and our sales of our NGOSS products would be adversely affected.



High project prices and the low number of projects sold by us may result in material fluctuations in our operating results, and may also cause our stock price to vary
significantly.



Our quarterly and annual operating results have varied
significantly in the past as a result of many factors, many of which are outside of our control. In particular, the high project prices and the low number of such projects sold, as well as the timing of sales, can produce significant fluctuations in
our quarter-to-quarter and year-to-year financial performance. These fluctuations may increase in the future if we succeed in obtaining larger contracts for projects. The fact that a significant portion of our revenues has been, and will continue to
be, derived from substantial orders placed by a few customers exaggerates these fluctuations. The timing and amount of such orders and their fulfillment have caused and will continue to cause material fluctuations in our operating results,
particularly on a quarterly basis. Our stock price may also vary significantly as a result of misinterpretation by potential investors of period-to-period comparisons.



6



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We depend on strategic relationships and our revenues may be reduced if such relationships are not successful. In
addition, our future growth will depend in part on our ability to form new strategic relationships.



We rely on strategic relationships with system integrators and hardware vendors such as IBM, Nortel, Siemens, CMGLogica, and Samsung to sell our products and services and these relationships may account for a larger
portion of our revenues in the future. These parties are not obligated to sell any of our products. Any failure of these relationships to generate significant revenues for us, a termination of any of these relationships, or if we are unable to form
additional strategic alliances in the future that will prove beneficial to us, could harm our operations and profitability. We rely on revenue from our international operations, and if we cannot overcome inherent risks, these operations will not
succeed.



Our current customers are located in more than 20 countries and we
are seeking to expand into other markets. We currently derive significant revenues from business in the United States, Europe and Israel. We expect our revenues from international sales to continue to account for a large portion of our total
revenues in the future.



Our international operations and revenues are subject
to a number of inherent risks, including:



| |  |  | difficulty in staffing and managing foreign operations generally, and time and costs spent on staffing and managing operations in markets from which we do not derive substantial
revenue but still need to maintain a presence;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the impact of possible recessionary environments in certain economies;
| | - |  | ----------------------------------------------------------------------



| |  |  | changes in regulatory requirements, including a slowdown in the rate of privatization of communications service providers;
| | - |  | --------------------------------------------------------------------------------------------------------------------------



| |  |  | difficulties in enforcing our rights in various jurisdictions;
| | - |  | --------------------------------------------------------------



| |  |  | reduced protection for intellectual property rights in some countries;
| | - |  | ----------------------------------------------------------------------



| |  |  | tariffs and other trade barriers;
| | - |  | ---------------------------------



| |  |  | adverse tax consequences;
| | - |  | -------------------------



| |  |  | restrictions on the conversion of currencies or the repatriation of earnings;
| | - |  | -----------------------------------------------------------------------------



| |  |  | the burdens of complying with a wide variety of foreign laws and regulations; and
| | - |  | ---------------------------------------------------------------------------------



| |  |  | economic and political instability.
| | - |  | -----------------------------------



We may not be able to manage these risks and these risks may lead to disputes with our customers. This may have an adverse effect on our operational margins. We may not
be able to sustain or increase revenues derived from our international operations.



Government regulatory policies in the communications industry may harm our business.



Government regulatory policies have had a major impact on our ability to attract and retain customers. For example, regulatory authorities have overseen the pricing of new and existing communications services, which,
in turn, has impacted our customers abilities to make significant



7



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capital expenditures. The enactment of new laws or regulations or changes in the interpretation of existing regulations could inhibit or prevent our
customers from purchasing our products.



We generally perform a substantial
part of our obligations to customers before we receive payment, and in some instances, we commence our performance before we have concluded a written agreement with a customer, which forces us to finance our performance and risk nonpayment.



We generally perform a substantial part or all of our obligations to
customers before receiving payment. In some instances we commence our performance before we have concluded a written agreement with a customer. Because of this, we must finance the costs of performing under our customer agreements, and risk
nonpayment. Although our customers are generally large companies, they may not pay our fees when due. Payment of our fees is generally not secured or guaranteed. Delayed payment or failure to receive payment may strain our finances.



Some of our customers may terminate their agreements with us after we have partially
performed under such agreements, and in such event, we may have difficulty recovering our costs and may lose future revenues.



In order to continue to sell our products despite the slow-down of expenditures by communications service providers, and resulting increased competition, we have often
been required to agree to provisions in our contracts with customers that generally make it easier for customers to terminate their agreements with us at various stages of performance, with minimal payments to us. Our performance often largely
comprises services and customized products which we cannot recover and resell. As a result, if any of our customers terminate their agreements with us, we may have difficulty recovering our costs up to the date of any termination, despite a
customers obligation to reimburse us. In such event, we may have reduced future revenues. Please see the discussion regarding the termination of a contract with a major customer in Item 8A  Legal Proceedings.



We may not be able to compete successfully in the highly competitive
markets for our products.



The markets for our products are very
competitive, and we expect competition to increase in the future. Our current and prospective competitors offer a variety of solutions to address the markets for network management system, or NMS, operational support system, or OSS, and Business
support system, or BSS. Our current and potential competitors include:



| |  |  | organizations IT departments that provide NMS, OSS and BSS applications for their particular internal needs;
| | - |  | -------------------------------------------------------------------------------------------------------------



| |  |  | providers of NMS, OSS and BSS, such as Agilent Technologies, Cramer Systems, Granite Systems, Hewlett-Packard, Inet, Metasolv, Micromuse and Telecordia Technology;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | communications equipment vendors, such as Ericsson and Lucent Technologies; and
| | - |  | -------------------------------------------------------------------------------



| |  |  | systems integrators who provide programming services to develop customer-specific applications, such as CMGLogica, BusinessEdge, Accenture, Cap Gemini and IBM Global Services.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Many of our current and potential competitors have significantly
greater financial, technical, sales, customer support, marketing and other resources and longer operating histories than we have. Many also have greater name recognition and a larger installed base of their products and technologies. Any of these
competitors may be able to respond more quickly than us to new or emerging technologies and changes in customer requirements. They may be able to devote greater resources to the development, promotion and sale of their products and may develop
products comparable or superior



8



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to ours. In addition, our competitive position may be adversely affected by the recent trend towards consolidation amongst our competitors.



In addition, as the NMS, OSS and BSS markets develop, a number of companies with
significantly greater resources than us could attempt to increase their presence in the market independently or by acquiring or forming strategic alliances with our competitors. This could result in increased competition for us.



Increased competition could result in price reductions, reduced margins or loss of market
share. If we are unable to compete successfully against current and future competitors, our revenues and profitability may be reduced.



We may compete with our customers internal efforts to design NMS, OSS and BSS solutions.



Some of our customers continuously evaluate whether to design and develop their own NMS, OSS and BSS solutions or purchase them from outside
vendors. As a result, we may lose customers and customer opportunities.



Currency fluctuations could reduce our revenues and profitability.



A portion of our revenues and expenses are in currencies other than U.S. dollars. Accordingly, fluctuations in exchange rates between these currencies and the U.S. dollar could reduce our revenues and profitability.



We may be unable to attract or exploit indirect sales channels that will market our
products effectively.



In the past, we have relied primarily on direct
sales to customers. In the future, we expect to make increasing use of original equipment manufacturers, commonly referred to as OEMs, strategic marketing agreements, alliances with system integrators and other indirect channels for sales and
support of our products. However, we may not be able to attract OEMs and strategic marketing partners that will be able to market our products effectively. The inability to recruit, or the loss of, important OEMs or strategic marketing partners
could cause a reduction in our revenues and profitability.



Our future
expansion may place a strain on our management personnel and resources.



Since our inception, our operations have significantly expanded. We intend to continue to expand into new markets worldwide. Expansion places a strain on our management personnel and resources. In addition, to support our expanded
operations we will have to hire additional skilled personnel. We may not be successful in expanding our operations or in hiring additional skilled personnel. Competition for qualified personnel is generally intense. Our ability to compete
effectively and to manage the future expansion of our operations will require us to continue to improve our financial and management controls, reporting systems and procedures. We may not be able to perform any of these activities successfully and
this could harm our business and reduce our profitability.



Due to recent
changes in our senior management, we may not be able to achieve our objectives.



In March 2005, Menahem Tirosh resigned from his position as our Chief Executive Officer. Meir Lipshes is serving as our acting Chief Executive Officer until we employ a new Chief Executive Officer. In addition, during 2004, several other
members of our senior management left the employ of the Company. The difficulties inherent in selecting a suitable Chief Executive Officer and other members of the management team, transitioning the Company under the leadership of new



9



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management, including a new Chief Executive Officer, and assimilating new management personnel into the Companys corporate culture could cause a
reduction in our efficiency and profitability, may harm perceptions of us in the investment community and may cause our stock price to decline.



If we are unable to retain and attract management and technical personnel, we may not be able to achieve our objectives.



The success of our business depends in large part on the continuing contributions of our
management and technical personnel. If we are unable to retain several key people, this could cause a reduction in our efficiency and profitability, may harm perceptions of us in the investment community and may cause our stock price to decline.



Our future success also depends on our continuing ability to attract and
retain highly qualified management and technical personnel. Highly qualified technical personnel are in demand in Israel, and competition for such personnel is generally intense. If we are not able to attract and retain such personnel when and as
needed, our business could be harmed.



One person beneficially owns a
substantial amount of our shares and may influence our affairs.



Shlomo
Eisenberg, the former chairman of our board of directors, beneficially owns 3,680,577 ordinary shares, which represents approximately 19.9% of our voting power. As a result, he will have a significant influence on the election of our directors and
on decisions by our shareholders on matters submitted to shareholder vote, including mergers, consolidations and the sale of all or substantially all of our assets.For additional details, see Item 7  Major Shareholders and Related Party
Transactions.This concentration of ownership of our ordinary shares could delay or prevent proxy contests, mergers, tender offers, open-market purchase programs or other purchases of our ordinary shares that might otherwise give
our shareholders the opportunity to realize a premium over the then-prevailing market price for our ordinary shares. This concentration of ownership may also adversely affect our share price.



Our former Chairmans conviction for violations under Israels Securities Law
and Penal Law may have adverse effects on our business.



Shlomo Eisenberg,
the former chairman of our board of directors and the beneficial owner of approximately 19.9% of our voting power, has been convicted and sentenced on several counts under Israels Securities Law and Penal Law which are not related to the
Company. For more details regarding this matter, please see the discussion under Item 6A  Directors and Senior Management in our annual report on Form 20-F for the year ended December 31, 2003. Mr. Eisenberg informed us that he is
in the process of appealing the conviction and the sentence. As of our annual general meeting of shareholders held on December 29, 2004, Mr. Eisenberg ceased to be a member of our board of directors. The conclusion of Mr. Eisenbergs services
may have adverse effects on our business.



The rights of the holders of our
Series A Preferred Shares are superior to those of the holders of our ordinary shares.



We recently issued 6,636,389 Series A Preferred Shares to the investors in the private placement transaction described elsewhere in this annual report. These preferential rights include:



| |  |  | weighted-average anti-dilution protection in the event that following the closing of the transaction we issue or are deemed to have issued (subject to certain exceptions) ordinary
shares at a price per share that is lower than the conversion price in effect at the time of such issuance or deemed issuance, which could result in dilution of the holdings of ordinary shareholders;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | a preference in the event of we are liquidated, which could result in the holders of our ordinary shares recovering a lesser amount in the event of our liquidation than they would
have received had we not issued the Series A Preferred Shares;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | veto rights over certain material actions taken by us, which could be exercised by the holders of the Series A Preferred Shares in a manner detrimental to the interests of the
holders of our ordinary shares; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the right to nominate one member to our board of directors, which could result in such member voting on matters brought before our board of directors in a manner detrimental to the
interests of the holders of our ordinary shares.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



In addition,
the investors have rights of first offer in the event we propose to offer or sell any of our ordinary shares in one or more transactions not involving a public offering prior to the first anniversary of the date upon which the registration statement
we filed in connection with the private placement is declared effective by the SEC. Finally, the investors have the right to receive payment for liquidated damages if a registration statement on Form F-3 is not declared effective within 90 days (or
120 days in the event the SEC conducts a review) following the closing of the private placement transaction. We did not obtain effectiveness of the registration statement within the timeframe set forth in our agreements with the investors.
Therefore, since May 4, 2005, we have been accruing liquidated damages at a rate equal to 2% of each investors investment in the Company for each 30 day period, or pro rata for any portion thereof, during the period for which the registration
statement is not declared effective. Because we believe that the Form F-3 will be declared effective shortly, we expect that such liquidated damages will total approximately $200,000. However, there can be no assurance if and when the SEC will
declare the Form F-3 effective.



We do not intend to pay dividends.



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



If we are characterized as a passive foreign investment company, our U.S. shareholders may suffer adverse tax consequences.



If, for any taxable year, our passive income, or our assets which produce
passive income, exceed specified levels, we may be characterized as a passive foreign investment company, or PFIC, for U.S. federal income tax purposes. This characterization could result in adverse U.S. tax consequences for our U.S. shareholders,
which may include having gains realized on the sale of our ordinary shares treated as ordinary income, rather than as capital gains income, having potentially punitive interest charges apply to those gains, and the denial of the taxation of certain
dividends paid by us at the lower rates applicable to long-term capital gains. Although we do not believe that we have been a PFIC for any tax year through and including 2004, the tests for determining PFIC status are applied annually and are based
in part on reference to the market value of our shares and valuing our intangible assets, and it is difficult to make accurate determinations about these items. Accordingly, we cannot make any assurances to you about our status. U.S. shareholders
are urged to consult with their own U.S. tax advisors with respect to the U.S. tax consequences of investing in our ordinary shares. For a discussion of the rules relating to PFIC and related tax consequences, please see the section of this annual
report entitled Taxation  United States Federal Income Tax Considerations.



Our proprietary technology is difficult to protect and we may lose our rights to it.



Our success and ability to compete depend in part on our proprietary software technology. We rely on a combination of trade secret, copyright and trademark laws,
nondisclosure and other contractual agreements and technical measures to protect our proprietary rights. We currently have no registered patents.



We are subject to a number of risks relating to intellectual property rights, including the following:



| |  |  | the measures we have taken to protect our proprietary rights may not be adequate to prevent others from misappropriating our technology or from independently developing or selling
technology or products with features based on or similar to ours;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | our customers that are given access to our intellectual property rights under rare circumstances, may infringe these rights;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------



| |  |  | our intellectual property rights may be challenged, invalidated, violated or circumvented and may not provide us with any competitive advantage;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | any future litigation to protect our proprietary rights could result in substantial cost to us, even if we ultimately prevail; and
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------



| |  |  | a determination against us in any such litigation could subject us to significant liabilities to other parties and could prevent us from manufacturing, selling or using our
products.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



If we lose any of our rights to our proprietary
technology, we may not be able to continue our business.



We currently rely
on software that we license from third parties, and we may in the future rely on software that we intend to license from third parties. If we fail to maintain these licenses, we may experience delays or reductions in our product shipments and have
difficulty continuing our business.



We rely on software that we license
from third parties, including software that is integrated with internally developed software and used in our products to perform key functions. In the future, we may rely on additional software that we intend to license from third parties. Some of
these third party software licensors are small or early-stage companies that are not as stable as larger and more



10



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established software licensors. Our third-party licensors that are larger and more established software licensors may impose on us stringent conditions to
maintain our licenses and may unilaterally change the price and other terms of our licenses. These third party software licenses may not continue to be available to us on commercially reasonable terms or at all or, if available, may infringe upon
the proprietary rights of other parties. Our loss of or inability to maintain our existing software licenses or obtain future licenses could result in delays or reductions in our product shipments. These delays or reductions in shipments could cause
a reduction in our revenues or profitability and could harm our business.



We may not be able to develop or license an inventory management solution for incorporation into our Netrac product offering on commercially reasonable terms.



Our Netrac service fulfillment solutions do not currently include full inventory management solution. We currently develop our inventory
management solution of a project basis. In parallel, we are exploring the possibility of licensing an inventory management solution from a third party for incorporation into our Netrac product offering. If we are unable to develop an adequate
inventory management solution independently and on a timely basis or license such solution on commercially reasonable terms from a third party, we may lose potential and existing customers that are seeking a comprehensive solution that includes such
features. Our loss of these potential and existing customers could harm our business.



Our technology may infringe on the intellectual property rights of third parties and we may lose our rights to it.



We rely on our proprietary software technology to compete in our markets. We are subject to a number of risks relating to intellectual property rights, including the
following:



| |  |  | we expect that software product developers will be increasingly 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;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | we may inadvertently violate the intellectual property rights of other parties and other parties may assert infringement claims against us;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | if we violate the intellectual property rights of other parties we may be required to modify our products or intellectual property or obtain a license to permit their continued use;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | any future litigation to defend us against allegations that we have infringed the rights of others could result in substantial cost to us, even if we ultimately prevail; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | determination against us in any such litigation could subject us to significant liabilities to other parties and could prevent us from manufacturing, selling or using our products.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



If we lose any of our rights to our proprietary technology, we
may not be able to continue our business.



Defects in our software products
could reduce our revenues and harm our reputation.



The development,
enhancement and implementation of our complex software products involve substantial risks of product defects or failures. Despite testing by us and our customers, errors may be found in products after they are licensed to customers. This could
result in:



| |  |  | a delay in recognition or loss of revenues;
| | - |  | -------------------------------------------



11



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| |  |  | loss of market share; and
| | - |  | -------------------------



| |  |  | failure to achieve market acceptance.
| | - |  | -------------------------------------



The complexities of the implementation of our products involve additional risks of performance failure and substantial delays. Because our customer base consists of a
relatively limited number of users, the harm to our reputation that could result from product defects or implementation errors could be especially damaging. This could seriously harm our business.



A securities class action lawsuit against us could harm our business.



A shareholder class action lawsuit was filed in September 2004 against us, Team Software
Industries Ltd., our principal shareholder, and certain of our executive officers. The lawsuit alleges that material misrepresentations and omissions concerning the Companys operations and performance artificially inflated the Companys
stock price, causing damages to investors. Based on our preliminary review of the complaint, we believe that the claims are without merit and intend to vigorously defend the actions. However, this purported class action is in a very preliminary
stage, and we cannot predict the outcome of this dispute. In the event of an unfavorable resolution, we may be required to pay damages and other costs in excess of the amounts covered by our insurance. In addition, the defense of this action may
divert the attention of some of our management from other aspects of our business. Accordingly, this action could have a materially adverse effect on our results of operations and financial condition.



We may not be successful in our ongoing lawsuit with a former major customer



In November 2002, we received a letter from a major customer notifying us
of the termination of an agreement for the supply by us of a Manager of Managers system (MoM), and its intention to call the $1.6 million performance bond issued by a bank on our behalf under the agreement. We believe that the customer
terminated the agreement unlawfully, and in violation of the termination provisions set out in the agreement. We filed an application in an English court on November 18, 2002, requesting an injunction to prevent the customer from calling the bond.
On January 23, 2003, an order was issued denying our request for the injunction to continue, on a number of grounds, including that our submissions were fact-based and related to the merits of the termination and not the procedural validity of the
termination or the conformity of the written notice with the requirements of the agreement. Because we believe that the termination of the agreement was unlawful, court proceedings were commenced (as part of the injunction proceedings) claiming
damages for the customers wrongful repudiation of the agreement.



Our
management believes, in light of the facts surrounding our relationship with this customer, and following consultations with legal counsel, that we have reasonably good prospects of establishing that the customer was not entitled to terminate the
agreement and by its conduct repudiated the agreement. We cannot currently quantify the amount of damages that we would receive if we were to succeed in a lawsuit against the customer, and we cannot estimate the amount of damages that could be
sought by the customer in a potential counterclaim. We are currently considering our options with respect to the best manner in which to pursue damages from this customer.



Risks Relating to Operations in Israel



Conditions in Israel could harm our results of operations.



We are incorporated under the laws of Israel, and our principal offices are located in Israel. Accordingly, political, economic and military conditions in Israel directly
affect our operations. A state of hostility, varying in degree and intensity, has led to security and economic problems for



12



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Israel. Since October 2000, there has been a high level of violence and hostilities between Israel and the Palestinians, which has strained Israels
relationship with its Arab citizens and several Arab countries. Such ongoing hostilities may hinder Israels international trade relations and may limit the geographic markets where we can sell our products. Furthermore, several countries
restrict business with Israel and Israeli companies, and additional companies may restrict doing business with Israel and Israeli companies as the result of the recent increase in hostilities.



We do not believe that the political and security situation has had a material impact on our
business to date; however, we can give no assurance that it will have no such effect in the future. Any hostilities involving Israel or threatening Israel, or the interruption or curtailment of trade between Israel and its present trading partners
or a significant downturn in the economic conditions in Israel could adversely affect our operations.



The rate of inflation in Israel may negatively impact our costs if it exceeds the rate of devaluation of the NIS against the U.S. dollar.



The majority of our revenues are denominated in U.S. dollars or are U.S. dollar-linked, but we incur a significant portion of our expenses,
principally the rent for our facilities in Israel and salaries and related personnel expenses in Israel, in NIS. As a result, we are exposed to the risk that the rate of inflation in Israel will exceed the rate of devaluation of the NIS in relation
to the U.S. dollar or that the timing of this devaluation lags behind inflation in Israel. In that event, the U.S. dollar cost of our operations in Israel will increase and our U.S. dollar-measured results of operations will be adversely affected.



To date, we have not engaged in hedging transactions. In the future, we may
enter into currency hedging transactions to decrease the risk of financial exposure from fluctuations in the exchange rate of the U.S. dollar against the NIS. If we perform hedging transactions, they may not adequately protect us from the effects of
inflation in Israel.



The tax benefits we currently receive require us to
meet several conditions, which we may fail to satisfy.



Our investment
programs were granted the status of an approved enterprise under Israels Law for Encouragement of Capital Investments, 1959, or the Investments Law. An approved enterprise is eligible for tax benefits on taxable income derived from its
approved enterprise programs. The benefits available to an approved enterprise are dependent upon the fulfillment of conditions stipulated in applicable law and the certificate of approval. If we fail to comply with these conditions, in whole or in
part, with respect to any approved enterprise program we establish, we may be required to pay additional taxes for the period in which we benefited from the tax exemption or reduced tax rates and we would likely be denied these benefits in the
future. This could harm our business and our profitability.



The tax
benefits we currently receive may be reduced in the future.



The Israeli
government may reduce or eliminate in the future tax benefits available to approved enterprise programs. Our approved enterprise program and the tax benefits thereunder may not continue in the future at their current levels or at any level. The
termination or reduction of these tax benefits would likely increase our taxes. The amount, if any, by which our taxes would increase will depend upon the rate of the tax increase, the amount of any tax benefit reduction, and the amount of any
taxable income that we may earn in the future.



13



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We may be required to pay stamp duty on agreements executed by it on or after June 1, 2003. This would increase the
Companys taxes.



The Israeli Stamp Duty on Documents Law, 1961, or
the Stamp Duty Law, provides that most documents signed by Israeli companies are subject to a stamp duty, generally at a rate of between 0.4% and 1% of the value of the subject matter of such document. De facto, it has been common practice in Israel
not to pay such stamp duty unless a document is filed with a governmental authority or with the courts. As a result of an amendment to the Stamp Duty Law that came into effect on June 1, 2003, the Israeli tax authorities have approached many
companies in Israel, including us, and have requested disclosure of all agreements signed by such companies since June 1, 2003, with the aim of collecting stamp duty with respect to such agreements. The legitimacy of the aforementioned amendment to
the Stamp Duty Law and of said actions by the Israeli tax authorities are currently under review by the Israeli High Court of Justice. Based on advice from our Israeli counsel, we believe that we may only be required to pay stamp duty on documents
signed on or after August 2004. However, we cannot assure you that the tax authorities or the courts will accept such view. Although at this stage it is not yet possible to evaluate the effect, if any, on us of the amendment to the Stamp Duty Law,
the same could materially adversely affect our results of operations.



In
January 2005, an order was signed in accordance with which the said requirement to pay stamp duty is cancelled with effect from January 1, 2008. Furthermore, pursuant to such order, as of January 1, 2005, stamp duty is no longer chargeable on, among
others, loan agreements.



The government programs we currently participate
in require us to meet several conditions, which we may fail to satisfy. Such grants may be terminated or reduced in the future, which would increase our costs.



We receive grants and participate in programs sponsored by the Office of the Chief Scientist of the Israeli Ministry of Industry, Trade and
Labor, the Israel-United States Binational Industrial Research and Development Foundation, known as the BIRD Foundation and from the European Union. To maintain our eligibility for these programs we must continue to meet several conditions under
these grant programs and the Law for the Encouragement of Research and Development in the Industry, 1984, and the regulations promulgated thereunder, or the R&D Law, including paying royalties with respect to the grants received. In addition,
some of these programs restrict our ability to manufacture particular products or transfer particular technology outside of Israel, or require that we share with others intellectual property rights that are the subject of such grants. If we fail to
comply with these conditions in the future we might be subject to certain sanctions such that, the benefits received could be cancelled. We could also be required to refund any payment previously received under these programs. If we do not receive
these grants in the future, we will have to allocate other funds to product development at the expense of other operational costs. Any non-Israeli who becomes a holder of 5% or more of our share capital is generally required to notify the Chief
Scientist and to undertake to observe the law governing the grant programs of the Chief Scientist, the principal restrictions of which are the transferability limits described above in this paragraph.



In addition, these programs may not continue in the future at their current levels or at any
level. From time to time, we may submit requests for new grants from the Chief Scientist. These requests might not be approved, particularly in light of the reduction in government spending in Israel. The termination or reduction of these grants
would require us to divert other funds to product development and increase our other operational costs.



14



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



Most of our executive officers and employees in Israel are
obligated to perform annual military reserve duty. They may also be further subject to being called to active duty at any time under emergency circumstances and could be required to serve in the military for extended periods of time. Our operations
could be disrupted by the absence for a significant period of one or more of our executive officers or key employees or a significant number of other employees because of military service. The full impact on our workforce or business if some of our
executive officers and employees are called upon to perform military service, especially in times of national emergency, is difficult to predict. Any disruption in our operations as the result of military service by key personnel could harm our
business.



It may be difficult to enforce a U.S. judgment against us, our
officers and directors or to assert U.S. securities law claims in Israel.



Service of process upon our directors and officers may be difficult to effect within the United States because some of these people reside outside the United States. Any judgment obtained in the United States against us or these individuals
or entities may not be enforceable within the United States.



There is doubt as
to the enforceability of civil liabilities under the Securities Act and the Exchange Act in original actions instituted in Israel. However, subject to specified time limitations, Israeli courts may enforce a U.S. final executory judgment in a civil
matter, provided that:



| |  |  | adequate service of process has been effected and the defendant has had a reasonable opportunity to be heard;
| | - |  | -------------------------------------------------------------------------------------------------------------



| |  |  | the judgment and its enforcement are not contrary to the law, public policy, security or sovereignty of the State of Israel;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------



| |  |  | the judgment was obtained after due process before a court of competent jurisdiction according to the rules of private international law prevailing in Israel;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the judgment was not obtained by fraudulent means and does not conflict with any other valid judgment in the same matter between the same parties;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | an action between the same parties in the same matter is not pending in any Israeli court at the time the lawsuit is instituted in the U.S. court; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the U.S. court is not prohibited from enforcing the judgments of Israeli courts.
| | - |  | --------------------------------------------------------------------------------



Provisions of Israeli law could delay, prevent or make difficult a merger or other business combination.



Provisions of Israeli corporate law may have the effect of delaying, preventing or making
more difficult a merger with, or acquisition of, us. The Israeli Companies Law generally provides that a merger be approved by the board of directors and a majority of the shares present and voting on the proposed merger. For purposes of the
shareholder vote, unless a court rules otherwise, the merger will not be deemed approved if shares, representing a majority of the voting power present at the shareholders meeting, and which are not held by the other party to the merger (or by any
person who holds 25% or more of the shares or the right to appoint 25% or more of the directors of the other party or its general manager) have voted against the merger. Upon the request of any creditor of a party to the proposed merger, a court may
delay or prevent the merger if it concludes that there is a reasonable concern that, as a result of the merger, the surviving company will be unable to satisfy the obligations of the surviving company. Finally, a merger may generally not be
completed unless



15



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at least (i) 50 days have passed since the filing of a merger proposal signed by both parties with the Israeli Registrar of Companies and (ii) 30 days have
passed since the merger was approved by the shareholders of each of the parties to the merger. Also, in certain circumstances an acquisition of shares in a public company must be made by means of a tender offer. Lastly, Israeli tax law treats some
acquisitions, such as stock-for-stock exchanges between an Israeli company and a foreign company, less favorable than U.S. tax laws. These provisions of Israeli corporate and tax law may have the effect of delaying, preventing or make more difficult
an acquisition of or merger with us, which could depress our share price.



Risks Related to the Market for Our Ordinary Shares





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Our share price has decreased significantly and could continue to fluctuate significantly.



The market price for our ordinary shares, as well as the prices of shares of other
technology companies, has been volatile. Our share price has decreased significantly since late 2002. Numerous factors, many of which are beyond our control, may cause the market price of our ordinary shares to fluctuate significantly, such as:



| |  |  | fluctuations in our quarterly revenues and earnings and those of our publicly held competitors;
| | - |  | -----------------------------------------------------------------------------------------------



17



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| |  |  | shortfalls in our operating results from levels forecast by securities analysts;
| | - |  | --------------------------------------------------------------------------------



| |  |  | announcements concerning us or our competitors;
| | - |  | -----------------------------------------------



| |  |  | the introduction of new telecommunications services and new industry standards;
| | - |  | -------------------------------------------------------------------------------



| |  |  | changes in pricing policies by us or our competitors;
| | - |  | -----------------------------------------------------



| |  |  | general market conditions, and changes in market conditions in our industry;
| | - |  | ----------------------------------------------------------------------------



| |  |  | the general state of the securities market (particularly the technology sector); and
| | - |  | ------------------------------------------------------------------------------------



| |  |  | political, economic and other developments in the State of Israel and worldwide.
| | - |  | --------------------------------------------------------------------------------



Substantial future sales of our ordinary shares may depress our share price.



If our shareholders sell substantial amounts of our ordinary shares, including shares issued
upon the exercise of outstanding preferred shares, warrants or employee options, or if the perception exists that our shareholders may sell a substantial number of our ordinary shares, the market price of our ordinary shares may fall. Any
substantial sales of our shares in the public market also might make it more difficult for us to sell equity or equity related securities in the future at a time and upon terms and conditions we deem appropriate.



|Item 4. | INFORMATION ON THE COMPANY
|------- | --------------------------



A. History and Development of the Company



Both
our legal and commercial name is TTI Team Telecom International Ltd. We were incorporated under the laws of the State of Israel in February 1990. We are domiciled in Israel. Our legal form is a company limited by shares. We operate under the laws of
the State of Israel. Our registered office is located at 7 Martin Gehl Street, Kiryat Aryeh, Petach Tikva 49512 Israel, and our telephone number is +972-3-926-9700.



We commenced independent operations in September 1992, as a subsidiary of Team Computers and Systems Ltd., after having operated as a
division of Team Computers since 1988. Team Computers is a publicly traded company in Israel.



In December 1996, we conducted the initial public offering of our ordinary shares, par value NIS 0.5 per share, in which 2,000,000 ordinary shares were issued and sold by us at the price of $6.25 per ordinary share.
In connection with this offering, Team Computers, sold 825,000 ordinary shares at the price of $6.25 per ordinary share.



In February of 1999, we conducted a follow-on public offering of our ordinary shares, in which 1,150,000 ordinary shares were issued and sold by us at the price of $7.875
per ordinary share.



In March of 2000, we conducted a follow-on public offering
of our ordinary shares, in which 1,100,000 ordinary shares were issued and sold by us at the price of $34.875 per ordinary share. In connection with this offering, Team Computers sold 550,000 ordinary shares at the price of $34.875 per ordinary
share.



18



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In January 2005, we completed a private placement transaction in which we issued (i) 6,636,389 Series A Convertible
Preferred Shares, par value NIS 0.5 each, or the Series A Preferred Shares, at a purchase price of $2.20 per share, resulting in aggregate proceeds (before expenses) of approximately $14.6 million and (ii) warrants to purchase up to 2,654,556 of our
ordinary shares. For additional details about this transaction, see Item 10C Material Contracts - Private Placement of Series A Preferred Shares.



B. Business Overview



We are a leading global
provider of Operations Support Systems (OSS) and Business Support Systems (BSS) for telecommunications service providers. With 13 years of experience delivering our products and solutions to industry leading companies in more than 20 countries, we
have a proven track record managing some of the worlds largest, most complex networks.



Our Netrac products deliver service fulfillment, service assurance and revenue assurance capabilities. Our Netrac software speeds problem detection and resolution, streamlines work processes, improves quality of
service, and maximizes network uptime and availability. Our software solutions enable communications service providers to maximize and leverage their investments in network infrastructure and to automate, simplify and manage the complex process of
delivering multiple communications services over diverse networks. Our Netrac suite of products supports multi-vendor voice and data architectures over wireline, wireless, Internet Protocol, or IP, cable, digital subscriber line, or DSL, and optical
networks, allowing our customers to streamline operations and efficiently and rapidly roll out new services.



We have a significant installed base of solutions with approximately 60 customers, including some of the worlds largest communications service providers, commonly referred to as tier 1 and tier 2 operators. We
have established working relationships with a number of leading network and communications equipment providers which allow us to provide end-to-end integrated solutions as well as stand-alone modules to meet our customers needs. Our Netrac
products is based on proven technology, which, when combined with our professional service offerings, including customization, implementation and integration expertise and post-sales customer support, make us an attractive turn-key solution
provider. Our software products are designed to work with a wide range of network equipment manufacturers and varied technologies, thus increasing the potential market for our systems.



Our Netrac service assurance products, including fault, performance and service management products, provide intelligence to help carriers
proactively and strategically manage their businesses in a complex environment. Our service assurance solution monitor and assure the quality of network services, and allow service providers to increase the utilization of their existing resources
and reduce capital and operational expenditures.



We continue to support and
develop our fulfillment products, which are already deployed and used by customers throughout the world. In addition, we are exploring the possibility of cooperating with leading resource management/inventory providers in order to broaden and
enhance our offering. Our Netrac service fulfillment products, consist of resource management, and service activation products, which enable network service providers to efficiently enter, manage and fulfill service orders for customers.



Our Netrac mediation products serve as the underlying support infrastructure for all
products. They are uniquely capable of interacting with all network equipment using variety of protocols in a service providers multi-domain, multi-technology network  both collecting data and sending commands to the network elements and
element managers.



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In addition, we recently launched an out-of-the-box product, NetracXpress, geared for tier-2 and tier-3 service wireless
providers.



Industry Background; Market Opportunity



The deregulation process of the U.S. telecommunications market, including AT&Ts
breakup in 1984 and the Telecommunications Act of 1996, revamped the competitive landscape. New market entrants were given access to incumbent networks, including, most significantly, the last mile connection to subscribers homes
and offices. Access to incumbent networks and the funding of vibrant capital markets spurred intense competition and the emergence of competitive local exchange carriers, or CLECs. Competition and funding encouraged massive network build-outs as
competitors sought to offer more services at lower costs.



Facing competition,
the new service providers, which depended on their ability to deploy their services rapidly and cost effectively without sacrificing quality, and the incumbents, which sought to protect their markets, placed a greater emphasis on customer
satisfaction. It became imperative to deliver timely services to customers over efficient networks. The new focus on customer service took place against a backdrop of increasing network complexity as voice and data transmissions converged and new
services and technologies emerged. Concurrently, service providers sought to reduce their capital and operational expenditures and streamline their business processes to operate more efficiently and gain a competitive edge. OSS and BSS solutions
maximize the return on invested capital by increasing the service providers efficiency and staff productivity, reducing operational costs and facilitating the rapid deployment of new services.



Many communications service providers, including most tier 1 and tier 2 operators, are
engaged in, or are in the planning stages of, rolling out next-generation architectures and managed IP services over wireline, wireless and optical networks. We intend to leverage our extensive installed base of solutions, customer contacts and
relationships with equipment manufacturers to become an integrated provider of OSS solutions for legacy and next-generation networks.



Network convergence and the Internet are delivering, and will continue to deliver, new services and increased efficiency. However, this convergence will not be possible
if the new networks are unmanageable. Service providers offer integrated services, including voice, long-distance, Internet, wireless and video, over multiple or converging networks and must operate and manage both legacy voice systems and
newly-built data networks, utilizing and combining traditional circuit-switched and new packet-based technologies. In addition to networks being more complex to manage and operate, services offered have also grown in complexity.



With complex networks to operate and manage and a growing demand for a variety of customized
services and billing schemes, communications service providers require sophisticated tools to execute their strategies, reduce customer churn and to maximize the return on their significant investments in infrastructure and customer acquisitions.
NMS, OSS and BSS solutions help to automate the installation, maintenance, monitoring and management of communications networks. Service providers use these systems to streamline the processes of adding subscribers, managing network availability and
performance and introducing new services.



Our Netrac Products



Our Netrac products, combined with our comprehensive professional service
offerings, enable communications service providers to improve the quality of existing services, streamline their operations to compete cost-effectively, maximize return on their investment in network infrastructure, offer new services over complex
networks and efficiently add new subscribers. Our expertise is derived from 13 years of experience in developing and implementing software solutions for diverse



20



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communications service providers around the world. We are currently leveraging this expertise and continue to develop our NGOSS family of products to provide
a comprehensive solution for next-generation architectures and managed IP services.



Our Netrac products are built on our Netrac infrastructure that provides our products graphical user interface, general system services (Authentication, Authorization and Audit) and a communications backbone. We are now in the process of
moving from Power Builder based 2-tier architecture into a J2EE based 3-tier architecture. As a result of this transition, basic application services are being moved from our base package (our Power Builder based infrastructure) to JCore (our J2EE
infrastructure). J2EE is an industry recognized redevelopment environment and the Power Builder is an industry recognized development tool.



Our Netrac products provide the following advantages:



| |  |  | End-to-End Integrated and Modular Product Offering.Our Netrac suite of products is composed of products that may be used in any combination to suit a communications
service providers specific business needs and budget. Our Netrac modules integrate with one another to provide either a comprehensive solution or address specific functions in areas such as fault management or service impact analysis.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Advanced, Stand-Alone Products. Our Netrac products deliver functionality in the areas of service fulfillment, service assurance, and revenue assurance. Each product was
developed based on years of accumulated experience in telecommunications and OSS development. In addition, we continuously enhance our products by incorporating customer-driven improvements derived from other projects.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Flexible Platform. Our modular system provides our customers with an easy way to add new functionality and services and adapt to new technologies, as well as a scalable
system that can accommodate the addition of network elements and growth in subscribers.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Management of Existing and Next-Generation Networks. Our Netrac suite of products is designed to manage both legacy and next-generation wireline and wireless networks via a
unified management platform. As a result, communication service providers will be able to manage heterogeneous networks consisting of both legacy and next-generation technologies, protect investments in legacy systems and facilitate the migration to
next-generation architectures.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Open Architecture. Netracs open mature APIs enables communications service providers to integrate their internal and third party systems and applications with their OSS
environments, allowing the exchange of information among these systems and applications. We continuously update our library of APIs, enabling interfaces with customers internal and third party software systems.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Cost Effectiveness and Maximizing Return on Investment.Our Netrac suite of products streamlines operations, improves service restoration times and
automates time-consuming service provisioning and assurance processes, leading to significant cost reductions. Netracs libraries and ability to communicate with
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



21



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| | various network elements and technologies result in rapid deployment of network devices and services, leading to faster time-to-revenue.
| | ----------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Professional Services Enabling Turn-Key Solutions. We deliver end-to-end integrated turn-key solutions to communications service providers which are tailored by our
professional services team to meet our customers specific requirements. Our professional services include customization, implementation and integration of our products within a communications service providers existing OSS environment,
along with specific functionality development according to customers requirements.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Rapidly Deployable Solutions.Our Netrac suite of products is network equipment vendor-independent and includes a pre-built set of modules and extensive libraries and
applications, which enables communications service providers to rapidly and cost effectively deploy new network elements and services.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Strategy



Our goal is to solidify and improve our position as a leading global provider of NMS, OSS and BSS solutions for wireline and wireless networks. Our strategy to achieve this goal contains the following key elements:



| |  |  | Expand and Enhance Product Offerings and Extend Technological Leadership. We intend to continue to develop and introduce new products and product features that address the
increasingly sophisticated needs of communications service providers. We are committed to keeping our products at the forefront of the industry by offering products that support new functionality services and technologies, including next-generation
architectures and managed IP services. We intend to strive to build strong brand recognition for our products.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Capitalize on our Worldwide Customer Base.We intend to leverage our customer installed base, including many industry-leading tier 1 and tier 2 operators, for
additional sales. We expect to leverage our relationships and proven track record to become their preferred choice for next-generation network solutions. In addition, positive referrals from our existing customers have historically resulted in new
sales opportunities for us.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Expand Presence in New and Existing Markets. We plan to capitalize on our global sales and marketing presence to further penetrate markets, win new customers and broaden our
installed base.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Leverage Installation Base for additional sales.We seek to continue to solidify and improve our existing relationships with tier 1 and tier 2 communications service
providers worldwide, as well as with tier 3 service providers via our recently launched NetracXpress product. We will leverage our extensive installed base and new product offerings to build on these relationships and to penetrate other large
communications service providers. By offering our products to a growing number of industry-leading communications service providers, we increase acceptance and demand for our products.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | Expand and Develop Additional Strategic Alliances. Our strategic alliances with leading software and hardware vendors and systems integrators enable us to leverage the
marketing strengths and customer base of our partners, thereby expanding our own installed base. Some of these partners assist us in generating sales leads. We intend to strengthen our existing strategic partnerships and to create new alliances as a
means of identifying new business opportunities and entering new markets.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Products and Services



Our Netrac products are capable of
service provisioning, activation and monitoring, and managing complex wireline and wireless networks encompassing various domains including Asynchronous Transfer Mode, or ATM, Digital Subscriber Line, or DSL, Synchronous Digital
Hierarchy/Synchronous Optical Network, or SDH/SONET, Time Division Multiple Access, or TDMA, and Signaling System 7, or SS7.



In addition, our products are deployed at a number of customer sites, and we are continuing our development efforts to enhance these products. Next-generation
architectures include Dense Wavelength Division Multiplexing, or DWDM, IP over SDH/SONET, General Packet Radio Service, or GPRS, Multiprotocol Label Switching, or MPLS, Single Carrier Radio Transmission Technology, or 1xRTT, Universal Mobile
Telecommunications, or UMTS, Third Generation Mobile Telecommunication Systems, or 3G, and Code Division Multiple Access 2000, or CDMA 2000. Managed IP services include IP Virtual Private Networks, or IP VPNs, Voiceover IP, or VoIP, Layer 2 VPN, or
L2VPN, Virtual Local Area network, or VLAN, and IP Security Protocol, or IP Sec.



Since the first quarter of 2003, we have been reducing our activities in the SS7 field; however, we continue to support existing customers.



Our quality management system for the development, design, testing, support and sales of our NMS, OSS and BSS solutions has been certified as meeting ISO 9001 standards
by the Standards Institution of Israel.



Mediation Products



Our Netrac mediation products collect raw data from various network elements and process
and transfer the data to other Netrac products and external third party systems. Our mediation products also support the sending of commands and controls from various applications to the network elements.



Our mediation products come with numerous libraries of rules already in place, enabling
communications service providers to quickly introduce and deploy new network elements and services, as well as rapidly define new network elements within the existing management environment.



Our Netrac mediation products include the following:



| |  |  | Device Expert (DvXpert) collects events, alarms, performance indicators, configuration information and xDR records from the entire network and processes and transforms the
raw information and distributes it to Netrac and third party applications.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



23



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| |  |  | Netrac Command Interface (NCI)serves as a platform for sending commands and controls to network elements, supporting various elements command language and
syntax.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Billing Mediationcollects and assembles information from network elements into specific records, which are then fed into billing systems.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------



| |  |  | SecureAccessprovides a centralized gateway through which authorized users can view, access and send commands to different network elements based on their security
authorizations.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Service Assurance Products



Our Netrac service assurance products, consisting of fault,
performance and service management products, provides intelligence to help carriers proactively and strategically manage their businesses in a complex environment. Our service assurance products monitor and assure the quality of network services and
ensure that appropriate SLAs are enforced, enabling network service providers to rapidly and remotely identify and correct any network bottlenecks or failures.



Service Management Products



Our Netrac service management product, ServiceView, is designed to allow communications service providers to easily and rapidly model new services and monitor services
across multi-technology, multi-vendor networks, perform historical analysis of service behavior for improved service planning and design, as well as document and manage Service Level Agreement, or SLAs.



Fault Management Products



Our Netrac fault management products detect alarms across all domains and alert controllers
of impending faults in near real-time. Our Fault Management (FaM) module comes with a packaged set of add-on modules that enable existing customers to leverage their investment in FaM for additional added-value benefits. The fault management
products perform root-cause analysis, manage trouble tickets from creation to resolution and facilitate automatic response to network problems.



Our Netrac fault management products include the following:



| |  |  | Fault Management (FaM)is a real-time alarm surveillance and management system that offers network operations center, or NOC, personnel an all-inclusive, prioritized view of
alarms from various network domains and equipment. Fam also comes with alarm correlation capabilities that help reduce the volume of alarms that personnel have to handle.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Dashboard (FaM add-on module)is a Web based tool designed for managers who require a high-level, real-time view of the state of their networks. From one screen whose view
can be customized to suit user preferences, managers can, among other things, see vital assurance statistics, filter and review active alarms and interact with the NOC message board.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | NetImpact (FaM add on module) provides information on a problems impact on services and customers, thus enabling prioritization of corrective actions.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Reporter (FaM add-on module)is a Web based tool that provides insight into the networks long-term behavior. Reporter produces informative
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------



24



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| | reports and also comes with a built-in statistical engine, converts alarms and action events into counters which enables saving historical data for longer
periods of time.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | FaultPro(FaM add-on module)automates the resolution of recurring problems in the network. In full automatic mode, it transmits corrective commands to the network. In
semi-automatic mode, FaultPro generates a list of possible corrective actions from which NOC personnel can select the most appropriate one.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Correlator+ TRS is an alarm correlation system that detects and isolates root-cause faults from the incoming alarm volume using network-wide topology data. Using information
on the physical and logical connections that exist between network elements, Correlator +TRS reduces large alarm volumes into a single root-cause alarm, thus considerably shortening, Mean Time To Repair, or MTTR and the number of alarms operators
must handle .
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Netrac Trouble Ticket (NeTkT)manages trouble tickets from creation through resolution. NeTkT allows communications service providers to implement the desired workflow in the
problem resolution cycle and ensure the assignment of problems to the appropriate personnel.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Performance Management Products



Our Netrac performance management products perform real-time monitoring and long-term analysis of network behavior based on performance measurements and xDR records. Our
performance management products help service providers identify and address traffic degradations before they impact customers, maximize network performance and increase network utilization.



Our Netrac performance management product includes:



| |  |  | Performance Management Module (PMM)which collects and analyzes performance measurements and xDR records in order to provide an accurate picture of network health and
utilization. The PMM also presents traffic information to help network staff understand network and service status and predict future network behavior.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | TrafficView(PMM add-on module) which provides operators with near real-time network monitoring and traffic surveillance capabilities based on performance measurements and
xDR records. TrafficView detects traffic exceptions using sophisticated dynamic thresholds, alerting service providers to potential performance malfunctions before they affect customers.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



xDR Analysis Products



Our Netrac xDR analysis products analyze quality of service in a network and assist service providers to maximize traffic routing based on
cost parameters.



Our Netrac xDR analysis products include:



| |  |  | CallExpertwhich transforms raw xDR records into information that can be used for network and service monitoring, capacity planning and marketing-related applications,
providing communications service providers with the tools to perform advanced quality of service, call failure and traffic trends analysis.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | Best Cost Routingwhich enables service providers to route traffic in the optimal way based on cost considerations.
| | - |  | ------------------------------------------------------------------------------------------------------------------



Revenue Assurance Products



Our revenue assurance products identify revenue leaks and fraudulent activity in the
network, which allows service providers to monitor and protect their revenues.



| |  |  | FraudDetectdetects fraudulent activity in the network by comparing suspicious usage patterns with predefined profiles, and alerts users to suspicious behavior.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Billing Verificationcollects and compares xDR records obtained from different network sources such as switches, billing gateways, dialers and test devices. By comparing and
correlating between the different types of xDR records, the Billing Verification module identifies and alerts network users to billing discrepancies.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Service Fulfillment Products



Our Netrac service fulfillment products, consisting of resource management and service activation products, enable network service providers to efficiently enter, manage
and fulfill orders for services from their customers. Our provisioning products streamline the provisioning process end-to-end, from order intake to fulfillment. By automating time-consuming manual operations, our provisioning products allow
operators to more quickly roll out services and meet customers demands promptly and cost-effectively.



In addition to developing our fulfillment products, we are also exploring the possibility of cooperating with leading resource management/inventory providers in order to broaden and enhance our service fulfillment
product offering.



Our Netrac service fulfillment products include:



| |  |  | Resource Managementwhich provides a physical and logical representation of the network, and contains information on the interdependencies between entities in the network.
Resource management is capable of modeling physical elements, technologies and services, and the relationships between them.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Syncsynchronizes an inventory database with the actual network and auto-discovers new network elements. Sync produces discrepancy reports that detail any inconsistencies
between the inventory database and the actual network, and pinpoints under-utilized network resources.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Provisioning solution



Our provisioning solution streamlines the provisioning process end-to-end, from intake to fulfillment. By automating time-consuming manual operations, our provisioning products allow operators to more quickly roll out
services and meet customers demands promptly and cost-effectively. Our provisioning solution manage information flow throughout the entire organization and provide users with complete information on an orders status, helping to rapidly
pinpoint and address any provisioning obstacles in real-time.



Our Netrac
provisioning products include the following:



| |  |  | Work Ordermodels and automates complex provisioning processes in dynamic environments. Work Order replaces error-prone manual operations with computerized
tasks,
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------



26



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| | eliminating inefficiencies from the provisioning process. Work Order processes and coordinates large volumes of service orders, and tracks the progression of
each activity in the provisioning process.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Activateautomatically activates services end-to-end across multi-vendor, multi-technology networks. Activate replaces manual processes with automated activities, thus
eliminating the problems that tend to plague manual activation and reducing service activation times, and performs rollback in case of an activation failure. This product also enables scheduling of network activation operations.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Professional Services



We provide a broad array of professional service offerings to assist our diverse customer
base. We focus on customer retention and our customers long-term satisfaction as key measures of the quality of these services.



We deliver the expertise necessary to customize, integrate and implement our software solutions. As of December 31, 2004, our professional services personnel consisted of
169 people operating in North America, Europe, Latin America and the Asia/Pacific region (including Australia). We provide a comprehensive series of training courses to our customers, partners and employees to provide and enhance the knowledge and
skills necessary to deploy, use and maintain our software solutions. Our training courses address the technical aspects of our products while providing examples of customer best practices and operational efficiencies. We also offer
Train-the-Trainer programs to enable our customers to conduct their own internal end-user training.



Project Installation; Maintenance and Customer Support



There are three distinct periods which occur during the process of providing a solution to a customer: (i) a functional specification period, (ii) an implementation
period and (iii) a stabilization period. Each period is divided into several phases; the number of phases is determined by the complexity of the project. During the functional specification period, the Company defines the specific requirements of
the customer and becomes familiar with its network. During the implementation period, the Company performs the work necessary to bring the solution up to a point where it is ready to begin to operate using real customer data. At the time of
installation, customers generally receive on-site training tailored to the user organization. We also offer supplementary training to clients on an as needed basis. During the stabilization period (which we refer to as a warranty period
in many of our contracts with customers), the Company monitors the operation of the solution using real data, and performs the work necessary to ensure that the solution is stabilized and actually provides the functionality required by the
particular customer. The stabilization period typically lasts approximately one year, but can be longer or shorter based on the particular solution. The project is considered completed when the stabilization period is over.



At the end of the stabilization period, the customer may elect to enter into a maintenance
period with us for which we offer support contracts, typically based on a percentage of the total license fee, but in some cases based on hourly rates. Our standard support contract entitles the customer to unlimited telephone support, product
updates and product maintenance during the support period. We offer toll-free technical customer support during business hours, which, for an additional fee, can be extended to 24 hours a day, seven days a week. Support is provided via telephone,
remote-access and e-mail. We generally provide an initial response within approximately six hours and, if necessary, on-site assistance within approximately 48 hours. Most of our customers are covered by support contracts with, in some cases,
services provided by local subcontractors.



27



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Beyond support contracts, we also provide on-site network support for additional fees. Our site management services
include:



| |  |  | system management;
| | - |  | ------------------



| |  |  | configuration changes;
| | - |  | ----------------------



| |  |  | failure recovery;
| | - |  | -----------------



| |  |  | performance tuning;
| | - |  | -------------------



| |  |  | database administration support;
| | - |  | --------------------------------



| |  |  | communications administration support; and
| | - |  | ------------------------------------------



| |  |  | preventive maintenance activities.
| | - |  | ----------------------------------



Customers



Our primary customers are established, large communications service providers. Our customers include:



| |  |  | incumbent local exchange carriers, or ILECs;
| | - |  | --------------------------------------------



| |  |  | CLECs;
| | - |  | ------



| |  |  | long-distance carriers;
| | - |  | -----------------------



| |  |  | wireless service providers and resellers; and
| | - |  | ---------------------------------------------



| |  |  | communications equipment vendors, such as vendors of switches, fixed wireless access equipment, transmission equipment and test equipment.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------



Potential intermediary customers include system integrators and private network owners, such
as financial institutions and governmental entities.



28



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To date, we have approximately 60 customers of our software solutions in more than 20 countries. Our significant
customers with which we have ongoing relationships include the following:



|                                    |  |                      
|----------------------------------- |  | ---------------------
|AT&T                                |  | Nortel Networks      
|                                    | 
|Bezeq                               |  | Partner Communication
|                                    | 
|Bezeq International                 |  | Pelephone            
|                                    | 
|Cable & Wireless                    |  | Tele2                
|                                    | 
|Cellcom                             |  | Telekom SA           
|                                    | 
|Cyprus Telecommunications Authority |  | Telia                
|                                    | 
|Hutchison 3GA                       |  | Telstra              
|                                    | 
|ICE                                 |  | Teracom              
|                                    | 
|KPN                                 |  | Unefone              
|                                    | 
|Luxemburg PTT                       |  | Wind                 
|                                    | 
|Maltacom                            |  |                      



Backlog



Our backlog represents signed purchase orders deliverable within 12 months. Backlog was
approximately $33 million on December 31, 2002, approximately $23 million on December 31, 2003 and approximately $20 million on December 31, 2004.



Sales and Marketing



We market our products and services to communications service providers. As a key part of our marketing strategy, we have established strategic alliances with leading software and hardware vendors and system
integrators.



We have focused our direct sales activities on North America,
Europe, Africa and the Asia Pacific region. Additionally, we market our products to communications service providers in Western Europe and Asia/Pacific Rim through relationships with strategic partners and agents.



Our sales and marketing efforts are managed by a small group of senior managers with
substantial experience in the communications software market. The sales process for new customers generally requires a significant investment of time and expenses and typically takes six to eighteen months. The process also involves system
designers, sales representatives and support personnel and typically requires presentations, demonstrations, field trials, visits to reference sites and lengthy negotiations.



To date, we have been successful in penetrating markets in North and South America, Europe, Israel, South Africa, the Asia/Pacific and
Australia. We have established offices in The Netherlands, South Africa, Australia, Hong Kong, Costa Rica and several locations in the United States. In addition, we have sales representatives and sales consultants located in Africa (including South
Africa, Botswana, Mozambique Mauritius, Namibia), Benelux countries, Italy, Poland, Brazil, Costa Rica, Cyprus, France, Germany, Greece, Mexico, Russia, Ukraine, Singapore, Taiwan, Thailand, Philippines, Turkey and UK.



29



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As of December 31, 2004, we employed 80 sales and marketing personnel. To date, we have established relationships with
many equipment, software and service providers, including IBM, BEA, Nortel, VocalTec, Samsung, Siemens, Smarts Communications, and LogicaCMG. Through these alliances, we deliver a joint, comprehensive solution that builds on each respective
companys strengths and jointly market our products. We intend to strengthen our existing strategic relationships, establish additional relationships and recruit additional sales representatives as a means of identifying business opportunities
and entering new markets.



Research and Development



Our research and development efforts are currently focused on developing our NGOSS family of
products to support next-generation technologies and managed IP services. We believe that the timely development of new products and enhancements is essential to maintaining our competitive position in the marketplace.



As of December 31, 2004, we employed 160 full-time employees in research and development. We
have expertise derived from more than a decade of developing software adapted to a variety of network hardware and software configurations. Our core capabilities include our:



| |  |  | familiarity with a wide variety of communications protocols and interfaces;
| | - |  | ---------------------------------------------------------------------------



| |  |  | ability to assess customers networks and understand their NMS, BSS and OSS requirements;
| | - |  | -----------------------------------------------------------------------------------------



| |  |  | ability to incorporate rule-based inference engines, data warehousing technology and replication tools into our Netrac solutions;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------



| |  |  | ability to adapt our products to different kinds of existing and next-generation wireline, wireless and optical networks; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------



| |  |  | expertise in utilizing leading programming languages, operating systems and databases to create user-friendly, distributed NMS, OSS and BSS solutions.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------



We reevaluate and enhance our product lines on an ongoing basis and seek to introduce new
releases of each product regularly.



Gross research and development expenses
were approximately $9.3 million, or 16% of our revenues, for the year ended December 31, 2002. Gross research and development expenses were approximately $10.5 million, or 22.9% of our revenues, for the year ended December 31, 2003. Gross research
and development expenses were approximately $11.3, or 30% of our revenues, for the year ended December 31, 2004. We also invested $2 million in 2002 in the development of our Service View management product, which amount was capitalized in our
financial statements. We did not capitalize any amount invested for development in 2003 and 2004. We anticipate that we will continue to invest substantially amounts in research and development in future periods.



The government of Israel encourages research and development projects oriented toward
producing systems and products for export. We received grants and participate in programs sponsored by the Office of the Chief Scientist of the Israel Ministry of Industry, Trade and Labor, the BIRD Foundation and the European Union. We have relied
on these grants for the financing of a portion of our product development expenditures. In the past, we recognized grants totaling $5.4 million from the Chief Scientist and the BIRD Foundation for the development of various aspects of our products.



30



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In 2003, we received a grant of approximately $185,000 from the Chief Scientist, out of which $133,000 was provided to us
as part of our participation in a consortium of companies engaged in the development of a management system for large networks (MAGNET program). In 2004, we received a grant of approximately $331,000 from the Chief Scientist as part of our
participation in the MAGNET program. We are not required to repay the MAGNET program grant, nor are we required to pay any royalties in respect thereof.



During 2003, we received a grant of approximately $52,000 from the European Union as part of our participation in a consortium of companies engaged in the development of
a platform for the management and control of IP over optical networks (DWDM). During 2004 we received a grant of approximately $75,000 from the European Union as part of our participation in DWDM. We are not required to repay this grant, nor are we
required to pay any royalties in respect thereof.



As of December 31, 2004, our
total contingent liability in respect of grants received from the Chief Scientist and the BIRD Foundation, net of royalties paid or accrued, was approximately $3 million. Although we have received grants in the past, and may continue to do so in the
future, we intend to fund future research and development efforts primarily from our own funds and through fees charged for customization and enhancement of products for our customers. For additional details regarding terms and conditions
relating to grants from the Chief Scientist, see Item 5B  Grants from office of Chief Scientist.



Competition



Competition in todays economically challenging telecommunications marketplace is intense and is characterized by rapidly changing technologies, evolving industry standards, frequent new product introductions and
constant changes in customer requirements. Competition in todays market is exacerbated by the fact that service providers are extremely price conscious, and place greater demands than ever before on their vendors.



The principal competitive factors affecting the market for our products are price, product
reputation, quality, performance, customer support and product features such as adaptability, scalability, ability to integrate with other products, functionality and ease of use.



Our current and prospective competitors offer a variety of solutions to address the communications service provider market and generally
fall within four categories:



| |  |  | organizations internal IT departments that design and develop NMS, OSS and BSS applications for their particular needs;
| | - |  | ------------------------------------------------------------------------------------------------------------------------



| |  |  | providers of NMS, OSS and BSS applications, such as Agilent Technologies, Cramer Systems, Granite Systems, Hewlett-Packard, Metasolv, Micromuse, Telecordia Technology and Watchmark;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | communications equipment vendors, such as Ericsson and Lucent Technologies; and
| | - |  | -------------------------------------------------------------------------------



| |  |  | systems integrators who provide programming services to develop customer-specific applications, such as LogicaCMG, BusinessEdge Solutions, Accenture, Cap Gemini and IBM Global
Services.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



31



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We believe that our product offerings in all of these categories are generally competitive on price and features and have
certain advantages and disadvantages as compared to competitors products. In particular, our extensive experience in software development, and the fact that our sole focus is communication service providers, enables us to create products that
meet their unique business and technological requirements.



Intellectual
Property



We rely on a combination of trade secret, copyright and
trademark laws, nondisclosure and other contractual agreements and technical measures to protect our proprietary rights. We seek to protect our software, documentation and other written materials under trade secret and copyright laws, which afford
only limited protection. As part of our confidentiality procedures, we generally enter into invention assignment and proprietary information agreements with our employees and consultants and nondisclosure agreements with our customers and
distributors. We also generally limit access to the source code of our products, documentation and other proprietary information. 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.



In addition,
in particular instances we are required by our customers to place the source codes for certain of our products into escrow arrangements to ensure that customers will not be adversely affected by an interruption in our business or if we materially
breach our agreement with such customer. In limited circumstances, we are required to grant to our customers access to such source code for internal development purposes according to agreed terms. Such arrangements relating to our source code may
increase the likelihood of misappropriation or other misuse of our intellectual property. Moreover, effective copyright and trade secret protection may be unavailable or limited in certain foreign countries, making the possibility of
misappropriation of our proprietary technology more likely.



The steps we take
to protect our proprietary technology may not prevent misappropriation of such technology, and such protections may not prevent competitors from developing products with functionality or features similar or superior to our products. For example, we
currently have no registered patents and two patent applications pending. If our pending patent applications will be rejected, our ability to protect the proprietary information underlying such applications may be limited. We believe that, because
of the rapid pace of technological change in the market for our products, legal protections of our proprietary technology are less significant factors in our success than the knowledge, technical expertise, ability and experience of our employees,
the frequency of product enhancements, timely introduction of new products and the quality of professional services and customer support we provide.



We develop customized solutions for certain customers to accommodate their specific requirements. Some of these customers retain certain intellectual property rights in
such customized applications.



We believe that our products and trademarks do
not infringe upon the proprietary rights of third parties and there are currently no pending claims to such effect. We may, however, receive future communications from third parties asserting that our products infringe, or may infringe, their
proprietary rights. We expect that software product developers will be increasingly 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. Any such claims, with or without merit, could:



| |  |  | be time-consuming;
| | - |  | ------------------



32



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| |  |  | result in costly litigation and diversion of technical and management personnel;
| | - |  | --------------------------------------------------------------------------------



| |  |  | cause product shipment delays;
| | - |  | ------------------------------



| |  |  | require us to develop non-infringing technology; or
| | - |  | ---------------------------------------------------



| |  |  | 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 or at all.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In the event of a successful claim of product infringement against us and our failure or inability to develop non-infringing technology or license the infringed or similar
technology, our business, financial condition and results of operations could be seriously harmed.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



We rely on certain software that we license from third parties, including software that is embedded in our products or integrated with third party and internally
developed software and used in our products to perform key functions. For instance, we have licensed databases from Oracle and Sybase and development tools from Sybase and ILOG. There can be no assurance that these third party software licenses will
continue to be available to us on commercially reasonable terms or at all. In addition, to a certain extent we are dependent upon such third parties ability to enhance their current products and develop new products on a timely and
cost-effective basis that will meet changing customer needs and respond to emerging industry standards and other technological changes.



C. Organizational Structure



Both our legal and
commercial name is TTI Team Telecom International Ltd. We were incorporated under the laws of the State of Israel and we are domiciled in Israel. We operate under the laws of the State of Israel. We commenced independent operations in September
1992, as a subsidiary of Team Computers and Systems Ltd. In April 2005, Team Computers distributed most of the ordinary shares of TTI held by it to Team Computers shareholders, and we ceased to be a subsidiary thereof. For additional
details about the distribution, see Item 7 Major Shareholders and Related Party Transactions.



A list of our subsidiaries appears in Exhibit 8 to this annual report.



D. Property, Plants and Equipment



We do not own
any real property. Our principal facilities, in which our corporate headquarters are located, comprise approximately 58,000 square feet of office space, and are located in Petach Tikva, Israel. These facilities are leased from Team Computers, our
former largest beneficial shareholder.



We also lease the following facilities,
used primarily as marketing and sales offices: approximately 4,135 square feet in Hoboken, New Jersey, USA; approximately 23,305 square feet in Atlanta, Georgia, USA; approximately 3,270 square feet in Lenexa, Kansas, USA; approximately 400 square
feet in Amsterdam, The Netherlands; approximately 1,300 square feet in Sydney, Australia; approximately 1,300 square feet in San Jose, Costa Rica; and approximately 2,433 square feet in Hong Kong. Our leasing expenses for our facilities were
approximately $1.1 million in 2004. We expect to pay total leasing expenses for our facilities of approximately $1.5 million in 2005.



We believe that the aforesaid offices and facilities are suitable and adequate for our operations as currently conducted and as currently foreseen. In the event that
additional facilities are required, we believe that we could obtain such facilities at commercially reasonable rates.



33



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



A. Operating Results.



The following discussion
of our consolidated financial condition and consolidated results of operations should be read in conjunction with the Item 3A - Selected Financial Data and our consolidated financial statements and notes to those statements included
elsewhere in this document. This discussion contains certain forward-looking statements that involve risks, uncertainties and assumptions. As a result of many factors, including those set forth under Item 3D - Risk factors and elsewhere
in this document, our actual results may differ materially from those anticipated in these forward-looking statements.



Overview



We commenced independent operations in September 1992, as a subsidiary of Team Computers and Systems Ltd., after having operated as a division of Team Computers since 1988. Team Computers is a publicly traded company
in Israel.



Product revenues consist primarily of product license fees and fees
for professional services required to customize our products for our customers. Service revenues consist of fees for maintenance, customer support and development services. In some cases, we receive commissions from hardware vendors which are
accounted for as either product or service revenues, depending upon the project. Our usual sale to a customer ranges from $1 million to $10 million, depending upon the scope of the network and functionality required for a specific customer
application. We believe that revenues from the license, service and support of our Netrac family of products will continue to account for most of our total revenues for the foreseeable future.



Our software licenses usually require significant customization, integration and
installation. The revenues are recognized using contract accounting on a percentage of completion method based on the relationship of labor days incurred to total estimated labor days to be incurred over the duration of the contract. Provisions for
estimated losses on uncompleted contracts are made in the period in which such losses are determined in the amount of the estimated loss on the entire contract. Revenues from maintenance and support contracts are recognized over the life of these
contracts, which is typically one year, or at the time when our services are rendered.



Generally, the time elapsed from when we receive an order for our products to the completion of installation averages from six to eighteen months. Under the terms of some of our contracts, we invoice our customers as we complete certain
milestones, which on average occur every few months, or, in certain cases, after installation has been completed. We generally receive payment 30 to 120 days after we invoice customers. As a result, an average of five to six months passes between
our performance of work and our receipt of payment.



Sales effected through our
strategic relationships with IBM, Nortel, VocalTec, Siemens and CMGLogica accounted for approximately 14% of our revenues in 2002, approximately 18% of our revenues in 2003 and approximately 14% of our revenues in 2004. The contractual terms of our
arrangement with our strategic partners are similar to the terms of the arrangement with customers that are end-users (projects in which we act as the prime contractor). In all of our arrangements we do not provide price protection and/or return
provisions. Our obligations, in any event, are limited exclusively to our obligation towards our partner.



34



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A majority of our revenues is paid to us in U.S. dollars or is U.S. dollar-linked. In addition, a substantial portion of
our costs is incurred in U.S. dollars. Since the U.S. dollar is the primary currency in the economic environment in which we operate, the dollar is our functional and reporting currency. Accordingly, we remeasure monetary accounts maintained in
currencies other than the U.S. dollar using the foreign exchange rate at the balance sheet date. We measure and record operational accounts and nonmonetary balance sheet accounts at the rate in effect at the date of the transaction. We report the
effects of foreign currency remeasurement in current operations.



Because a
majority of our revenues is paid to us in U.S. dollars or is U.S. dollar-linked, and a substantial portion of our expenses is incurred in NIS, we are exposed to risk to the extent that the rate of inflation, or specifically the rate at which our
costs increase, in Israel, exceeds the rate of devaluation of the NIS in relation to the U.S. dollar or if the timing of such devaluation lags behind in Israel.



Our Functional Currency



Our consolidated financial statements are prepared in dollars in accordance with U.S. generally accepted accounting principles. The currency of the primary economic
environment in which we operate is the U.S. dollar. Transactions and balances denominated in dollars are presented at their original amounts. Accordingly, monetary accounts maintained in currencies other than the dollar are remeasured into U.S.
dollars in accordance with Statement of Financial Accounting Standards No. 52, Foreign Currency Translation (SFAS No. 52). All exchange gains and losses from translation of monetary balance sheet items denominated in
non-dollar currencies are reflected in the income statement when they arise. These exchange gains and losses are included in the same income statement items in which the related transactions are included.



Critical Accounting Policies



The discussion and analysis of our financial condition and results of operations are based
upon our consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosure of contingent assets and liabilities. These estimates are evaluated by us on an on-going basis. We base our estimates on our historical experience and on various other assumptions that we believe to be
reasonable under the circumstances, the results of which form the basis for making judgments about the carrying amount values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates
under different assumptions or conditions.



We believe that application of the
following critical accounting policies entails the more significant judgments and estimates used in the preparation of our consolidated financial statements.



Revenue recognition. We derive our revenues from the sale of software licenses and from services. Our products are sold worldwide through a combination of our
direct sales force and indirect sales channels. Our services revenues consist primarily of fees derived from annual maintenance and customer support.



Significant management judgments and estimates must be made and used in connection with the recognition of revenue in any accounting period. Material differences in the
amount of revenue in any given period may result if these judgments or estimates prove to be incorrect or if managements estimates change on the basis of development of the business or market condition.



We recognize revenue from our software licenses, which require significant customization,
integration, installation and development services, in accordance with Statement of Position (SOP) 81-1,



35



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Accounting for Performance of Construction - Type and Certain Production - Type Contracts, using contract accounting on a percentage of
completion method based on the relation of actual labor days incurred to total labor days estimated to be incurred over the duration of the project to which the contract relates. In general, we divide each project into three distinct periods: (i) a
functional specification period, (ii) an implementation period and (iii) a stabilization period, as more fully described in Item 4B under Project Installation: Maintenance and Customer Support. A project is considered completed when the
stabilization period is over.



According to SOP 81-1, costs that are incurred
for a specific anticipated contract prior to the existence of a persuasive evidence of an agreement are deferred, subject to evaluation of their probable recoverability, and only if the costs can be directly associated with a specific anticipated
contract. Such deferred costs are recorded as unbilled contract costs, in other accounts receivable and prepaid expenses. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are determined in the
amount of the estimated loss on the entire contract.



Revenues from maintenance
and support contracts are recognized ratably over the life of the agreement, which is typically one year, or at the time when such services are rendered.



Unbilled receivables include all amounts that had been billed as of the balance sheet date due to contractual or other arrangements with customers.



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



If we do not accurately estimate the resources required or the scope of the work to be
performed, or do not manage our projects properly within the planned periods of time or satisfy our obligations under the contracts, then future results may be significantly and negatively affected or losses on existing contracts may need to be
recognized.



Goodwill. Under Statement of Financial Accounting Standard
No. 142, Goodwill and Other Intangible Assets (SFAS No. 142) goodwill acquired in a business combination which closes on or after July 1, 2001 is deemed to have indefinite life and will not be amortized. SFAS No.142 requires
goodwill to be tested for impairment on adoption and at least annually thereafter or between annual tests in certain circumstances, and written down when impaired, rather than being amortized as previous accounting standards required. Goodwill is
tested for impairment by comparing the fair value of the reporting unit with its carrying value. Fair value is determined using market multiples and comparative analysis. Significant estimates used in the methodologies include estimates of market
multiples for the reportable unit. We have performed impairment tests and determined that our goodwill in the amount of $1.1 million is not subject to an impairment charge as of December 31, 2002. On September 30, 2003, we performed impairment tests
on our goodwill, which resulted in impairment of $1.1 million. Following such impairment, the value of our goodwill is zero.



Marketable securities. We account for investments in debt securities in accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity
Securities. We determine the proper classification of investments in marketable securities at the time of purchase and reevaluate such designations as of each balance sheet date. At December 31, 2004, all securities were designated as
available-for-sale. Accordingly, the available-for-sale securities are stated at fair value, with unrealized gains and losses reported in a separate component of shareholders equity, accumulated other comprehensive income. Amortization of
premium and accretion of discounts are included in financial income and other, net. Realized gains and losses on sales of investments, as determined on a specific identification basis, are included in the consolidated statements of operations.



Capitalized software development costs. Based on our product
development process, technological feasibility is established upon completion of a working model. Costs incurred by us between



36



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completion of the working model and the point at which the product is ready for general release, are capitalized in accordance with Statement of Financial
Accounting Standards No. 86, Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed. (FSAS No. 86) and amortized these costs over the product estimated economic life which historically has been
between three to six years. No software development costs were capitalized in 2003 and 2004.



The Company and its subsidiaries assess the recoverability of capitalized software development costs in accordance with SFAS No. 86 at each balance sheet date by determining whether the amount by which the unamortized
capitalized cost of a computer software product exceeds the net realizable value. The net realizable value is the estimated future gross revenues from that product reduced by the estimated future costs of completing and disposing of that product,
including the cost of performing maintenance and customer support required to satisfy the Companys responsibility set forth at the time of sale. Based on its most recent analyses, management believes that no further impairment of capitalized
software development costs exists as of December 31, 2004.



On September 30,
2003, the net realizable value of the capitalized software development costs were periodically reviewed by management, based on the estimated future gross revenues from such technologies reduced by the estimated future costs for completing and
disposing of each of them. This review indicated that the net realizable value of the capitalized software development costs exceed the unamortized capitalized costs. An amount of $5.9 million has been reduced and recorded as an impairment of
capitalized software costs included in the cost of revenues. On December 31, 2004 additional amount of $3.6 million, has been reduced and recorded as an impairment of capitalized software costs included in the cost of revenues.



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.



Results of Operations



The following table sets forth certain items from our results of operations as a percentage of total revenues for the periods indicated:



|                                                       |  |                          |    |  |       |    |  |       |   
|------------------------------------------------------ |  | ------------------------ | -- |  | ----- | -- |  | ----- | --
|                                                       |  | Years Ended December 31, |   
|                                                       |  | 2002                     |    |  | 2003  |    |  | 2004  |   
|Revenues:                                              |  |                          |    |  |       |    |  |       |   
|Product                                                |  | 80.6                     | %  |  | 73.8  | %  |  | 57.3  | % 
|Service                                                |  | 19.4                     |    |  | 26.2  |    |  | 42.7  |   
|                                                       |  |                          |    |  |       |    |  |       |   
|Total revenues                                         |  | 100.0                    |    |  | 100.0 |    |  | 100.0 |   
|Cost of revenues:                                      |  |                          |    |  |       |    |  |       |   
|Product                                                |  | 47.0                     |    |  | 64.5  |    |  | 44.0  |   
|Service                                                |  | 9.7                      |    |  | 13.9  |    |  | 25.7  |   
|Impairment of capitalized software development costs   |  |                         |    |  | 12.8  |    |  | 9.6   |   
|                                                       |  |                          |    |  |       |    |  |       |   
|Total cost of revenues                                 |  | 56.7                     |    |  | 91.2  |    |  | 79.3  |   
|                                                       |  |                          |    |  |       |    |  |       |   
|Gross profit                                           |  | 43.3                     |    |  | 8.8   |    |  | 20.7  |   
|Operating expenses:                                    |  |                          |    |  |       |    |  |       |   
|Research and development, net                          |  | 13.6                     |    |  | 22.5  |    |  | 28.4  |   
|Selling and marketing,                                 |  | 30.4                     |    |  | 42.4  |    |  | 50.8  |   
|General and administrative                             |  | 12.0                     |    |  | 13.8  |    |  | 17.6  |   
|goodwill write-off                                     |  |                         |    |  | 2.3   |    |  |      |   
|                                                       |  |                          |    |  |       |    |  |       |   
|Allowance for doubtful accounts and bad debt write-off |  | 12.8                     |    |  | 0.4   |    |  |      |   
|                                                       |  |                          |    |  |       |    |  |       |   
|Total operating expenses                               |  | 68.8                     |    |  | 81.4  |    |  | 96.8  |   
|                                                       |  |                          |    |  |       |    |  |       |   
|Operating income (loss)                                |  | (25.5                    | )  |  | (72.7 | )  |  | (76.0 | ) 
|Financial income, net                                  |  | 5.8                      |    |  | 6.1   |    |  | 3.5   |   
|                                                       |  |                          |    |  |       |    |  |       |   
|Income (loss) before income taxes                      |  | (19.6                    | )  |  | (66.6 | )  |  | (72.5 | ) 
|Income taxes                                           |  | (1.0                     | )  |  | (1.0  | )  |  | 5.6   |   
|                                                       |  |                          |    |  |       |    |  |       |   
|Net income (loss)                                      |  | (18.6                    | %) |  | (65.6 | %) |  | (78.0 | %)
|                                                       |  |                          |    |  |       |    |  |       |   





37



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|                           |  |                          |   |  |       |   |  |       |  
|-------------------------- |  | ------------------------ | - |  | ----- | - |  | ----- | -
|                           |  | Years Ended December 31, |  
|                           |  | 2002                     |   |  | 2003  |   |  | 2004  |  
|Sales by Geographic Areas: |  |                          |   |  |       |   |  |       |  
|Israel                     |  | 10.5                     | % |  | 7.3   | % |  | 11.1  | %
|United States              |  | 30.7                     |   |  | 39.4  |   |  | 37.3  |  
|Europe                     |  | 32.5                     |   |  | 26.3  |   |  | 30.5  |  
|Australia                  |  | 7.4                      |   |  | 4.2   |   |  | 8.8   |  
|South America              |  | 7.9                      |   |  | 11.8  |   |  | 7.2   |  
|Far East                   |  | 8.9                      |   |  | 5.0   |   |  | 1.9   |  
|South Africa               |  | 2.1                      |   |  | 6.0   |   |  | 3.2   |  
|                           |  | 100.0                    | % |  | 100.0 | % |  | 100.0 | %
|                           |  |                          |   |  |       |   |  |       |  



Comparison of 2002, 2003 and 2004



Revenues



|                |      |                        |      |                        |      |      |                        |   |      |  |     |    |  |     |   
|--------------- | ---- | ---------------------- | ---- | ---------------------- | ---- | ---- | ---------------------- | - | ---- |  | --- | -- |  | --- | --
|($ in millions) |      | Year ended December31, |      | % Change 2002 vs. 2003 |      |      | % Change 2003 vs. 2004 |  
|                | 2002 |                        | 2003 |                        | 2004 |      |                       
|Product sales   |      | $                      | 47.0 |                        | $    | 33.9 |                        | $ | 21.7 |  | (28 | )% |  | (36 | )%
|                |      |                        |      |                        |      |      |                        |   |      |  |     |    |  |     |   
|Services        |      |                        | 11.3 |                        |      | 12.0 |                        |   | 16.1 |  | 6   | %  |  | 34  | % 
|                |      |                        |      |                        |      |      |                        |   |      |  |     |    |  |     |   
|Total revenues  |      |                        | 58.3 |                        |      | 45.9 |                        |   | 37.8 |  | (21 | )% |  | (18 | )%
|                |      |                        |      |                        |      |      |                        |   |      |  |     |    |  |     |   



Revenues consist primarily of product
revenues, which include license fees and fees for professional services required to customize, implement and integrate our products and commissions from hardware vendors. Service revenues include fees for maintenance and customer support .The
decrease in our product revenues in 2004 and 2003 was primarily attributable to delays in some of our customers network roll-outs, extension of customers sale cycles and difficulties in obtaining new



38



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contracts and longer-lasting acceptance processes, all of which we believe was a result of the overall decline in capital expenditure by customers in the
telecommunication industry.



The decrease in product revenues was partially
offset by a 34% increase in our service revenues in 2004, a 6% increase in our service revenues in 2003, which were primarily attributable to our entering into new maintenance contracts, and renewals of maintenance contracts with existing customers.



Cost of Revenues



|                                                     |      |                          |      |                        |      |      |                        |   |      |  |    |   |  |     |   
|---------------------------------------------------- | ---- | ------------------------ | ---- | ---------------------- | ---- | ---- | ---------------------- | - | ---- |  | -- | - |  | --- | --
|($ in millions)                                      |      | Years ended December 31, |      | % Change 2002 vs. 2003 |      |      | % Change 2003 vs. 2004 |  
|                                                     | 2002 |                          | 2003 |                        | 2004 |      |                       
|Cost of product sales                                |      | $                        | 27.4 |                        | $    | 29.6 |                        | $ | 16.6 |  | 8  | % |  | (44 | )%
|                                                     |      |                          |      |                        |      |      |                        |   |      |  |    |   |  |     |   
|Cost of services                                     |      |                          | 5.7  |                        |      | 6.4  |                        |   | 9.7  |  | 12 | % |  | 51  | % 
|                                                     |      |                          |      |                        |      |      |                        |   |      |  |    |   |  |     |   
|Impairment of capitalized software development costs |      |                          | 0    |                        |      | 5.9  |                        |   | 3.6  |  |   |   |  | (39 | )%
|                                                     |      |                          |      |                        |      |      |                        |   |      |  |    |   |  |     |   
|Total cost of revenues                               |      |                          | 33.1 |                        |      | 41.9 |                        |   | 29.9 |  | 27 | % |  | (29 | )%
|                                                     |      |                          |      |                        |      |      |                        |   |      |  |    |   |  |     |   



Cost of product revenues consists
primarily of labor costs relating to customization, integration and installation of our products, license fees paid to third party vendors, depreciation of equipment, other allocated expenses, amortization of capitalized software and royalties paid
to the Office of the Chief Scientist in each year.



Cost of service revenues
consists primarily of personnel costs for providing maintenance services, fees paid to third-party providers of maintenance services and third-party software vendors, personnel costs for telephone support and maintenance and other allocated
expenses.



We recorded charges during 2003 and 2004 in connection with the
impairment of capitalized software development costs of the following software products:



Netrac 2



The Netrac 2 platform serves as the foundation for many of our products. Our products are divided into six families: Mediation, Service Management, Fault Management,
Performance Management, xDR and Fulfillment. Relative part of Netrac2 within the products varies and described in the products families descriptions.



ServiceView



The ServiceView line of products manages service availability and Service Level Agreements (SLA). Monitoring service levels helps service providers ensure
that customers are benefiting from guaranteed quality of service. The Service management products detect services in danger of



39



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exceeding SLA thresholds and notify service providers of impending problems before customers are affected and SLAs are jeopardized.



The table below describes the impairment charges attributed to each product during 2003 and
2004:



|                          |  |       |  |      
|------------------------- |  | ----- |  | -----
|U.S. Dollars in thousands |  | 2003  |  | 2004 
|Netrac 2                  |  | 5,461 |  | 3,079
|                          |  |      
|Service View              |  | 403   |  | 518  
|                          |  |      
|Total                     |  | 5,864 |  | 3,597



The events and circumstances
surrounding these charges and the factors that led us to conclude that the software was impaired are as follows:



Regarding Netrac 2:



2003: The net realizable value of Netrac 2 was lower than the unamortized capitalized cost because the estimated gross margin for Netrac 2 sales declined due to: (1) a
decline in our sales mainly resulting from the difficult market situation at the time and strong competition and (2) an increase in our operational expenses mainly resulting from further investment in development (using other technologies) and the
fact that the workforce has not been reduced significantly.



2004: We started
using more standard advanced commercial infrastructures (e.g., J2EE application servers and web GUI) to improve performance and maintainability, which meant that the use of the Netrac 2 platform in its projects declined and is predicted to decline
even further in the future. As a result, we predicted a significant decline in its future revenues from this product.



Regarding ServiceView:



2003: Difficulties in the telecommunications market during this period caused a general decline in our sales and adversely affected the future revenues of this product,
resulting in a decline in its net realizable value.



2004: We lost many major
ServiceView product-specific tenders, which caused us to change its predictions as to the future gross revenues of this product. As such, we found that the demand for this product in the telecom market was lower than we expected. In addition, we
discovered that parts of the old source code could not be effectively reused, which required us to develop new code for this product using new infrastructures.



40



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Current status:



Netrac 2: The infrastructure components that were developed for the Netrac 2 are a significant part of our Assurance product family, but
this importance is declining as we continue to develop and change the infrastructure (making the relative percentage of the code that was capitalized smaller) and our use of more advanced commercial infrastructures grows. We expect Netrac 2s
capitalized value will be negligible in our system within the next three years.



ServiceView: All development carried out from this product will be included as additional modules in the existing Assurance modules.



Estimate of Economic Lives



We assessed the recoverability of capitalized software development costs in accordance with SFAS 86 at each balance sheet date by determining whether the amount by which
the unamortized capitalized cost of a computer software product exceeded the net realizable value.



A third party specialist performed the evaluation tests under SFAS 86. The evaluation dates were December 31, 2003 and December 31, 2004.



The evaluations indicated that the net realizable value of each of the Netrac 2 technology and the ServiceView technology was lower than
their unamortized capitalized costs. The evaluations were based on the estimated future gross revenues from such technologies reduced by the estimated future costs for completing and disposing of each of them. There were no changes in our
estimations regarding the economic lives of these technologies.



Changes in
Cost of Sales:



In 2002 and 2003, product sales declined in comparison
with 2001, while the cost of product sales have increased. The main reasons are as follows: (1) we engaged in projects with much higher requirements for development efforts of new software modules and product offerings; (2) strong competition in the
market led to declining market prices and resulted in a greater demand by customers for products with more functionalities; (3) fixed costs remained high; and (4) we decided not to dramatically reduce our work force in anticipation of market
recovery and of obtaining new projects, and also in order to maintain our know-how.



Compared to 2003, product sales and cost of sales in 2004 declined, as part of our plan to reduce costs and increase efficiency, consisting primarily of termination of employment of approximately 220 software and information technology
specialists and administrative professionals from December 31, 2003 through December 31, 2004. In addition, we closed some of our offices abroad. During the second quarter of 2004, we undertook several major management changes and replaced most of
our senior management. At that time, we hired an external consultant to help us focus our business efforts. We implemented other cost reduction measures, including travel cuts and reductions in communication expenses, exhibitions and employee
benefits.



Although service sales increased during 2002 and 2003 in comparison
with 2001, the cost of service sales increased even more as a result of more extensive requirements on the part of our customers relating to such services. This trend continued through 2004.



41



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See also the discussion regarding Gross Profit below.



Gross Profit



|                                                     |  |                          |      |      |                       |      |      |                       |   |      |   |  |     |    |  |     |   
|---------------------------------------------------- |  | ------------------------ | ---- | ---- | --------------------- | ---- | ---- | --------------------- | - | ---- | - |  | --- | -- |  | --- | --
|($ in millions)                                      |  | Years ended December 31, |      |      | % Change2002 vs. 2003 |      |      | % Change2003 vs. 2004 |  
|                                                     |  | 2002                     |      | 2003 |                       |      | 2004 |                       |   |     
|Product sales                                        |  |                          | 19.6 |      |                       | 4.2  |      |                       |   | 5.0  |   |  | (79 | )% |  | 19  | % 
|Services                                             |  |                          | 5.6  |      |                       | 5.7  |      |                       |   | 6.4  |   |  | 2   | %  |  | 12  | % 
|Impairment of capitalized software development costs |  |                          |     |      |                       | (5.9 | )    |                       |   | (3.6 | ) |  |    |    |  | (39 | )%
|Total gross profit                                   |  | $                        | 25.3 |      | $                     | 4.0  |      |                       | $ | 7.8  |   |  | (84 | )% |  | 95  | % 



Gross profit as a percentage of
revenues



|                   |  |                          |   |  |      |   |  |      |  
|------------------ |  | ------------------------ | - |  | ---- | - |  | ---- | -
|                   |  | Years ended December 31, |  
|                   |  | 2002                     |   |  | 2003 |   |  | 2004 |  
|Product sales      |  | 42                       | % |  | 12   | % |  | 23   | %
|Services           |  | 50                       | % |  | 47   | % |  | 40   | %
|Total gross profit |  | 43                       | % |  | 9    | % |  | 21   | %



Total gross profit increased to $7.8
million in 2004 from $4 million in 2003. The increase in gross profit resulted from the decrease in product sales of 36%, while the cost of product sales decreased by 44%, and the increase in service revenues by 34% while the cost of services
increased by 51%. These elements, together with a lower impairment of capitalized software development costs resulted in a 21% increase in gross profit. The disproportionate decrease in cost of product sales is the result of our restructuring
activities. The disproportionate increase in the cost of services is the result of more extensive requirements of our customers relating to such services, and the different mixture of types of services rendered.



42



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Operating Expenses



|                                |  |                         |      |                       |   |      |                       |   |      |  |     |    |  |    |   
|------------------------------- |  | ----------------------- | ---- | --------------------- | - | ---- | --------------------- | - | ---- |  | --- | -- |  | -- | --
|($ in millions)                 |  | Year ended December 31, |      | % Change2002 vs. 2003 |   |      | % Change2003 vs. 2004 |  
|                                |  | 2002                    |      | 2003                  |   | 2004 |                       |  
|Research and development, net   |  | $                       | 8.0  |                       | $ | 10.3 |                       | $ | 10.7 |  | 29  | %  |  | 4  | % 
|Selling and marketing           |  |                         | 17.7 |                       |   | 19.5 |                       |   | 19.2 |  | 10  | %  |  | (2 | )%
|Allowance for doubtful accounts |  |                         | 7.4  |                       |   | 0.2  |                       |   |     |  | (97 | )% |  |   |   
|Impairment of good-will         |  |                         |     |                       |   | 1.1  |                       |   |     |  |    |    |  |   |   
|General and administrative      |  |                         | 7.0  |                       |   | 6.3  |                       |   | 6.6  |  | (10 | )% |  | 5  | % 
|Total operating expenses        |  |                         | 40.1 |                       |   | 37.3 |                       |   | 36.5 |  | (7  | )% |  | (2 | )%



Research and Development Expenses,
Net.Gross research and development expenses consist primarily of compensation and related costs of employees engaged in ongoing research and development activities, subcontractors and other related costs.



|                                                    |  |                         |      |      |   |      |  |     
|--------------------------------------------------- |  | ----------------------- | ---- | ---- | - | ---- |  | ----
|($ in millions)                                     |  | Year ended December 31,
|                                                    |  | 2002                    |      | 2003 |   | 2004
|Total cost                                          |  | $                       | 11.4 |      | $ | 10.5 |  | 11.3
|Less grant participations                           |  |                         | 1.4  |      |   | 0.2  |  | 0.6 
|Less - capitalization of software development costs |  |                         | 2.0  |      |   |     |  |    
|Research and development, net                       |  |                         | 8.0  |      |   | 10.3 |  | 10.7



Gross research and development
expenditures increased 7.7% to $11.3 million in 2004, from $10.5 million in 2003, and were offset by $0.6 million in grants recognized in 2004, compared to an offset of $0.2 million in grants recognized in 2003. As a result, research and development
expenses, net, increased 4% to $10.7 million in 2004 from $10.3 million in 2003.



Gross research and development expenditures decreased 8% to $10.5 million in 2003, from $11.4 million in 2002, and were offset by $0.2 million in grants recognized in 2003 compared to an offset of $1.4 million for grants recognized in 2002.
As a result, research and development expenses, net (and after capitalization of our investments in the development of our Service View management product in the amount of $2 million in 2002), increased 29% to $10.3 million in 2003 from $8.0 million
in 2002.



The increases in research and development net, in 2002 and 2003 and
2004 were primarily due to improving infrastructure and adding functionality to our products, which was partially offset by the increase in grants recognized in 2004 compared to 2003.



Selling and Marketing Expenses.Selling and marketing expenses consist primarily of compensation for sales and marketing personnel,
as well as promotion of contract administration, traveling and entertainment expenses. Selling and marketing expenses were 51% of total revenues in 2004, 42% of



43



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total revenues in 2003, and 30.4% of total revenues in 2002. These level of expenditures were primarily due to a decision to maintain the selling and
marketing infrastructure on a lower amount of revenues to allow us to preserve our market presence, and to allow more aggressive marketing of our products in order to gain more orders in the future.



In addition, the sales process has become longer and sales efforts have become more
complicated and intensive due to the demands to perform proof of concepts and to invest significant resources in presale activities.



General and Administrative Expenses.General and administrative expenses consist primarily of compensation for finance, human resources, general management,
networks and information systems, personnel, as well as insurance, consultancy services expenses, and other expenses. General and administrative expenses increased 6% to $6.6 million, or 17% of total revenues in 2004, from 10% to $6.3 million, or
14% of total revenues in 2003. The reason general and administrative expenses did not decrease, even though our revenues decreased, was primarily due to our decision to maintain the critical mass necessary to manage and support our global business.



General and administrative expenses decreased 10% to $6.3 million, or 14% of
total revenues in 2003, from $7.0 million, or 12% of total revenues in 2002. This decrease was primarily due to our efforts to reduce discretionary expenses.



Goodwill write off. During 2003 we incurred a charge for impairment of goodwill in the amount of $1.1 million relating to our
investment in Axarte Limited. There was no comparable charge in 2004.



Financial Income, Net.Financial income consists primarily of interest derived from cash and cash equivalents, short-term investments and foreign currency translation adjustments, off-set by impairment of marketable securities, if
any. Our financial income decreased to $1.3 million in 2004, from $2.8 million in 2003, due to the decrease in our liquid assets during the year 2004 and decrease of our exposure to Euro based assets. Our financial income decreased to $2.8 million
in 2003 from $3.4 million in 2002, due to the decrease in our liquid assets during the year 2003.



Allowance for doubtful accounts and bad debt write off. The allowance for doubtful accounts consists of the balance of the unpaid sums under our agreements with two major customers. One of these agreements was
terminated by the customer, and the second was terminated by mutual agreement, and the dispute thereunder was settled. Please see the information about these customers set forth below under the heading Item 8A  Legal Proceedings.
Allowance for doubtful accounts was in the aggregate amount of $7.5 million in 2002 and $177,000 in 2003. There was no allowance for doubtful accounts during the year 2004.



Research and Development



We conduct our research and development operations in Israel. Our research and development efforts have been financed through internal resources and grants from the
Office of the Chief Scientist, the BIRD Foundation and the European Union. The Chief Scientist and the European Union provided grants of approximately $1.4 million for the year ended December 31, 2002, approximately $237,000 for the year ended
December 31, 2003 and approximately $406,000 for the year ended December 31, 2004. Of our total research and development expenses, these grants accounted for 12.4% in 2002, 2.3% in 2003 and 3.6% in 2004.



With respect to grants we received from the Office of the Chief Scientist of the Israeli
Ministry of Industry, Trade and Labor, we paid or accrued to the Israeli government approximately $258,000 for royalties for the year ended December 31, 2002, approximately $110,000 for the year ended



44



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December 31, 2003, and approximately $4,000 for the year ended December 31, 2004. See Item 5B  Grants from the Office of the Chief
Scientist.



We have also received royalty-bearing grants from the
BIRD Foundation to be repaid at the rate of 3.5% to 5% of sales of products developed as a result of the research projects funded by the BIRD Foundation until a maximum of 150% of the U.S. dollar amount we received, linked to the United States
consumer price index, is repaid. These royalty-bearing grants received for research and development are offset against our gross research and development expenditures. We paid or accrued to the BIRD Foundation approximately $36,000 for the year
ended December 31, 2002, approximately $9,000 for the year ended December 31, 2003 and approximately $6,000 for the year ended December 31, 2004. We have not received grants from the BIRD Foundation since 1996.



We received grants of approximately $2.7 million in 2002, approximately $185,000 in 2003 and
approximately $331,000 in 2004, from the Chief Scientist, out of which approximately $ 687,000 in 2002, $133,000 in 2003 and $331,000 in 2004 was provided to us as part of our participation in a consortium of companies (MAGNET program) engaged in
the development of a management system for large networks. We are not required to repay these MAGNET program grants, nor are we required to pay any royalties in respect thereof.



We received grants of approximately $62,000 in 2002, $52,000 in 2003 and $75,000 in 2004 from the European Union as part of our
participation in a consortium of companies engaged in the development of a platform for the management and control of IP over optical networks (DWDM). We are not required to repay these grants, nor are we required to pay any royalties in respect
thereof.



Corporate Tax Rate



Israeli companies are generally subject to corporate tax on their taxable income at the rate
of 35% for the 2004 tax year, 34% for the 2005 tax year, 32% for the 2006 tax year and 30% for the 2007 tax year and thereafter, and to capital gains tax at a rate of 25% for capital gains derived after January 1, 2003. However, our facilities in
Petach Tikva have been granted approved enterprise status under the Law for Encouragement of Capital Investments, 1959. Consequently, these facilities are eligible for tax benefits. We have derived, and expect to continue to derive, a substantial
portion of our income from our approved enterprise facilities.



Subject to
compliance with applicable requirements, the income derived from our approved enterprise facilities will be subject through 2011 to a reduced tax rate of a maximum of 25%. The actual tax rate will depend upon the percentage of non-Israeli holders of
our share capital. The above benefits are conditioned upon our fulfillment of conditions stipulated by the Law for the Encouragement of Capital Investments, the regulations promulgated thereunder and the instruments of approval for the specific
investments in approved enterprises. If we fail to comply with these conditions, our benefits may be canceled and we may be required to refund the amount of benefits received, in whole or in part.



Our effective tax rate was 5.1% in 2002. Due to the expiration of certain of the tax benefits
and exceptions discussed above and a decrease in the impact of the remaining benefits, our effective tax rate was expected to increase to 17% in 2003, but since we incurred losses in that year, we were not required to pay taxes. During the year 2003
we recorded deferred taxes expenses in the amount of $456,000. In 2004, we have written off the deferred tax reserved in our financial statement in the amount of $1.6 million because we do not expect taxable income within the following 3 years.



45



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Impact of Inflation, Devaluation and Fluctuation in Currencies on Results of Operations, Liabilities and Assets



The dollar cost of our operations is influenced by the extent to which
any increase in the rate of inflation in Israel is offset by the devaluation of the NIS in relation to the U.S. dollar. Inflation in Israel will cause contracts under which we are to receive payment in dollars or dollar-linked NIS, while incurring
expenses in NIS linked to the Israeli consumer price index, to be less profitable, unless such inflation is offset by a devaluation of the NIS.



Most of our sales are denominated in dollars or are dollar linked. However, a significant portion of our expenses, primarily expenses associated with employee
compensation, is denominated in NIS unlinked to the dollar. A devaluation of the NIS in relation to the dollar has the effect of decreasing the dollar value of any asset of ours which consists of NIS or receivables payable in NIS, unless such
receivables are linked to the dollar. Such a devaluation also has the effect of reducing the dollar amount of any of our expenses or liabilities which are payable in NIS, unless such expenses or payables are linked to the dollar. Conversely, any
increase in the value of the NIS in relation to the dollar has the effect of increasing the dollar value of any of our unlinked NIS assets and the dollar amounts of any of our unlinked NIS liabilities and expenses. For more information about
these risks and the methods we employ to mitigate these risks, see also Item 11.Quantitative and Qualitative Disclosures about Market Risk.



The table below sets forth the annual rate of inflation, the annual rate of devaluation (or revaluation) of the NIS against the U.S. dollar
and the gap between them for the periods indicated:



|                            |  |                         |    |  |      |    |  |      |    |  |      |    |  |      |   
|--------------------------- |  | ----------------------- | -- |  | ---- | -- |  | ---- | -- |  | ---- | -- |  | ---- | --
|                            |  | Year Ended December 31, |   
|                            |  | 2004                    |    |  | 2003 |    |  | 2002 |    |  | 2001 |    |  | 2000 |   
|Inflation (Deflation)       |  | 1.2                     | %  |  | (1.9 | %) |  | 6.5  | %  |  | 1.4  | %  |  | 0    | % 
|Devaluation (Revaluation)   |  | (1.6                    | %) |  | (7.6 | %) |  | 7.3  | %  |  | 9.3  | %  |  | (2.7 | %)
|Inflation (devaluation) gap |  | 2.8                     | %  |  | 5.7  | %  |  | (0.8 | %) |  | (7.9 | %) |  | 2.7  | % 



Because exchange rates between the NIS
and the dollar fluctuate continuously, albeit with a historically declining trend in the value of the NIS, exchange rate fluctuations and especially larger periodic devaluations will have an impact on our profitability and period-to-period
comparisons of our results. We believe that inflation in Israel and exchange rate fluctuations between the NIS and the dollar have not had a material effect on our results of operations.



Quarterly Results of Operations



The following tables set forth certain unaudited quarterly financial data for each of our last eight quarters and this data is expressed as a percentage
of total revenues for each quarter. The data have been prepared on a consistent basis with our audited consolidated financial statements included elsewhere in this prospectus and include all necessary adjustments, consisting only of normal recurring
accruals that we consider necessary for a fair presentation. The operating results for any quarter are not necessarily indicative of results for any future period.



46



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|                                                        |  |                |    |  |             |    |  |              |    |  |             |    |  |             |    |  |             |    |  |              |    |  |             |   
|------------------------------------------------------- |  | -------------- | -- |  | ----------- | -- |  | ------------ | -- |  | ----------- | -- |  | ----------- | -- |  | ----------- | -- |  | ------------ | -- |  | ----------- | --
|                                                        |  | Quarters Ended |   
|                                                        |  | Mar. 312003    |    |  | June 302003 |    |  | Sept. 302003 |    |  | Dec. 312003 |    |  | Mar. 312004 |    |  | June 302004 |    |  | Sept. 302004 |    |  | Dec. 312004 |   
|Revenues:                                               |  |                |    |  |             |    |  |              |    |  |             |    |  |             |    |  |             |    |  |              |    |  |             |   
|Products                                                |  | 8,551          |    |  | 8,480       |    |  | 7,732        |    |  | 9,068       |    |  | 8,147       |    |  | 4,654       |    |  | 3,532        |    |  | 5,337       |   
|Services                                                |  | 2,789          |    |  | 3,047       |    |  | 3,301        |    |  | 2,899       |    |  | 3,292       |    |  | 4,612       |    |  | 3,708        |    |  | 4,516       |   
|                                                        |  |                |    |  |             |    |  |              |    |  |             |    |  |             |    |  |             |    |  |              |    |  |             |   
|Total revenues                                          |  | 11,340         |    |  | 11,527      |    |  | 11,033       |    |  | 11,967      |    |  | 11,439      |    |  | 9,266       |    |  | 7,240        |    |  | 9,853       |   
|Cost of revenues:                                       |  |                |    |  |             |    |  |              |    |  |             |    |  |             |    |  |             |    |  |              |    |  |             |   
|Products                                                |  | 7,670          |    |  | 7,697       |    |  | 6,815        |    |  | 7,437       |    |  | 6,121       |    |  | 3,735       |    |  | 3,148        |    |  | 3,641       |   
|Services                                                |  | 1,552          |    |  | 1,559       |    |  | 1,713        |    |  | 1,544       |    |  | 1,777       |    |  | 2,687       |    |  | 2,576        |    |  | 2,679       |   
|Impairment of capitalized software development costs    |  |                |    |  |             |    |  | 5,864        |    |  |             |    |  |             |    |  |             |    |  | 2,475        |    |  | 1,122       |   
|                                                        |  |                |    |  |             |    |  |              |    |  |             |    |  |             |    |  |             |    |  |              |    |  |             |   
|Total cost of revenues                                  |  | 9,222          |    |  | 9,256       |    |  | 14,392       |    |  | 8,981       |    |  | 7,898       |    |  | 6,422       |    |  | 8,199        |    |  | 7,442       |   
|                                                        |  |                |    |  |             |    |  |              |    |  |             |    |  |             |    |  |             |    |  |              |    |  |             |   
|Gross profit                                            |  | 2,118          |    |  | 2,271       |    |  | (3,359       | )  |  | 2,986       |    |  | 3,541       |    |  | 2,844       |    |  | (959         | )  |  | 2,411       |   
|Operating expenses:                                     |  |                |    |  |             |    |  |              |    |  |             |    |  |             |    |  |             |    |  |              |    |  |             |   
|Research and development, net                           |  | 2,463          |    |  | 2,425       |    |  | 2,456        |    |  | 2,974       |    |  | 3,180       |    |  | 2,819       |    |  | 2,597        |    |  | 2,148       |   
|Selling and marketing                                   |  | 4,715          |    |  | 4,950       |    |  | 4,871        |    |  | 4,929       |    |  | 4,551       |    |  | 4,984       |    |  | 4,756        |    |  | 4,929       |   
|General and administrative                              |  | 1,580          |    |  | 1,486       |    |  | 1,670        |    |  | 1,597       |    |  | 1,565       |    |  | 1,686       |    |  | 1,620        |    |  | 1,765       |   
|goodwill write-off provision for doubtful accounts      |  |               |    |  |            |    |  | 1,052        |    |  |            |    |  |            |    |  |            |    |  |             |    |  |            |   
|Allowance for doubtful accounts and bad debt write-off  |  |               |    |  | 165         |    |  |             |    |  | 12          |    |  |            |    |  |            |    |  |             |    |  | (50         | ) 
|                                                        |  |                |    |  |             |    |  |              |    |  |             |    |  |             |    |  |             |    |  |              |    |  |             |   
|Total operating expenses                                |  | 8,758          |    |  | 9,026       |    |  | 10,049       |    |  | 9,512       |    |  | 9,296       |    |  | 9,489       |    |  | 8,973        |    |  | 8,792       |   
|Operating Income (loss)                                 |  | (6,640         | )  |  | (6,755      | )  |  | (13,408      | )  |  | (6,526      | )  |  | (5,755      | )  |  | (6,645      | )  |  | (9,932       | )  |  | (6,381      | ) 
|Financial income, net                                   |  | 547            |    |  | 865         |    |  | 756          |    |  | 625         |    |  | 200         |    |  | 146         |    |  | 243          |    |  | 737         |   
|                                                        |  |                |    |  |             |    |  |              |    |  |             |    |  |             |    |  |             |    |  |              |    |  |             |   
|Income (loss) before income taxes                       |  | (6,093         | )  |  | (5,890      | )  |  | (12,652      | )  |  | (5,901      | )  |  | (5,555      | )  |  | (6,499      | )  |  | (9,689       | )  |  | (5,644      | ) 
|Income taxes                                            |  | (325           | )  |  | (41         | )  |  | 14           |    |  | (104        | )  |  | 24          |    |  | 34          |    |  | 1,584        |    |  | 465         |   
|                                                        |  |                |    |  |             |    |  |              |    |  |             |    |  |             |    |  |             |    |  |              |    |  |             |   
|Net income (loss)                                       |  | (5,768         | )  |  | (5,849      | )  |  | (12,666      | )  |  | (5,797      | )  |  | (5,579      | )  |  | (6,533      | )  |  | (11,273      | )  |  | (6,109      | ) 
|                                                        |  |                |    |  |             |    |  |              |    |  |             |    |  |             |    |  |             |    |  |              |    |  |             |   
|Basic (loss) net earnings per share                     |  | (0.49          | )  |  | (0.49       | )  |  | (1.07        | )  |  | (0.49       | )  |  | (0.47       | )  |  | (0.55       | )  |  | (0.95        | )  |  | (0.51       | ) 
|                                                        |  |                |    |  |             |    |  |              |    |  |             |    |  |             |    |  |             |    |  |              |    |  |             |   
|Diluted net earnings (loss) per share                   |  | (0.49          | )  |  | (0.49       | )  |  | (1.07        | )  |  | (0.49       | )  |  | (0.47       | )  |  | (0.55       | )  |  | (0.95        | )  |  | (0.51       | ) 
|                                                        |  |                |    |  |             |    |  |              |    |  |             |    |  |             |    |  |             |    |  |              |    |  |             |   
|                                                        | 
|                                                        |  | Quarters Ended |   
|                                                        |  | Mar. 312003    |    |  | June 302003 |    |  | Sept.2003    |    |  | Dec. 312003 |    |  | Mar. 312004 |    |  | June 302004 |    |  | Sept.2004    |    |  | Dec. 312004 |   
|Revenues:                                               |  |                |    |  |             |    |  |              |    |  |             |    |  |             |    |  |             |    |  |              |    |  |             |   
|Products                                                |  | 75.4           | %  |  | 73.6        | %  |  | 70.1         | %  |  | 75.8        | %  |  | 71.2        | %  |  | 50.2        | %  |  | 48.8         | %  |  | 54.2        | % 
|Services                                                |  | 24.6           |    |  | 26.4        |    |  | 29.9         |    |  | 24.2        |    |  | 28.8        |    |  | 49.8        |    |  | 51.2         |    |  | 45.8        |   
|                                                        |  |                |    |  |             |    |  |              |    |  |             |    |  |             |    |  |             |    |  |              |    |  |             |   
|Total revenues                                          |  | 100.0          |    |  | 100.0       |    |  | 100.0        |    |  | 100.0       |    |  | 100.0       |    |  | 100.0       |    |  | 100.0        |    |  | 100.0       |   
|Cost of revenues:                                       |  |                |    |  |             |    |  |              |    |  |             |    |  |             |    |  |             |    |  |              |    |  |             |   
|Products                                                |  | 67.6           |    |  | 66.8        |    |  | 61.8         |    |  | 62.1        |    |  | 53.5        |    |  | 40.3        |    |  | 43.5         |    |  | 37.0        |   
|Services                                                |  | 13.7           |    |  | 13.5        |    |  | 15.5         |    |  | 12.9        |    |  | 15.5        |    |  | 29.0        |    |  | 35.6         |    |  | 27.2        |   
|Impairment of capitalized software development costs    |  |                |    |  |             |    |  | 53.1         |    |  |             |    |  |             |    |  |             |    |  | 34.2         |    |  | 11.4        |   
|                                                        |  |                |    |  |             |    |  |              |    |  |             |    |  |             |    |  |             |    |  |              |    |  |             |   
|Total cost of revenues                                  |  | 81.3           |    |  | 80.3        |    |  | 130.4        |    |  | 75.0        |    |  | 69.0        |    |  | 69.3        |    |  | 113.2        |    |  | 75.5        |   
|                                                        |  |                |    |  |             |    |  |              |    |  |             |    |  |             |    |  |             |    |  |              |    |  |             |   
|Gross profit                                            |  | 18.7           |    |  | 19.7        |    |  | (30.4        | )  |  | 25.0        |    |  | 31.0        |    |  | 30.7        |    |  | (13.2        | )  |  | 24.5        |   
|Operating expenses:                                     |  |                |    |  |             |    |  |              |    |  |             |    |  |             |    |  |             |    |  |              |    |  |             |   
|Research and development, net                           |  | 21.7           |    |  | 21.1        |    |  | 22.3         |    |  | 24.9        |    |  | 27.8        |    |  | 30.4        |    |  | 35.9         |    |  | 21.8        |   
|Selling and marketing                                   |  | 41.6           |    |  | 42.9        |    |  | 44.1         |    |  | 41.2        |    |  | 39.8        |    |  | 53.8        |    |  | 65.7         |    |  | 50.0        |   
|General and administrative                              |  | 13.9           |    |  | 12.9        |    |  | 15.2         |    |  | 13.3        |    |  | 13.7        |    |  | 18.2        |    |  | 22.4         |    |  | 17.9        |   
|goodwill write-off                                      |  | 0.0            |    |  | 0.0         |    |  | 9.5          |    |  | 0.0         |    |  |            |    |  |            |    |  |             |    |  |            |   
|                                                        |  |                |    |  |             |    |  |              |    |  |             |    |  |             |    |  |             |    |  |              |    |  |             |   
|allowance for doubtful accounts and bad debts write-off |  | 0.0            |    |  | 1.4         |    |  | 0.0          |    |  | 0.1         |    |  |            |    |  |            |    |  |             |    |  | (0.5        | ) 
|                                                        |  |                |    |  |             |    |  |              |    |  |             |    |  |             |    |  |             |    |  |              |    |  |             |   
|Total operating expenses                                |  | 77.2           |    |  | 78.3        |    |  | 91.1         |    |  | 79.5        |    |  | 81.3        |    |  | 102.4       |    |  | 123.9        |    |  | 89.2        |   
|                                                        |  |                |    |  |             |    |  |              |    |  |             |    |  |             |    |  |             |    |  |              |    |  |             |   
|Operating Income (loss)                                 |  | (58.5          | )  |  | (58.6       | )  |  | (121.5       | )  |  | (54.5       | )  |  | (50.3       | )  |  | (71.7       | )  |  | (137.2       | )  |  | (64.8       | ) 
|Financial income, net                                   |  | 4.8            |    |  | 7.5         |    |  | 6.9          |    |  | 5.2         |    |  | 1.7         |    |  | 1.6         |    |  | 3.4          |    |  | 7.5         |   
|                                                        |  |                |    |  |             |    |  |              |    |  |             |    |  |             |    |  |             |    |  |              |    |  |             |   
|Income (loss) before Income taxes                       |  | (53.7          | )  |  | (51.1       | )  |  | (114.7       | )  |  | (49.3       | )  |  | (48.6       | )  |  | (70.1       | )  |  | (133.8       | )  |  | (57.3       | ) 
|Income Taxes                                            |  | (2.8           | )  |  | (0.4        | )  |  | 0.1          |    |  | (0.9        | )  |  | 0.2         |    |  | 0.4         |    |  | 21.9         |    |  | 4.7         |   
|                                                        |  |                |    |  |             |    |  |              |    |  |             |    |  |             |    |  |             |    |  |              |    |  |             |   
|Net income (loss)                                       |  | (50.9          | )% |  | (50.7       | )% |  | (114.8       | )% |  | (48.4       | )% |  | (48.8       | )% |  | (70.5       | )% |  | (155.7       | )% |  | (62.0       | )%
|                                                        |  |                |    |  |             |    |  |              |    |  |             |    |  |             |    |  |             |    |  |              |    |  |             |   



47



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B. Liquidity and Capital Resources



We had cash
and cash equivalents, marketable securities and bank deposits of $48.1 million for the year ended December 31, 2002, $35 million for the year ended December 31, 2003 and $20.4 million for the year ended December 31, 2004.



Our operating activities provided (used) cash of $1.9 million for the year ended December 31,
2002, $(11.1) million for the year ended December 31, 2003 and $(13.8) million for the year ended December 31, 2004.



Our capital expenditures were $0.9 million in 2004, $2.1 million in 2003 and $3.1 million in 2002. Our capital investments for improvements of leased premises were $0.3
million in 2002 and $0.2 million in 2003. We did not invest in improvements of leased premises in 2004. We also invested $2 million in 2002 in the development of our Service View management program, which investments were capitalized in our
financial statements. We did not capitalize any amount invested for development in 2003 and 2004.



We do not have any off-balance-sheet concentration of credit risk, such as foreign exchange contracts, option contracts or other foreign hedging arrangements. We may be subject to concentrations of credit risk from
financial instruments, consisting principally of cash and cash equivalents, short-term bank deposits, trade and unbilled receivables and investments in marketable securities. We invest our cash and cash equivalents and marketable securities in US$
deposits with major Israeli and U.S. banks. We believe that the financial institutions that hold our investments are financially sound, and, accordingly, minimal credit risk exists with respect to these investments.



In January 2005, we issued 6,636,389 Series A Convertible Preferred Shares to investors in a
private placement transaction, at a price per share of $2.20, for an aggregate investment of approximately $14.6 million (before expenses). We also issued to the investors in the private placement transaction warrants to purchase the number of
ordinary shares equal to 40% of the number of Series A Preferred Shares purchased by them, exercisable for a period of six years, at an exercise price per share of $2.50.



Management believes our cash, and cash equivalents reserve, including the proceeds from the private placement transaction mentioned above,
as well as cash flow from our operations in 2005, will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for the next twelve months. However, if we carry out acquisitions of other companies or new
technologies by paying cash, there may be a need to raise additional capital by issuing debt or equity during the year.



48



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Market Risk



For information on our market risk, see Item 11 Quantitative and Qualitative Disclosures About Market Risk.



Grants from the Office of the Chief Scientist



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



Under the R&D Law, research and development programs that meet specified criteria and are approved by the research
committee of the Office of the Chief Scientist are eligible for grants of up to 50% of certain approved expenditures of such programs, as determined by the research committee of the Chief Scientist.



In exchange, the recipient of such grants is required to pay the Office of
the Chief Scientist royalties from the revenues derived from products incorporating know-how developed within the framework of each such program or derived from such program (including ancillary services in connection with such program), usually up
to an aggregate of 100% of the dollar-linked value of the total grants received in respect of such program, plus interest. The royalty rates applicable to our programs range from 3% to 3.5%.



The R&D Law generally requires that the product developed under a program
be manufactured in Israel. However, upon the approval of the Chief Scientist, some of the manufacturing volume may be performed outside of Israel, provided that the grant recipient pays royalties at an increased rate, which may be substantial, and
the aggregate repayment amount is increased up to 300% of the grant, depending on the portion of the total manufacturing volume that is performed outside of Israel. Effective April 1, 2003, the R&D Law also allows for the approval of grants in
cases in which the applicant declares that part of the manufacturing will be performed outside of Israel or by non-Israeli residents and the research committee is convinced that doing so is essential for the execution of the program. This
declaration will be a significant factor in the determination of the Office of Chief Scientist whether to approve a program and the amount and other terms of benefits to be granted. For example, the increased royalty rate and repayment amount will
be required in such cases.



The R&D Law also provides that
know-how developed under an approved research and development program may not be transferred to third parties in Israel without the approval of the research committee. Such approval is not required for the sale or export of any products resulting
from such research or development. The R&D Law further provides that the know-how developed under an approved research and development program may not be transferred to any third parties outside Israel.



In March 2005, an amendment to the R&D Law was approved by Israels
Parliament, which amendment is intended to make the R&D Law more compatible with the global business environment by, among other things, relaxing restrictions on the transfer of manufacturing rights outside Israel and on the transfer of
OCS-funded know-how outside of Israel. As described above, currently, the law permits the Office of the Chief Scientist to approve the transfer of manufacturing rights outside Israel, in exchange for payment of higher royalties. The amendments
further permit the Office of the Chief Scientist, among other things, to approve the transfer of manufacturing rights outside Israel in exchange for an import of different manufacturing into Israel as a substitute, in lieu of increased



49



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royalties. The amendment further permits, under certain circumstances and subject to the Office of the Chief Scientists prior approval, the transfer
outside Israel of know-how that has been funded by Office of the Chief Scientist, generally in the following cases: (a) the subject company pays to the Office of the Chief Scientist a portion of the consideration paid for such funded know-how
(according to certain formulas), or (b) the subject company receives know-how from a third party in exchange for its funded know-how, or (c) such transfer of funded know-how arises in connection with certain types of cooperation in research and
development activities. Said amendment will come into effect on June 7, 2005. To our knowledge, the Israeli government intends to amend the royalty regulations promulgated under the R&D Law to reflect said amendments. Such amendment to the
regulations may also include an update to the royalty rates.



The R&D Law imposes reporting requirements with respect to certain changes in the ownership of a grant recipient. The law requires the grant recipient and its controlling shareholders and interested parties to notify the Office of the
Chief Scientist of any change in control of the recipient or a change in the holdings of the means of control of the recipient that results in a non-Israeli becoming an interested party directly in the recipient and requires the new interested party
to undertake to the Office of the Chief Scientist to comply with the R&D Law. In addition, the rules of the Office of the Chief Scientist may require prior approval of the Office of the Chief Scientist or additional information or
representations in respect of certain of such events. For this purpose, control is defined as the ability to direct the activities of a company other than any ability arising solely from serving as an officer or director of the company.
A person is presumed to have control if such person holds 50% or more of the means of control of a company. Means of control refers to voting rights or the right to appoint directors or the chief executive officer. An interested
party of a company includes a holder of 5% or more of its outstanding share capital or voting rights, its chief executive officer and directors, someone who has the right to appoint its chief executive officer or at least one director, and a
company with respect to which any of the foregoing interested parties owns 25% or more of the outstanding share capital or voting rights or has the right to appoint 25% or more of the directors. Accordingly, any non-Israeli who acquires 5% or more
of our ordinary shares will be required to notify the Office of the Chief Scientist that it has become an interested party and to sign an undertaking to comply with the R&D Law.



The funds available for Office of the Chief Scientist grants out of the annual budget of the State of Israel have been
reduced in the past and may be further reduced in the future. We cannot predict whether, if at all, we would be entitled to any future grants or the amounts of any such grants.



C. Research and Development, Patents and Licenses



Our research and development efforts are focused on developing new products to meet the evolving needs of communications service providers and equipment vendors and on improving existing products by incorporating new features, interfaces
and technologies. We believe that the timely development of new products and enhancements is essential to maintaining our competitive position in the marketplace.



We currently employ 160 full-time employees in research and development. Gross research and development expenses were approximately $11.3
million, or 19.4% of our revenues, for the year ended December 31, 2002. Gross research and development expenses were approximately $10.5 million, or 22.9% of our revenues, for the year ended December 31, 2003. Gross research and development
expenses were approximately $11.3 million, or 30% of our revenues, for the year ended December 31, 2004. For information on our research and development expenditures and grants we



50



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received, see Item 5A  Results of Operations  Research and Development. We anticipate that we will commit increasing amounts to
research and development in future periods.



As a recipient of grants from the
Office of the Chief Scientist, we are obligated to perform all manufacturing activities for projects subject to the grants in Israel unless we receive an approval to perform any portion of them outside of Israel. Know-how from the research and
development which is used to produce these products may not be transferred to third parties without the approval of the Office of the Chief Scientist. Approval is not required for the sale or export of any products resulting from the research and
development based on these grants. For further information regarding the Office of the Chief Scientist of the Israeli Ministry of Industry and Trade, see Item 5B  Liquidity and Capital Resources Grants from the Office of the
Chief Scientist.



D. Trend Information



General.The
deterioration of the global economy in general and economic uncertainty in the communications industry in particular has resulted in a decline of capital investment by communications service providers, and in the communications industry in
particular, has significantly reduced spending by communications service providers since late 2000. Many new and small communications service providers have failed and existing communications service providers have been reducing or delaying
expenditures on new equipment and applications. The attacks of September 11, 2001, caused a further decline in the global economy. As a result, many companies, including current and potential customers of ours, have indicated that they plan to
postpone or decrease further capital investment. We believe that this slow-down in communications-related spending will continue compared to the level of investments before the year 2000. Recently, published studies indicated an increase in spending
by telecom operators that might result in an increased demand for OSS\BSS solutions. This is shown in various indicators such as in the number of proposal requests that communication service providers are issuing, the new services being announced by
communication service providers and the new technologies deployed by such communication service providers. However, we are unable to predict the duration of this trend or the extent of any impact that it may have on our results of operations. If
this trend reverses and the slow-down in capital expenditures resumes, it would reduce our sales and could result in pressure on the price of our products, each of which would have a material adverse effect on our operating results.



Composition of revenue.In recent years, our revenues from services as a percentage
out of total revenues has been increasing due primarily to recurring orders and the entering into new maintenance contracts whereas our sales of new products contracts was slowed down. Due to these conflicting trends as well as numerous factors
beyond our control, we cannot predict at this time whether the year-by-year increase in revenues from services out of our overall revenues will continue in 2005.



E. Off-Balance Sheet Arrangements



We have no
off-balance sheet arrangements.



51



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F. Tabular Disclosure of Contractual Obligations



The following table sets forth, as of December 31, 2004, our known contractual obligations by type of obligation and for the periods indicated:



|                                                      |       |                                          |                 |       |           |       |           |  |                 | 
|----------------------------------------------------- | ----- | ---------------------------------------- | --------------- | ----- | --------- | ----- | --------- |  | --------------- | 
|Contractual Obligations                               |       | Payment due by period (in thousands US$)
|                                                      | Total |                                          | Less than1 year |       | 1-3 years |       | 3-5 years |  | morethan 5years
|Operating Lease Obligations (facilities and vehicles) |       | 3,171                                    |                 | 1,473 |           | 1,697 |           |  |                 | 



Additional contractual obligations
relating to royalty commitments to the Chief Scientist and the BIRD Foundation are as set forth above in Item 5A - Operating Results  Research and Development.



|Item 6. | DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
|------- | ------------------------------------------



A. Directors and Senior Management



Our directors and officers are as follows:



|                  |  |     |  |                                                         
|----------------- |  | --- |  | --------------------------------------------------------
|Name              |  | Age |  | Position                                                
|Meir Lipshes      |  | 59  |  | Chairman of the Board and acting Chief Executive Officer
|Meir Dvir         |  | 74  |  | Director                                                
|Rami Zivony       |  | 53  |  | Director                                                
|Doron Zinger      |  | 52  |  | Director                                                
|Ilan Toker        |  | 35  |  | Director                                                
|Lior Bregman      |  | 46  |  | Director                                                
|Israel Ofer       |  | 50  |  | Chief Financial Officer                                 
|Alon Zelzion      |  | 53  |  | Executive Vice President of Sales                       
|Avshalom Ben-Zoor |  | 45  |  | Vice President of Business Development                  
|Hanun Dvey-Aharon |  | 58  |  | Vice President of Development Group                     
|Shahar Ebel       |  | 35  |  | Chief Technology Officer                                
|Dubi Yoeli        |  | 44  |  | Vice President solution Engineering                     
|Nava Pollak       |  | 47  |  | Vice President of Human Resources                       



Meir Lipshes
has served on our board of directors since we commenced independent operations in September 1992 and was appointed our acting Chief Executive Officer in March 2005 on an interim basis. On December 29, 2004, Mr. Lipshes became the Chairman of our
board of directors. Mr. Lipshes also served as our Chief Executive Officer from January 1996 through September 2004. Mr. Lipshes continues to be engaged by us in the capacity of Executive Director. Mr. Lipshes was one of the founders and is a
current shareholder of Team, our former principal shareholder, served as Teams President from 1972 to May 1995 and as its Chief Executive Officer from May 1995 until September 1996. Mr. Lipshes also served as acting President of Omnitek-Eichut
Ltd. from



52



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November 1994 until September 1996. Mr. Lipshes has been a director of Team since 1972 and a director of Omnitek since 1979. From 1970 to 1972, he was
employed in the electronics and engineering division at Motorola Israel, where he was one of the founders of the computing department. He also served as a development engineer for encoding equipment in the Signal Corps of the Israel Defense Forces.
Mr. Lipshes has a degree in electronics from the Technical School of the Israeli Air Force.



Meir Dvir became a director in 1997. Since 1999, Dr. Dvir has served as a director of Bank Leumi B.M. and Israel Military Industries. Since 1998, Mr. Dvir has served as a director of Intergamma Ltd. Since 1996,
Dr. Dvir has served as a director of TAT Technologies. Since 1994, Dr. Dvir has served as President of Dea Shnia Ltd., a consulting company. Dr. Dvir additionally has held the following positions, among others: Executive Vice President of R&D
and Business Development at Israel Aircraft Industries from 1985 to 1994, Director of the Aircraft Division of Israel Aircraft Industries from 1987 to 1989, Chief Operating officer of Elscint Ltd., a publicly-held Israeli high technology and defense
company from 1984 to 1985, and President of Elta, a subsidiary of Israeli Aircraft Industries, from 1998, to 1983. Dr. Dvir holds a Masters Degree and a Ph.D. in physics from the Hebrew University, Israel.



Rami Zivonybecame a director in 2003. He also served as a director of
TTI from the commencement of its independent operations in 1992 through 1998. From 2003 until February 2004, Mr. Zivony was the Chief Executive Officer of CelleBrite Ltd., a company engaged in manufacturing and marketing universal memory exchangers
for cellular telephones. From 2000 through 2002, Mr. Zivony served as Chief Executive Officer of Callscape Inc., a start-up company he founded, which engaged in the development of a system to enhance the availability of telephone users, especially
cellular users. During 1999, Mr. Zivony acted as Chief Executive Officer of Madah-Com Ltd., a start-up company engaged in wireless public announcement systems. From 1983 through 1998, Mr. Zivony was employed with Team Computers, in various
capacities, including as Joint Chief Executive Officer. Mr. Zivony received a Masters Degree in Business (with honors) from The Technion  Israel Institute of Technology.



Doron Zinger became a director in 2004. Mr. Zinger currently operates Zinger Communications, an independent
communications consulting company, and is a venture partner (Telecommunications) with Giza Venture Capital Fund, a member of the Board of Directors of Vsecure Ltd. Effective May 31, 2005, he will become the chief executive officer of RiT
Technologies Ltd., a Nasdaq-listed company engaged in providing physical network infrastructure control and management solutions. Mr. Zinger was a member of the Advisory Board of Iamba Technologies Limited until October 2004, member of the Advisory
Board of Main.net communications Ltd until June 2004 and a member of the Advisory Board of cellot until December 2004. From February through July 2000, Mr. Zinger served as Chief Executive Officer of Lambda Crossing Ltd., a start-up company engaged
in the development of electro optic components for optical communications networks. From 1997 through 2000, Mr. Zinger served as President and Chief Executive Officer of VocalTec Communications Ltd., a leading company in the emerging IP telephony
industry. From 1980 through 1997, Mr. Zinger held various technical, marketing and management positions at ECI Telecom Ltd., a leading provider of telecommunications equipment worldwide, including: Senior Vice President and Chief Operating Officer
from 1995 through 1997, Corporate Vice President and General Manager DCME SBU from 1993 through 1995, and Director of Marketing and SalesTelecommunications Products from 1991 through 1993. Mr. Zinger received a B.Sc. Degree from The
TechnionIsrael Institute of Technology in 1975, and an MBA from Tel Aviv University in 1991. Mr. Zinger is a Major (Res.) in the Israeli Navy.



Ilan Toker became a director in 2004. Mr. Toker is an executive of Arad Investments and Industry Development Ltd. (a company the shares of which
are publicly traded on the Tel Aviv Stock Exchange), where he has served as the acting Chief Executive Officer since 2002, and as the Chief Financial Officer since 2000. From 1997 to 2000, Mr. Toker was the Chief Financial Officer of Isras



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Investment Company Ltd. (a company the shares of which are publicly traded on the Tel Aviv Stock Exchange). Mr. Toker is a director of Hasin Aish Ceramic
Products Company (1990) Ltd. (a company the shares of which are publicly traded on the Tel Aviv Stock Exchange). Mr. Toker holds a BA in accounting and economics and an MBA degree, both from Tel Aviv University.



Lior Bregman became a director in 2004. Mr. Bregman is a private
investor. From 1988 to 2001 Mr. Bregman served as a Managing Director with CIBC/Oppenheimer. Mr. Bregman was involved in the development of CIBC/Oppenheimers high technology effort and was responsible for its telecommunication equipment
research effort in general and the wireless communication area in particular, as well as its research on defense and Israeli companies. Mr. Bregmans work was recognized by the Wall Street Journal and Institutional Investor All Star surveys.
Until 2001 Mr. Bregman was also a partner in Genesis I, an Israeli-based venture capital fund, and also served on the investment committee of Genesis II. Prior to joining CIBC/Oppenheimer, Mr. Bregman served as a research analyst at Hambrecht &
Quist. Mr. Bregman is currently a director of ViryaNet. Mr. Bregman received his MBA from Stanford University in 1986, and his BA from the Hebrew University of Jerusalem.



Israel Ofer, Chief Financial Officer, joined us in September 1996. From 1984 to September 1996, Mr. Ofer was the
Chief Financial Officer and Comptroller of TAT Technologies, a group of high-technology companies based in Israel and traded on Nasdaq and the Tel Aviv Stock Exchange. From 1982 to 1984, Mr. Ofer worked as Accounting Supervisor and Administrative
Manager at Amcor Ltd., an Israeli appliance manufacturer. He was previously an accountant at Maadanot and an inspector at the Israeli Income Tax Authority. Mr. Ofer earned a Bachelor of Arts degree in Finance and Accountancy from Tel Aviv
University. He is a certified public accountant in Israel.



Alon Zelzion,Executive Vice President of Sales, joined us in January 2005. Alon Zelzion is a 25-year veteran in the software and telecommunications industry, and has held senior leadership positions in general management, sales,
marketing, business development and R&D. Mr. Zelzion was a co-founder of several successful technology companies in the U.S. and Israel, most notably Given Imaging Ltd. and Scorpio Communication, a developer of ATM chip and sub-systems, which
was acquired by U.S. Robotics. Mr. Zelzion also served from 1998 to 2001 as chief operating officer of Vsoft, a developer of software for management of broadcast video over IP networks, and from 1989 to 1992 as President of Ace Communications Inc.,
a developer of data communications and networking systems. Mr. Zelzion holds a BSc in Electrical and Computer Engineering from California State Polytechnic University, and an MSc in Engineering from California State University.



Avshalom Ben-Zoor,joined us in September 2003 as Sales Marketing
General Manager and was appointed Vice President of Business Development in April 2005. Mr. Ben-Zoor has seventeen years of experience in the telecommunications industry, an extensive background in software development, and management expertise.
Prior to his current position, Mr. Ben-Zoor served as System Engineering Manager at TTI and led the development of our Netrac product suite. Before joining us, from 1993 to 2003 Mr. Ben-Zoor held various positions at ECI Telecom Ltd., including AVP,
R&D Management Systems at ECI Telecom Ltd., a leading global provider of telecommunications solutions to service providers. Prior to ECI Telecom, Mr. Ben-Zoor worked at RAD Data Communications, a manufacturer of access equipment for data
applications. Mr. Ben-Zoor holds a BA in Management Information Systems and Marketing from Pace University, New York.



Hanun Dvey-Aharon,Vice President Development Group,joined us in March 2004.Hanun Dvey-Aharon brings more than two decades of
R&D management experience to the product group. Prior to joining us, Dr. Dvey-Aharon served from September 2000 to January 2004 as AVP Technology at Ofek, an NGN Telecom Professional Services group. Prior to that, he worked at Telrad Networks as
Director of Network Management Systems, and at Elbit Systems as Technical and



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Software Development Director. Dr. Dvey-Aharon holds a BSc in Physics from the Technion-Israel Institute of Technology and an MSc in Computer Science from
Case Western Reserve University.



Shachar Ebel,Chief
Technology Officer, joined us in March 2004. From September 2000 to January 2004, Mr. Ebel has held various positions at Ofek, the NGN Telecom Professional Services group, including Chief System Engineer and Senior OSS Consultant for Bezeq. Prior to
that, Mr. Ebel was System Engineering Department Manager for OSS Solutions at Telrad Networks, where he was responsible for managing large-scale project engineering. Mr. Ebel holds a BSc in Electronic Engineering and an MBA from Tel Aviv University.



Duby Yoeli,Vice President Solution Engineering, joined
us in 2001 as Engineering Group Manager, responsible for telecom solutions and professional services. He has held telecom management positions since 1989, when he joined Bezeq as an engineer. After ten years at Bezeq as NMC Engineer and then
manager, Mr. Yoeli joined Partner (Orange IL), where he started as NOC manager, taking part in building the new field of GSM operator network rollout. Mr. Yoeli holds a BSc in Electrical Engineering from the Technion-Israel Institute of Technology.



Nava Pollak, Vice President Human Resources, joined us
in December 2004. Before joining us, Ms. Pollak served since 2001 as VP human resources at Xpert, an international provider of security and business continuity solutions. Prior to that, Ms. Pollak was HR manager at Motorola Israel. Before Motorola,
Ms. Pollak was head of training at the Israeli Management Institute. Ms. Pollak holds a BA in mathematics and computers from Haifa University and an MSc in organizational behavior from the Technion-Israel Institute of Technology.



There are no family relationships between any of the directors or members of senior
management named above.



Recent Management Changes



During 2004 and through March 2005, we underwent several key changes to our management team:



| |  |  | in March 2005, Menahem Tirosh resigned from his position as our Chief Executive Officer. Meir Lipshes is serving as our acting Chief Executive Officer until we employ a new Chief
Executive Officer;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | in December 2004, Shlomo Eisenberg, who has been our Chairman since our inception in September 1992, ceased to be a member of our board of directors; and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | several other members of our senior management left the employ of TTI, including Roni Eldar, who was our President from August 1996 to April 2004 and continues to advise us as a
consultant.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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B. Compensation



Compensation to Directors:



In 2004, our directors, other than Meir Lipshes, and our former
director, Shlomo Eisenberg, received annual compensation of approximately $10,500 each and approximately $380 (approximately $190 per telephone meetings) per board meeting or per board committee meeting in which they participate. We paid our
directors, other than Meir Lipshes, and our former director, Shlomo Eisenberg, the aggregate amount of approximately $98,137 in 2004, out of which $62,783 were paid in respect of their services in 2004. Our directors other than Meir Lipshes will
continue to receive the aforesaid compensation in 2005.



In 2004, we were
obligated to pay monthly management fees of NIS 30,000 to our former Chairman, Shlomo Eisenberg, and NIS 60,000 to Meir Lipshes, our current Chairman, linked to the Israeli Consumer Price Index, or CPI. As of December 31, 2004, we paid monthly
management fees of NIS 31,696 ($7,357 according to the exchange rate prevailing on December 31, 2004) to Shlomo Eisenberg, and NIS 63,392 ($14,715 according to the exchange rate prevailing on December 31, 2004) to Meir Lipshes.



Total compensation paid to Shlomo Eisenberg and Meir Lipshes during 2004 was $343,181, out of
which approximately $84,050 was in respect of amounts accrued during 2003. Total compensation paid to Shlomo Eisenberg and Meir Lipshes during 2003 was $227,336, out of which $73,750 was in respect of amounts accrued during 2002. The total amount of
the compensation paid during 2004 includes pension, retirement and similar benefits. We no longer pay management fees to Shlomo Eisenberg. Since January 1, 2005, we pay Meir Lipshes a monthly salary of NIS 80,000 (approximately $18,600 according to
the exchange rate prevailing on December 31, 2004) linked to the CPI, plus applicable social benefits.



In November 2001, our board of directors authorized the grant of options to purchase up to an additional 15,000 Ordinary Shares to Shlomo Eisenberg (which options have been expired), and options to purchase up to an
additional 20,000 Ordinary Shares to Meir Lipshes. Out of the 20,000 options granted to Meir Lipshes, 16,000 options have an exercise price of $19.00 per share, and 4,000 options have an exercise price of $30.00 per share. These options are
currently fully exercisable. These options expire on November 9, 2005. These option grants were approved by our shareholders in October 2002.



In November 2004, our board of directors authorized the grant of options to purchase up to an additional 75,000 Ordinary Shares to Meir Lipshes, at an exercise price of
$3 per share. On December 29, 2004, the option grant to Meir Lipshes was approved by our shareholders. Of the options granted to Meir Lipshes, 18,750 of these options vested immediately, 18,750 of these options vest on July 1, 2005, 18,750 of these
options vest on January 1, 2006 and 18,750 of these options vest on July 1, 2006. The options expire on October 15, 2008



Compensation to executive officers:



Total compensation during 2004 to the members of senior management amounted to approximately $1.9 million. This amount includes special bonuses, pension, retirement and
similar benefits amounting to approximately $356,000. These figures for compensation include amounts paid in 2004 to members of senior management whom we are no longer employ.



Our employment agreements with our executive officers located in Israel, including those that are also members of our board of directors,
provide for standard Israeli benefits, which are managers insurance and educational fund payments. We make payments in this context as follows: pension -



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5.0% of gross salary; severance pay - 8.33% of gross salary; loss of earning capacity - up to 2.5% of gross salary; and educational fund - 7.5% of gross
salary. With respect to some of our employees, such payments are made based on 75% to 85% of their gross salary.



In November 2001, certain of these members of senior management (other than Shlomo Eisenberg and Meir Lipshes), were granted options to purchase a total of up to 53,333
ordinary shares for an exercise price of either $19 or $30 each. 15,000 of these options are currently outstanding and fully exercisable. The expiration date of these options is November 9, 2005.



In May 12, 2004, certain of these members of senior management (other than Shlomo Eisenberg
and Meir Lipshes) were granted options to purchase a total of up to 80,000 ordinary shares for an exercise price of either $6 or the higher of $8 or the average of the market price in the 30 days prior to the end 12 months from the date the option
was granted (i.e., the period between April 12, 2005 and May 11, 2005). 40,000 of these options vest on May 12, 2005 and 40,000 of these options vest on May 12, 2006. These options expire on September 30, 2009.



C. Board Practices.



We are subject to the
provisions of the Israeli Companies Law, 5759-1999, or the Israeli Companies Law, and the regulations adopted thereunder. In addition, as a Nasdaq-listed company, we also subject to certain corporate governance standards adopted by Nasdaq.



Board of Directors



The management of our business is vested in our board of directors, which may exercise all
such powers and do all such acts as we are authorized to exercise and do, and are not, by the provisions of our articles of association or by law, required to be exercised or done by our shareholders. Our board of directors may, in its discretion,
cause our company to borrow or secure the payment of any sum or sums of money for the purposes of our company, at such times and upon such terms and conditions in all respects as it thinks fit, and, in particular, by the issuance of bonds, perpetual
or redeemable debentures, debenture stock, or any mortgages, charges, or other securities on the undertaking or the whole or any part of the our property, both present and future, including its uncalled or called but unpaid capital for the time
being.



Our articles of association provide for a board of directors of not
less than three and not more than seven members. Each director is elected at the annual general meeting of shareholders and holds office until the election of his successor at the next annual general meeting, except for external directors, who hold
office for three-year terms and may be re-elected by the shareholders for an additional three-year term. We recently amended our Articles of Association to provide that, notwithstanding the foregoing, for so long as at least 50% of the Series A
Preferred Shares issued under the Purchase Agreement dated November 29, 2004 remain outstanding, the holders of a majority of the outstanding Series A Preferred Shares are entitled to appoint, elect, remove and replace one director to our board of
directors.



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Under new Nasdaq Marketplace Rules, effective as of July 31, 2005, absent an exemption therefrom, a majority of our board
of directors must qualify as independent directors within the meaning of the Nasdaq Marketplace Rules. We intend to comply with such standard by July 31, 2005, or seek an exemption therefrom if we deem appropriate and available.



Alternate Directors



Our articles of association provide that a director may appoint, by written notice to the Company, any individual who is not a member of the
board of directors, to serve as an alternate director. An external director may not appoint an alternate director, except in very limited circumstances. Any alternate director shall have all of the rights and obligations of the director appointing
him or her, except the power to appoint an alternate. The alternate director may not act at any meeting at which the director appointing him or her is present and may not act as the alternate for several directors. Unless the time period or scope of
any such appointment is limited by the appointing director, such appointment is effective for all purposes and for an indefinite time, but expires upon the expiration of the appointing directors term. Notwithstanding the foregoing, a director
may serve as an alternate director on any committee of our board of directors of which he or she is not already a member. At present, there are no appointments of alternate directors.



External Directors



Qualifications of External Directors



Under the Israeli Companies Law, companies incorporated under the laws of Israel whose shares have been offered to the public in or outside of Israel, are required to
appoint at least two external directors. The Companies Law provides that a person may not be appointed as an external director if the person or the persons relative, partner, employer or any entity under the persons control, has, as of
the date of the persons appointment to serve as external director, or had, during the two years preceding the date of appointment, any affiliation with the company, any entity controlling the company or any entity controlled by the company or
by this controlling entity. The term affiliation includes:



| |  |  | an employment relationship;
| | - |  | ---------------------------



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



| |  |  | control; and
| | - |  | ------------



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



The Companies Law defined the term office holder of a company to include a director, the chief executive officer, the chief business manager, a vice president and any officer that reports directly to the
chief executive officer. No person can serve as an external director if the persons position or other business creates, or may create, conflict of interests with the persons responsibilities as an external director. Until the lapse of
two years from termination of office, a company may not engage an external director to serve as an office holder and cannot employ or receive services from that person, either directly or indirectly, including through a corporation controlled by
that person.



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Election of External Directors



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



| |  |  | including at least one third of the shares of non-controlling shareholders voted at the meeting in favor of election; or
| | - |  | ------------------------------------------------------------------------------------------------------------------------



| |  |  | the total number of shares voted against the election of the external director does not exceed one percent of the aggregate voting rights in the company.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------



The initial term of an external director is three years and may be extended for an
additional three years. External directors may be removed from office only by the same percentage of shareholders as is required for their election, or by a court, and then only if the external directors cease to meet the statutory qualifications
for their appointment or if they violate their duty of loyalty to the company. Each committee of a companys board of directors is required to include at least one external director. Rami Zivony commenced his term as an external director on
August 11, 2003. Doron Zinger commenced his term as an external director on April 1, 2004.



An external director is entitled to compensation as shall be provided in regulations under the Companies Law and is otherwise prohibited from receiving any other compensation, directly or indirectly, in connection
with service provided as an external director. We do not have, nor do our subsidiaries have, any directors service contracts granting to the directors any benefits upon termination of their employment.



Committees of the Board



Subject to the provisions of the Companies Law, our board of directors may delegate its powers to committees consisting of board members.
Our board of directors established only the following committee:



Audit
Committee



Under the Companies Law, our board of directors is required to
appoint an audit committee, comprised of at least three directors including all of the external directors, but excluding:



| |  |  | the chairman of the board of directors;
| | - |  | ---------------------------------------



| |  |  | any director who is employed by the company or provides services to the company on a regular basis; and
| | - |  | -------------------------------------------------------------------------------------------------------



| |  |  | a controlling shareholder or its relative.
| | - |  | ------------------------------------------



The role of the audit committee is to examine flaws in the business management of the company, in consultation with the internal auditor and the companys
independent accountants and suggest appropriate course of action and to approve certain related-party transactions.



An audit committee may not approve a related-party transaction under the Companies Law, unless at the time of approval the two external directors are serving as members
of the audit committee and at least one of whom was present at the meeting in which an approval was granted. The current members of our audit committee are Rami Zivony and Doron Zinger, our two external directors, and Meir Dvir.



Since our ordinary shares are listed on Nasdaq, we are also subject to Nasdaq rules and
listing requirements. As a foreign private issuer, we received an exemption from the listing requirements of Nasdaq relating to audit committees that were adopted in 2000, such as the requirement to adopt an audit committee charter (which we
recently adopted) and that all three members of our audit



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committee be independent directors under the Nasdaq definition. Under current Nasdaq and SEC rules, effective as of July 31, 2005, our Audit
Committee must have at least three members and generally be comprised only of independent directors, each of whom satisfies the respective independence requirements of the SEC and Nasdaq. In addition, current Nasdaq rules require all of
the members of the Audit Committee to be financially literate and one of whom must possess accounting or related financial management expertise. We intend to comply with such rules on or prior to July 31, 2005, or seek an exemption therefrom if we
deem appropriate and available.



Internal Auditor



Under the Companies Law, the board of directors must also appoint an internal auditor
proposed by the audit committee. The role of the internal auditor is to examine whether the companys actions comply with the law, integrity and orderly business procedure. Under the Companies Law, the internal auditor may be an employee of the
company, but may not be an interested party, an office holder or a relative of any of the foregoing, nor may the internal auditor be the companys independent accountant or its representative. Our internal auditor in accordance with the
requirements of the new Companies Law is Yardeni Gelfand & Co. C.P.A (ISR).



Indemnification and D&O Insurance



We have agreed to
indemnify our office holders to the fullest extent permitted under Israeli law, but up to a maximum aggregate amount for all indemnified office holders equal to 25% of our total shareholders equity at the time of actual indemnification. We
currently maintain directors and officers liability insurance for the benefit of our office holders. For more details, see in Item 10C below under the caption Exculpation, Insurance and Indemnification of Office
Holders.



Fiduciary Duties of Office Holders



The Companies Law imposes a duty of care and a duty of loyalty on all
office holders of a company. The duty of care requires an office holder to act with the level of care with which a reasonable office holder in the same position would have acted under the same circumstances.



The duty of care of an office holder includes a duty to use reasonable means to obtain:



| |  |  | information on the advisability of a given action brought for his approval or performed by him by virtue of his position; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------



| |  |  | all other important information pertaining to these actions.
| | - |  | ------------------------------------------------------------



The duty of loyalty of an office holder includes a duty to:



| |  |  | refrain from any conflict of interest between the performance of his duties in the company and the performance of his other duties or his personal affairs;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | refrain from any activity that is competitive with the company;
| | - |  | ---------------------------------------------------------------



| |  |  | refrain from exploiting any business opportunity of the company to receive a personal gain for himself or others; and
| | - |  | ---------------------------------------------------------------------------------------------------------------------



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| |  |  | disclose to the company any information or documents relating to a companys affairs which the office holder has received due to his position as an office holder.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------



Under the Companies Law, the approval of the board of directors
is required for all compensation arrangements of office holders who are not directors. Under the Companies Law, directors compensation arrangements require the approval of the audit committee, the board of directors and the shareholders, in
that order.



Related-Party Transactions



The Companies Law requires that an office holder of a company disclose to the company,
promptly and in any event no later than the board of directors meeting in which the transaction is first discussed, any personal interest that he may have and all related material information known to him, in connection with any existing or proposed
transaction by the company. In the case of an extraordinary transaction, the office holders duty to disclose applies also to a personal interest held by:



| |  |  | the office holders spouse, siblings, parents, grandparents, descendants, spouses descendants and the spouses of any of the these people; or
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | any corporation in which the office holder is a 5% or greater shareholder, director or general manager or in which the office holder has the right to appoint at least one director
or the general manager.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Under Israeli law, an extraordinary
transaction is a transaction:



| |  |  | other than in the ordinary course of business;
| | - |  | ----------------------------------------------



| |  |  | otherwise than on market terms; or
| | - |  | ----------------------------------



| |  |  | that is likely to have a material impact on the companys profitability, assets or liabilities.
| | - |  | -----------------------------------------------------------------------------------------------



Under the Companies Law, once an office holder complies with the above disclosure requirement, the board of directors may approve a
transaction between the company and an office holder, or a third party in which an office holder has a personal interest. A transaction that is adverse to the companys interest may not be approved.



If the transaction is an extraordinary transaction, approval of both the audit committee and
the board of directors is required. Under specific circumstances, shareholder approval may also be required. A director who has a personal interest in an extraordinary transaction which is considered at a meeting of the board of directors or the
audit committee generally may not be present at this meeting or vote on such transaction, unless a majority of members of the board of directors or the audit committee, as the case may be, has a personal interest. If a majority of the members of the
board of directors has a personal interest, shareholder approval is also required.



D. Employees



We currently employ 471 full-time
employees, including 329 in research and development and project integration, 80 in sales and marketing and 62 in finance and administration. Competition for technical personnel in the communications and computer industry is intense. Although we
believe



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we have been able to attract talented development and other support personnel, there is a large demand for highly qualified technical personnel in Israel and
competition is intense.



None of our employees are represented by a labor union
and we have not experienced a work stoppage. We believe our relationship with our employees is good and that our future success will depend on a continuing ability to hire, assimilate and retain qualified employees.



Certain provisions of the collective bargaining agreements between the Histadrut, General
Federation of Labor in Israel, and the Coordination Bureau of Economic Organizations, including the Industrialists Associations, are applicable to our employees by order of the Israeli Ministry of Labor and Welfare. These provisions principally
concern cost of living increases, recreation pay and other conditions of employment. We generally provide our employees with benefits and working conditions above the required minimums.



Israeli labor laws and regulations are applicable to all of our employees in Israel. The laws principally concern matters such as paid
annual vacation, paid sick days, the length of the workday, pay for overtime, insurance for work-related accidents, severance pay and other conditions of employment. Israeli law generally requires severance pay, which may be funded by managers
insurance described below, upon the retirement or death of an employee or termination of employment without cause as defined in the law. These payments amount to approximately 8.3% of wages. Furthermore, Israeli employees and employers are required
to pay predetermined sums to the National Insurance Institute, which is similar to the United States Social Security Administration. Since January 1, 1995, such amounts also include payments for national health insurance. The payments to the
National Insurance Institute are approximately 14.5% of wages up to a specified amount, of which the employee contributes approximately 66% and the employer contributes approximately 34%.



Although not legally required, we regularly contribute to a managers insurance fund on behalf of our employees. This fund provides
employees with a lump sum payment upon retirement or severance pay, if legally entitled, upon termination of employment. Each employee who agrees to participate in the managers insurance plan contributes an amount equal to 5.0% of such
employees salary and the employer contributes an average of approximately 6.1% of such salary.



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E. Share Ownership



Security Ownership of Our
Directors and Executive Officers



The following table details as of May
22, 2005 the number of our ordinary shares owned (including the shares underlying options or warrants held by such person that are exercisable within 60 days), and stock options held, by members of our senior management.



|                                                                                                                           |  |                      |  |                             |   |  |                              
|-------------------------------------------------------------------------------------------------------------------------- |  | -------------------- |  | --------------------------- | - |  | -----------------------------
|Name and Address                                                                                                           |  | Number ofSharesOwned |  | Percent ofSharesOutstanding |   |  | Number ofstock optionsheld(1)
|Lior Bregman (2)                                                                                                           |  | 253,908              |  | 1.36                        | % |  |                             
|Meir Lipshes (3) (4)                                                                                                       |  | 500,080              |  | 3.6                         | % |  | 75,000                       
|All other members of senior management, as a group (consisting of 5 persons, other than Lior Bergman and Meir Lipshes) (5) |  | 49,999               |  | *                           |   |  | 40,000                       



|* | less than 1% of our outstanding ordinary shares.
|- | ------------------------------------------------



|(1) | Each stock option is exercisable into one ordinary share.
|--- | ---------------------------------------------------------



|(2) | Lior Bregman, our director, is the beneficial owner of LB Capital Investments, which holds approximately 1.36% of our outstanding shares, comprised of 181,818 of our Series A
Preferred Shares, and warrants to purchase 72,727 of our ordinary shares which are exercisable within 60 days.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(3) | The number of shares owned includes 57,500 options exercisable into ordinary shares within 60 days.
|--- | ---------------------------------------------------------------------------------------------------



|(4) | As of May 10, 2005, Team Computers and its wholly-owned subsidiary, Team Software Industries Ltd., beneficially owned 693,688 of our ordinary shares, representing approximately 3.7%
of our outstanding share capital. As of May 11, 2005, Meir Lipshes, the Chairman of our board of directors and our acting Chief Executive Officer, owned approximately 8.4% of Team Computers shares. Meir Lipshes is also a member of the board of
directors of Team Software and Team Computers, and therefore, may be deemed to beneficially own the ordinary shares owned by Team Software in us. Mr. Lipshes disclaims any beneficial interest in the ordinary shares owned by Team Software or Team
Computers in us.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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|(5) | The number of shares owned consist solely of options exercisable into ordinary shares within 60 days.
|--- | -----------------------------------------------------------------------------------------------------



Options to Purchase Our Ordinary Shares



From time to time, we grant our employees and directors options to purchase our shares pursuant to our share option plans:



Old Plans



In November 1996, we adopted our Share Option Plan, primarily designed for employees of TTI and its subsidiaries, and, from time to time, we
established and granted additional options under sub-plans. We refer to such plan and sub-plans as the Old Plans because we do not intend to grant any additional options under such plans.



Our board of directors is empowered, among other things, to designate the optionees, dates of grant and the exercise price of options
granted under such plans.



Under our old Plans, as of May 22, 2005, we have
reserved 2,325,515 Ordinary shares and had granted options to purchase an aggregate of 2,457,533 Ordinary Shares to certain of our employees and directors, at exercise prices ranging from $0.66 to $30.00 per ordinary share. As of May 22, 2005,
1,573,497 of such options had been exercised, 665,536 of these options were forfeited or expired and 218,500 of these options remain outstanding. On November 28, 2004, our board of directors approved the cancellation of the pool of 420,910 ordinary
shares available under our old plans (the number of options remained available for issuance as of November 1, 2004), and approved, subject to the approval of our shareholders, a new 2004 Employee Share Option Plan, or the 2004 Plan, and the
reservation of a pool of 1,000,000 ordinary shares for issuance thereunder. In December 2004, our shareholders approved the cancellation of the pool of 420,910 ordinary shares available under our old plans. We do not intend to grant any additional
options under the old plans.



The 2004 Plan



In December 2004, our shareholders approved the adoption of the 2004 Employee Share Option
Plan, or the 2004 Plan, and the reservation of a new pool of 1,000,000 ordinary shares for issuance thereunder. Pursuant to the 2004 Plan, primarily designed for employees of TTI and its subsidiaries, our board of directors is empowered, among other
things, to designate the optionees, dates of grant and the exercise price of options granted under such plans. The terms of the 2004 plan are described in Item 9 of our Notice and Proxy Statement for the Annual General Meeting of our shareholders
held on December 29, 2004, included in our report on Form 6-K, filed with the SEC on December 2, 2004, which is incorporated herein by reference.



As of May 22, 2005, we had not granted any options under the 2004 Plan other than the 75,000 options granted to Meir Lipshes described above.



The following table set forth, as of May 22, 2005, the number of options outstanding under
our Old Plans and 2004 Plan and their respective expiration date:



|                  |  |                         |  |                 
|----------------- |  | ----------------------- |  | ----------------
|Number of Options |  | exercise prices (range) |  | Expiration Date 
|12167             |  | $18.625 - $23           |  | October 31, 2005
|35,000            |  | $19-$30                 |  | November 9, 2005
|3333              |  | $20                     |  | April 5, 2006   
|168,000           |  | $6-$8 *                 |  | June 30, 2009   
|75,000            |  | $3                      |  | October 15, 2008
|Total: 293,550    |  |                         |  |                 



|* | the higher of $8 or the average of the market price in the 30 days prior to the end 12 months from the date the option was granted (i.e., the period between April 12, 2005 and May
11, 2005)
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



A. Major Shareholders



Ordinary Shares



Set forth below is information known to us concerning our shareholders
that are the beneficial owners of 5% or more of outstanding ordinary shares as of May 22, 2005.



|                                           |  |                              |  |                                              |   |  |                                          |  
|------------------------------------------ |  | ---------------------------- |  | -------------------------------------------- | - |  | ---------------------------------------- | -
|Name of shareholder                        |  | Number ofordinaryshares held |  | Percentageof ouroutstandingordinaryshares(1) |   |  | Percentageof ouroutstandingsharecapital* |  
|Shlomo Eisenberg (2)(3)(4)(5)              |  | 3,680,577                    |  | 31.0                                         | % |  | 19.9                                     | %
|Fidelity Management & Research Company (6) |  | 1,172,000                    |  | 9.9                                          | % |  | 6.3                                      | %



|* | Based on an aggregate of 18,509,327 ordinary and preferred shares outstanding as of May 22, 2005.
|- | -------------------------------------------------------------------------------------------------



|(1) | Based on 11,872,938 ordinary shares outstanding as of May 22, 2005. Ordinary shares deemed beneficially owned by virtue of the right of any person or group to acquire such ordinary
shares within 60 days are treated as outstanding only for purposes of determining the percent owned by such person or group.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) | Shlomo Eisenberg, our former chairman, holds 28,101 ordinary shares. In addition, Mr. Eisenberg, directly and indirectly (through a wholly owned corporation), owns approximately
14.6% of Team Computers and Systems Ltd. and is also a member of the controlling group of shareholders of Arad Investments and Industrial Development Ltd. In addition, he is the chairman of the board of the directors of Team Computers, Team Software
Industries Ltd., and Arad. Therefore, Mr. Eisenberg may be deemed to beneficially own the ordinary shares held by Arad, Team Computers and Team Software (see below). Mr. Eisenberg disclaims any such beneficial ownership.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(3) | Arad, directly and indirectly (through a wholly owned corporation), holds 2,958,788 ordinary shares. In addition, Arad owns 57.3% of Team Computers and, therefore, may be deemed to
beneficially own the ordinary shares held by Team Computers and Team Software. Arad disclaims any such beneficial ownership. Arad is an Israeli company, whose shares are publicly traded on the Tel Aviv Stock Exchange.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



65



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|(4) | Team Software holds 680,230 Ordinary Shares. Team Computers holds 13,458 ordinary shares. Since Team Computers holds 100% of the issued and outstanding shares of Team Software, it
may be deemed to beneficially own the Ordinary Shares held by Team Software. Team Computers, an Israeli company whose shares are publicly traded on the Tel Aviv Stock Exchange, is a large computer vendor in Israel
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(5) | As of May 11, 2005, Meir Lipshes, the Chairman of our board of directors and our acting Chief Executive Officer, owned approximately 8.4% of Team Computers shares. Meir
Lipshes is also a director of each of Team Software, Team Computers and us, and therefore may be deemed to beneficially own the ordinary shares owned by Team Software. Mr. Lipshes disclaims any beneficial interest in our ordinary shares owned by
Team Software.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(6) | Fidelity Management & Research Company, or Fidelity, is a wholly-owned subsidiary of FMR Corp., and acts as an investment adviser to various investment companies. The ownership
of one investment company, Fidelity Low Priced Stock Fund, amounted to 1,172,000 of such shares or 6.33% of our outstanding shares.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Series A Preferred Shares



In January 2005, we issued 6,636,389 Series A Preferred Shares to investors in a private placement transaction, at a price per share of $2.20, for an aggregate investment
of approximately $14.6 million. We also issued to the investors in the private placement transaction warrants to purchase the number of ordinary shares equal to 40% of the number of Series A Preferred Shares purchased by them, exercisable for a
period of six years, at an exercise price per share of $2.50. Set forth below is information known to us concerning our shareholders that are the beneficial owners of 5% or more of outstanding preferred shares as of May 22, 2005.



|                                     |  |                                                   |  |                                                         |   |  |                                            |  
|------------------------------------ |  | ------------------------------------------------- |  | ------------------------------------------------------- | - |  | ------------------------------------------ | -
|Name of shareholder                  |  | Number of SeriesA ConvertiblePreferred Sharesheld |  | Percentage of ouroutstanding SeriesA PreferredShares(1) |   |  | Percentage of ouroutstandingshare capital* |  
|LibertyView Funds(2)                 |  | 2,272,725                                         |  | 34.25                                                   | % |  | 12.28                                      | %
|Leaf Investment Funds (3)            |  | 909,091                                           |  | 13.70                                                   | % |  | 4.91                                       | %
|Close Finsbury Funds(4)              |  | 681,818                                           |  | 10.27                                                   | % |  | 3.68                                       | %
|Crestview Capital Master Fund LLC(5) |  | 909,091                                           |  | 13.70                                                   | % |  | 4.91                                       | %
|Shrem, Fudim, Kelner & Co.(6)        |  | 454,546                                           |  | 6.85                                                    | % |  | 2.46                                       | %
|Leonidas Opportunity Funds(7)        |  | 340,909                                           |  | 5.14                                                    | % |  | 1.84                                       | %



|* | Based on 18,509,327 ordinary and preferred shares outstanding as of May 22, 2005.
|- | ---------------------------------------------------------------------------------



|(1) | Based on 6,636,389 Series A Preferred Shares outstanding as of May 22, 2005.
|--- | ----------------------------------------------------------------------------



|(2) | LibertyView Special Opportunities Fund, LP holds 1,363,635 Series A Preferred Shares, and warrants to purchase 545,454 ordinary shares which are exercisable within
60 days, with an exercise price of $2.50 per share. LibertyView Funds, LP holds 909,090 Series A Preferred Shares, and warrants to purchase 363,636 ordinary shares which are exercisable within 60 days, with an exercise price of $2.50 per share.
Trust D for a Portion of the Assets of the Kodak Retirement Income Plan holds 227,273 Series A Preferred Shares, and warrants to purchase 90,909 ordinary shares which are exercisable
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



66



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| | within 60 days, with an exercise price of $2.50 per share. LibertyView Special Opportunities Fund, LP, LibertyView Funds, LP and Trust D for a Portion of the
Assets of the Kodak Retirement Income Plan have a common investment advisor that has been hired to manage their portfolios. Since they have hired a common investment advisor, these entities are likely to vote together. Additionally, there may be
common investors within the different accounts managed by the same investment advisor.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(3) | Leaf Investment Partners, LP holds 708,059 Series A Preferred Shares, and warrants to purchase 283,224 ordinary shares which are exercisable within 60 days, with an exercise price
of $2.50 per share. Leaf Offshore Investment Fund, Ltd. holds 201,032 Series A Preferred Shares, and warrants to purchase 80,413 ordinary shares which are exercisable within 60 days, with an exercise price of $2.50 per share. Leaf Investment
Partners, LP and Leaf Offshore Investment Fund, Ltd. have a common investment advisor that has been hired to manage their portfolios. Each fund has its own board and makes its own decisions, but since they have hired a common investment advisor,
these entities are likely to vote together. Additionally, there may be common investors within the different funds managed by the same investment advisor.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(4) | Close Finsbury Eurotech holds 45,455 Series A Preferred Shares, and warrants to purchase 18,182 ordinary shares which are exercisable within 60 days, with an exercise price of $2.50
per share. Close Finsbury Global Investment Technology Fund holds 6,818 Series A Preferred Shares, and warrants to purchase 2,727 ordinary shares which are exercisable within 60 days, with an exercise price of $2.50 per share. Consulta holds 113,636
Series A Preferred Shares, and warrants to purchase 45,455 ordinary shares which are exercisable within 60 days, with an exercise price of $2.50 per share. Close Tech & General VCT holds 31,818 Series A Preferred Shares, and warrants to purchase
12,727 ordinary shares which are exercisable within 60 days, with an exercise price of $2.50 per share. Finsbury Technology Trust holds 484,091 Series A Preferred Shares, and warrants to purchase 193,636 ordinary shares which are exercisable within
60 days, with an exercise price of $2.50 per share. Close Finsbury Eurotech, Close Finsbury Global Investment  Technology Fund, Consulta, Close Tech & General VCT and Finsbury Technology Trust have a common investment advisor that has been
hired to manage their portfolios. Each fund has its own board and makes its own decisions, but since they have hired a common investment advisor, these entities are likely to vote together. Additionally, there may be common investors within the
different funds managed by the same investment advisor.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(5) | Crestview Capital Master Fund LLC also holds warrants to purchase 363,636 ordinary shares which are exercisable within 60 days, with an exercise price of $2.50 per share.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(6) | Shrem, Fudim, Kelner & Co. Ltd. holds 136,364 Series A Preferred Shares, and warrants to purchase 54,545 ordinary shares which are exercisable within 60 days, with an exercise
price of $2.50 per share. Sphera Master Fund LP holds 318,182 Series A Preferred Shares, and warrants to purchase 127,273 ordinary shares which are exercisable within 60 days, with an exercise price of $2.50. Shrem, Fudim, Kelner & Co. Ltd. owns
51% of the interests in Sphera Master Fund LP.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(7) | Leonidas Opportunity Fund LP holds 293,533 Series A Preferred Shares, warrants to purchase 117,413 ordinary shares which are exercisable within 60 days, with an exercise price of
$2.50 per share, and 183,410 ordinary shares. Leonidas Opportunity Offshore Fund Ltd. holds 47,376 Series A Preferred Shares, warrants to purchase 18,950 ordinary shares which are exercisable within 60 days, with an exercise price of $2.50 per
share, and 27,865 ordinary shares. Skiritai Capital LLC is the general partner of the Leonidas Opportunity Fund LP and the investment manager of the Leonidas Opportunity Offshore Fund Ltd., which has voting and investment power over the shares
beneficially owned by such funds, exercised by Messrs. Lyron L. Bentovim and Russell R. Silvestri.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Significant changes in percentage ownership by major shareholders during last three years



On February 7, 2003, Team Software commenced a tender offer to purchase 650,000 of our ordinary shares at the price of $6.00 per share. On
March 17, 2003, Team Software accepted 650,000 ordinary shares under the tender offer. Prior to the tender offer, Team Software held 5,312,550 of our ordinary shares, representing 44.75% of our issued and outstanding ordinary shares. Following
completion of the tender offer, Team Software held 5,962,550 of our ordinary shares, representing 50.22% of our issued and outstanding ordinary shares. On January 30, 2005, Team Software transferred 5,200,000 of our ordinary shares held thereby to
Team Computers and Systems Ltd., its



67



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parent company, such that Team Computers held 5,200,020 or our ordinary shares directly and 762,530 of our ordinary shares through Team Software.



On April 19, 2005, Team Computers and Systems has distributed to Team
Computers shareholders 5,166,062 Ordinary Shares, such that immediately following the distribution, Team Computers held 719,488 of our ordinary shares, representing approximately 3.9% of our outstanding share capital. Of the 5,166,062 ordinary
shares distributed by Team Computers, 3,714,435 will be distributed to Team Computers controlling shareholders (and will be subject, under the U.S. securities laws, to a holding period of one year following the distribution, unless they are
sold pursuant to a registration statement declared effective by the SEC or the existence of an available exemption from the registration requirements), including Arad Investments and Industrial Development Ltd., Shlomo Eisenberg and Meir Lipshes
(see the table above).



Voting Rights



The holders of our ordinary shares and the holders of our Series A Preferred Shares each
have one vote per share held. However, the holders of our Series A Preferred Shares have special voting rights, as follows: for so long as at least 65% of the Series A Preferred Shares issued shall be outstanding, and no more than 35% of all Series
A Preferred Shares issued shall have been converted into ordinary shares, the approval of the holders of 50% or more of the then outstanding Series A Preferred Shares shall be required prior to TTI taking any of the following actions:



| |  |  | Amendment of our Articles of Association which adversely affects the rights of the Series A Preferred Shares or authorizes additional shares of the TTIs share capital;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Alter or change the rights, preferences or privileges of the Series A Preferred Shares;
| | - |  | ---------------------------------------------------------------------------------------



| |  |  | Declare or pay any dividends or make any distributions on any of our securities (other than on the Series A Preferred Shares);
| | - |  | ------------------------------------------------------------------------------------------------------------------------------



| |  |  | Redeem, purchase or otherwise acquire any of the our securities ranking junior or pari passu with the Series A Preferred Shares (except for (i) repurchases of ordinary shares from
employees upon termination of employment pursuant to arrangements approved by our board of directors and (ii) redemptions of Series A Preferred Shares);
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Authorize or issue any equity securities having rights or preferences senior to or pari passu with the Series A Preferred Shares with respect to voting, dividends redemption or
liquidation;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Sale of TTI by sale of all or substantially all of our issued and outstanding securities, merger, consolidation, sale of assets or otherwise if sale is not a sale resulting in
consideration to the holders of Series A Preferred Shares of at least $6.00 per Series A Preferred Share, as adjusted for share splits, consolidations, share dividends, bonus share issuances and other recapitalizations of our shares;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Sale or transfer of all of substantially all of our intellectual property assets;
| | - |  | ---------------------------------------------------------------------------------



| |  |  | Voluntary dissolution or cessation of our operations;
| | - |  | -----------------------------------------------------



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| |  |  | Any material change of the nature of our business;
| | - |  | --------------------------------------------------



| |  |  | Incur indebtedness (including any guarantees other than guarantees in the normal course of business, it being understood that such exclusion shall not include guarantees for
borrowed monies) exceeding an aggregate principal amount of $3,000,000 outstanding at any time, except for bank debt which, when combined with other debt, may be incurred for up to $10,000,000 outstanding at any time;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Create or incur any material lien on our assets (other than liens for current taxes not yet payable or liens pursuant to certain permitted indebtedness);
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Transaction with any director, officer, employee or affiliate (other than customary employment arrangements and benefit plans);
| | - |  | -------------------------------------------------------------------------------------------------------------------------------



| |  |  | Enter into an agreement that would limit our ability to perform our obligations in respect of the Series A Preferred Shares or the ordinary shares issued upon conversion of the
Series A Preferred Shares;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Any other action, which pursuant to our Articles of Association or the Companies Law requires the vote of the Series A Preferred Shares as a separate class or series;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Create any subsidiary other than a wholly-owned subsidiary or permit any existing subsidiary to issue equity securities to any person or entity other than TTI; or
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Take any action relating to the above.
| | - |  | --------------------------------------



Record Holders



As of May 20, 2005, there were approximately 35 record holders of our ordinary shares, of which 18 were record holders with mailing addresses in the United States owning an aggregate of approximately 66.44% of our
outstanding Ordinary Shares. The number of record holders in the United States is not representative of the number of beneficial holders nor is it representative of where such beneficial holders are resident since many of these ordinary shares were
held of record by brokers or other nominees (including one U.S. nominee company, CEDE & Co., which held approximately 66.40% of our outstanding ordinary shares as of said date).



As of May 20, 2005, there were approximately 21 record holders of our Series A Preferred Shares, of which 12 were record holders with
mailing addresses in the United States owning an aggregate of approximately 5,250,025, or 79.11% of our outstanding Series A Preferred Shares.



B. Related Party Transactions



Sale of
Products; Services



Since the commencement of our operations in 1992, Team
Computers, our former parent company, has from time to time paid us commissions in respect of the sale by us of certain products represented and offered by Team Computers. This relationship is reflected in an agreement between us and Team Computers
dated October 1996. Team Computers generally pays us a commission at the rate of 15% of the sales price of these products, up to a maximum of 50% of the amount received by Team



69



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Computers from these sales less the cost to Team Computers. In connection with these sales, we recorded commissions of approximately $520,000 in 2002,
$157,000 in 2003 and $249,000 in 2004.



In addition, Team Computers provides us
certain administrative services, including computer servicing, salary administration, automotive fleet maintenance, legal counsel and basic insurance coverage, and we reimburse Team Computers for the actual cost of such services. We recorded
expenses for such services of $583,000 in 2002, $503,000 in 2003 and $208,000 in 2004. We and Team Computers have agreed to indemnify each other for liabilities resulting from the acts or omissions of our respective employees constituting
intellectual property violations. The agreement is automatically renewed for successive terms of one year on each December 31, and can be terminated by either party at the end of any such term upon at least 60 days prior written notice.



Since 1992, we have also purchased fixed assets, such as computer hardware,
from Team Computers and Omnitek-Eichut Ltd. (Omnitek-Eichut), a subsidiary of Team Computers. We pay Team Computers and Omnitek-Eichut prices for these assets that are no less favorable to us than those we could obtain from unrelated
third parties. The payments made by us to Team Computers and Omnitek-Eichut in respect of such asset purchases were, in the aggregate, approximately $884,000 in 2002, $711,000 in 2003 and $555,000 in 2004.



In addition, Team Computers supplies us with hardware, software related to such hardware and
support services for such hardware for our customer projects in accordance with the agreement referred to above. Under the agreement between us and Team Computers, we are required to pay for such hardware, related software and support services when
we receive payment from our customers. A disagreement arose between us and Team Computers regarding whether we are required to pay Team Computers for hardware and related software that it supplied to three of our major customers as part of projects
for which we receive payments based on milestones which do not allocate specific amounts for hardware and related software. Following negotiations to achieve a compromise with Team Computers on this issue, we agreed to pay Team Computers the amount
of $1,047,000 in respect of hardware and related software supplied by Team Computers as part of our projects for these customers. We also agreed that, when and if we will receive additional payments for these projects, we are required to pay Team
Computers an additional payment based on Team Computers pro rata share of the project, up to a maximum additional amount of $563,000. In 2003, we paid the additional amount of $272,000 to Team Computers in respect of these projects. Please see
the information about this customer set forth below under the heading Item 8A  Legal Proceedings. On March 23, 2003, we executed a written agreement reflecting our understanding with Team Computers. This agreement was approved by
our audit committee on June 23, 2003, by our board of directors on June 29, 2003, and by our shareholders on August 11, 2003.



In December 2003 we issued a purchase order to Team Computers with respect to third party software, Team Computers represents in Israel, for the integration as part of
our Netrac products. We have purchased licenses to be deployed as part of our solution to be sold to our customers, as part of our solution, in the initial amount of $100,000. The engagement with Team Computers was approved by our Board of Directors
on December 23, 2003.



70



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Registration Rights



Team Software has registration rights with respect to our ordinary shares held by it (currently 680,230 shares). We have agreed that, at the request of Team
Software, but on no more than two occasions, we will file a registration statement under the Securities Act of 1933, as amended, for an offering of those shares as to which registration is requested. In addition, if we otherwise propose to register
any of our ordinary shares under the Securities Act, we shall include in such registration Team Softwares shares, subject to certain limitations. All fees and expenses incurred in connection with any registration will be borne by us, except
that Team Software will pay all fees and expenses of its own counsel and all underwriting discounts and commissions relating to Team Softwares shares.



Leased Facilities



Since February 1998, we have leased our principal facilities in Petach Tikva, Israel from Team Computers pursuant to a lease agreement dated February 1, 1998. Aggregate payments under this lease, which amount includes
rent, maintenance and additional related expenses, were approximately $1.3 million during 2002, $1.4 million during 2003 and $1.4 million during 2004. We exercised our option to extend the lease until August 31, 2007.



Since we became a tenant of Team Computers, Team Computers has performed various internal
construction projects on our behalf, adapting our premises to our requirements. These construction projects were performed on a cost only basis. On September 2, 2002, we and Team Computers amended the lease, such that, among other things, the space
leased by us was expanded by an additional 2,800 square meters, for a total of approximately 5,830 square meters. The amendment was approved by our shareholders on October 24, 2002.



Umbrella Insurance



In April 2004, we decided to obtain insurance under the umbrella insurance policy of Arad Investments and Industrial Development Ltd., or Arad, and its affiliates, with
Clal Bituach Insurance Company, or Clal Bituach. This policy includes employers liability insurance, third party liability insurance, product liability insurance and property insurance, but does not include directors and officers liability
insurance, which we maintain independently. The policy covers the period from May 1, 2004 through April 30, 2005. We paid to Clal Bituach $121,309 as our portion of the premium for the policy. Our management determined that our participation in the
policy was more beneficial to us than insurance which we could obtain independently.



Due to the fact that Mr. Shlomo Eisenberg, at that time was the chairman of our board of directors, a member of the controlling group of shareholders and Chairman of the board of directors of Arad, and Arad owned approximately 56.5% of the
outstanding shares of Team Computers and Systems Ltd., which owned all of the outstanding shares of Team Software Industries Ltd., which was the holder of 50.22% of our issued and outstanding share capital, entering into the umbrella insurance
policy of the Arad group required approval by our audit committee, followed by our board of directors, and then by a special majority of our shareholders. Although we did not believe that the entering into the policy by us constituted an
extraordinary transaction, for the avoidance of doubt, we decided to treat the entering into the policy as if it was an extraordinary transaction under the Israeli Companies Law. The approval of an extraordinary transaction under the Companies Law
requires the affirmative vote of a majority of the shares present, in person or by proxy, and voting on the matter, including at least one third of the shares of non-controlling shareholders voted on the matter (unless the total number of shares of
non-controlling shareholders voted against the approval does not exceed one percent of the outstanding ordinary shares).



71



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Accordingly, on May 12, 2004, this matter was approved by our audit committee, followed by our board of directors, both
were subject to the approval of our shareholders. On December 29, 2004, this matter was brought before our shareholders for approval at our 2004 Annual General Meeting of Shareholders. We did not receive the requisite approval of the shareholders
and, consequently, effective May 1, 2005, we have secured alternative insurance coverage (no longer under the Arad umbrella policy).



Compensation to Directors



With respect to compensation including options granted to our directors, see Item 6B under the caption Compensation to Directors.



Compensation.



C. Interests of Experts and Counsel



Not
applicable.



|Item 8. | FINANCIAL INFORMATION
|------- | ---------------------



A. Consolidated Statements and Other Financial Information



Financial Statements



See Item 18.



Legal Proceedings



Dispute with a Former Major Customer



On November 13, 2002, we received a letter from a major customer notifying us of the
termination of its agreement with us dated January 30, 2002, for the supply by us of a Manager of Managers system (MoM), and its intention to call the performance bond issued by a bank on our behalf under the agreement. We believe that
this customer terminated the agreement unlawfully, and in violation of the termination provisions set out in the agreement.



We filed an application in an English court on November 18, 2002, requesting an injunction to prevent the customer from calling the bond. During the hearings on this
matter, the customer asserted (among other things) that it was entitled to terminate the agreement as a result of our failure to deliver specific functionalities of the MoM by the milestone dates set out in the agreement. In response, we asserted
(among other things) that the milestone dates were varied by the agreement of the parties, that we substantially met the revised milestone dates, and to the extent that there was any failure to do so, any delay was caused by the customer. An interim
injunction pending a further hearing was granted.



On January 23, 2003, an
order was issued denying our request for the injunction to continue, on a number of grounds, including that our submissions were fact-based and related to the merits of the termination and not the procedural validity of the termination or the
conformity of the written notice with the requirements of the agreement. For that and other reasons, the court held that our submissions were not capable of supporting an application to restrain a call on the bond. Thereafter, an amount representing
the amount of the bond, approximately £1 million, was paid to the customer out of monies previously paid into court as security by us. Under the circumstances, the bond did not need to be (and was not) called by the customer.



72



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Because we believe that the termination of the agreement was unlawful, court proceedings were commenced (as part of the
injunction proceedings) claiming damages for the customers wrongful repudiation of the agreement. During the course of the hearings regarding our application for an injunction, the customer indicated that it intends to bring a
substantial counterclaim (which, in the context of the agreement, could run to several millions of British pounds) against us for our alleged failure to complete the supply of the MoM. A draft Defense and Counterclaim has recently been
served by the customer which denies liability and seeks to recover against us damages said to be in region of about 11 million British Pounds.



Our management believes, in light of the facts surrounding our relationship with this customer, that we are likely to be able to establish that the customer was not
entitled to terminate the agreement and by its conduct repudiated the agreement and, accordingly, that we are likely to be able to defeat the counterclaim. We cannot currently quantify the amount of damages that we would receive if we were to
succeed in a lawsuit against the customer, and we cannot estimate the amount of damages that could be sought by the customer in a potential counterclaim. We are currently considering our options with respect to the best manner in which to pursue
damages from this customer.



In 2002, we also signed an agreement for a similar
project with an affiliate of the customer referred to above. Following a dispute that arose between us and such affiliate, a settlement agreement was signed in the beginning of 2004. Pursuant to the settlement agreement, the parties agreed to
terminate the agreement with such customer, we refunded the amount of £100,000 to this customer, and the parties waived all claims against each other in connection with the agreement.



In 2002, we recorded trade and unbilled receivables in the amount of $10.3
million as due from these customers. Due to the letter of termination received from the first customer and our managements concerns about termination by the second customer, as described above, in 2002 we classified the amount of $2.9 million
as long-term trade and unbilled receivables, which represents the amount whose collection is probable, in our managements opinion. As of December 31, 2003, this amount was $3.1 million due to the devaluation of the United States
dollar against the British Pound. As of December 31, 2004, this amount was $3.3 million due to the devaluation of the United States dollar against the British Pound. With respect to this receivable, our management believes that the collection is
probable (i.e., likely to occur, as defined in SFAS 5) in light of (i) the solution delivered by us to the customer, (ii) the approval by the customers users of the functionality of the solutions delivered and (iii) the customers
contractual obligations.



The balance, in the amount of $7.4 million was
recorded in 2002 as allowance for doubtful accounts.



Putative Shareholder Class Action



A
putative shareholder class action lawsuit was filed in September 2004 against the Company, Team Software Industries Ltd. and certain of the Companys executive officers. The lawsuit purports to be a class action filed on behalf of persons who
held our shares during the period between May 15, 2001 and November 14, 2002. The complaint alleges that material misrepresentations and omissions concerning the Companys operations and performance artificially inflated the Companys
stock price, causing damages to investors. Based on our preliminary review of the complaint, we believe that the claims are without merit and intend to vigorously defend the actions. However, this purported class action is in a very preliminary
stage, and we cannot predict the outcome of this dispute.



73



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B. Significant Changes



No significant change has
occurred since December 31, 2004, except as otherwise disclosed in this annual report.



|Item 9. | THE OFFER AND LISTING
|------- | ---------------------



A. Offer and Listing Details.



Our ordinary
shares have been traded on the Nasdaq National Market under the symbol TTIL since our initial public offering on December 4, 1996. The following tables set forth, for the periods indicated, the high and low closing prices of our ordinary
shares, as reported by the Nasdaq National Market.



|                        |  |      |       |     |   |      
|----------------------- |  | ---- | ----- | --- | - | -----
|                        |  | High |       | Low
|2000:                   |  |      |       |     |   |      
|Full Year               |  | $    | 50.75 |     | $ | 14.13
|2001:                   |  |      |       |     |   |      
|Full Year               |  | $    | 26.84 |     | $ | 10.19
|2002:                   |  |      |       |     |   |      
|Full Year               |  | $    | 34.50 |     | $ | 4.11 
|2003:                   |  |      |       |     |   |      
|Full Year               |  | $    | 6.65  |     | $ | 4.05 
|First Quarter           |  |      | 5.97  |     |   | 4.05 
|Second Quarter          |  |      | 5.80  |     |   | 4.40 
|Third Quarter           |  |      | 6.25  |     |   | 4.17 
|Fourth Quarter          |  |      | 6.65  |     |   | 4.56 
|2004:                   |  |      |       |     |   |      
|Full Year               |  | $    | 6.40  |     | $ | 1.71 
|First Quarter           |  |      | 6.40  |     |   | 4.67 
|Second Quarter          |  |      | 6.19  |     |   | 3.11 
|Third Quarter           |  |      | 3.20  |     |   | 1.71 
|Fourth Quarter          |  |      | 2.63  |     |   | 1.82 
|                        |  |     
|Most Recent Six Months: |  |      |       |     |   |      
|November 2004           |  | $    | 2.63  |     | $ | 1.86 
|December 2004           |  |      | 2.50  |     |   | 2.00 
|January 2005            |  |      | 2.55  |     |   | 1.84 
|February 2005           |  |      | 2.31  |     |   | 2.02 
|March 2005              |  |      | 2.24  |     |   | 1.95 
|April 2005              |  |      | 2.58  |     |   | 1.89 



On May 19, 2005, the
last reported sale price of our ordinary shares on the Nasdaq National Market was $2.20 per share.



B. Plan of Distribution



Not applicable.



74



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C. Markets



Our ordinary shares are quoted on the
Nasdaq National Market under the symbol TTIL.



D. Selling Shareholders



Not applicable.



E. Dilution



Not applicable.



F. Expenses of the Issue



Not applicable.



|Item 10. | ADDITIONAL INFORMATION
|-------- | ----------------------



A. Share Capital



Not applicable.



B. Memorandum and Articles of Association



Our
memorandum of association and articles of association were amended in October 2000 and on December 29, 2004. The following is a summary description of certain provisions of our amended memorandum of association and articles of association, and
certain relevant provisions of the Israel Companies Law which apply to us:



Objects and Purposes



We were first registered by the Israeli
Registrar of Companies on February 5, 1990, as a private company. On November 17, 1996, we became a public company. We are registered with the Israeli Registrar of Companies under No. 52-004301-9.



Section 2 of our memorandum of association attached as an exhibit to this annual report
includes a comprehensive list of our objects and purposes of the Company. Among these objects and purposes are the following: to engage in the field of computer software as a software house in the design, development, conversion, manufacturing,
marketing, enhancement, sale and manufacture of software; to organize, promote, and establish investment and financial services; to form all kinds of companies; to acquire shares in companies who have a business similar to ours; to purchase or
otherwise own assets; and to fulfill any other objects any place in the world.



75



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Directors



According to the our articles of association, our board of directors is to consist of not less than three and not more than seven directors, such number to be determined
by a resolution of our shareholders.



Election of Directors



Directors, other than external directors, are elected by our shareholders at our annual
general meeting of shareholders, or by our board of directors. In the event that any directors are appointed by our board of directors, their appointment is required to be ratified by the shareholders at the next shareholders meeting following
the appointment. Our shareholders may remove a director from office under certain circumstances.



Notwithstanding the above, for so long as at least 50% of the Series A Preferred Shares issued under the Purchase Agreement dated November 29, 2004 remain outstanding, the holders of a majority of the outstanding
Series A Preferred Shares are entitled at any time to appoint, elect, remove and replace one director to our board of directors.



There is no requirement that a director own any of our shares. Directors may appoint alternate directors in their stead. See Item 6C  Board
Practices.



Remuneration of Directors



Directors remuneration is subject to shareholders approval, except for reimbursement
of reasonable expenses incurred in connection with carrying out the directors duties.



Powers of the Board of Directors



Our
board of directors may resolve to take action by a resolution approved by a vote of at least a majority of the directors present at a meeting in which a quorum is constituted. A quorum at a meeting of our board of directors requires the presence of
at least a majority of the directors then in office who are lawfully entitled to participate in the meeting, but in any event, shall not be less than two directors. Our board of directors may elect one director to serve as the Chairman of the board
of directors to preside at the meetings of the board of directors, and may also remove such director.



Ordinary Shares



The holders of our
ordinary shares have, among other rights generally available to shareholders of an Israeli company under our Articles of Association, as amended, and under the Companies Law, the following rights, preferences and restrictions:



| |  |  | one vote at meetings of our shareholders in respect of each ordinary share held thereby;
| | - |  | ----------------------------------------------------------------------------------------



| |  |  | the right to share pro rata in any distributions of dividends; and
| | - |  | ------------------------------------------------------------------



| |  |  | subject to the liquidation preference of holders of any shares having preferred rights upon liquidation, to share pro rata in the proceeds available for distribution upon
liquidation.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



76



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Series A Preferred Shares



The holders of our Series A Preferred Shares have, among other rights generally available to shareholders of an Israeli company under our
Articles of Association, as amended, and under the Companies Law, the following rights, preferences and restrictions:



| |  |  | weighted-average anti-dilution protection in the event that following the closing of the private placement transaction in which the Series A Preferred Shares were issued (i.e.,
January 3, 2005), we issue or are deemed to have issued (subject to certain exceptions) ordinary shares at a price per share that is lower than the conversion price in effect at the time of such issuance or deemed issuance, which could result in
dilution of the holdings of ordinary shareholders;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | automatic conversion into ordinary shares in the event that, at any time commencing two years from the effective date (which has not occurred as of yet) of the registration
statement which we filed in connection with the aforesaid private placement, our ordinary shares trade at a closing bid price of 100% above the price per share of $2.20 in the private placement (i.e., $4.40) for a 20 consecutive trading day period,
with an average daily trading volume of at least 100,000 shares per day during such period;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | for so long as at least 50% of the Series A Preferred Shares issued under the Purchase Agreement dated November 29, 2004 remain outstanding, the holders of a majority of the
outstanding Series A Preferred Shares are entitled at any time to appoint, elect, remove and replace one director to our board of directors;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | one vote at meetings of our shareholders in respect of each ordinary share held thereby, however, the holders of our Series A Preferred Shares have special voting rights, as
follows: for so long as at least 65% of the Series A Preferred Shares issued shall be outstanding, and no more than 35% of all Series A Preferred Shares issued shall have been converted into ordinary shares, the approval of the holders of 50% of the
then outstanding Series A Preferred Shares shall be required prior to taking any of the following actions:
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Amendment of our Articles of Association which adversely affects the rights of the Series A Preferred Shares or authorizes additional shares of our share capital;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Alter or change the rights, preferences or privileges of the Series A Preferred Shares;
| | - |  | ---------------------------------------------------------------------------------------



| |  |  | Declare or pay any dividends or make any distributions on any of our securities (other than on the Series A Preferred Shares);
| | - |  | ------------------------------------------------------------------------------------------------------------------------------



| |  |  | Redeem, purchase or otherwise acquire any of our securities ranking junior or pari passu with the Series A Preferred Shares (except for (i) repurchases of ordinary shares from
employees upon termination of employment pursuant to arrangements approved by our board of directors and (ii) redemptions of Series A Preferred Shares);
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Authorize or issue any equity securities having rights or preferences senior to or pari passu with the Series A Preferred Shares with respect to voting, dividends redemption or
liquidation;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



77



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| |  |  | Sale of our company by sale of all or substantially all of our issued and outstanding securities, merger, consolidation, sale of assets or otherwise if sale is not a sale resulting
in consideration to the holders of Series A Preferred Shares of at least $6.00 per Series A Preferred Share, as adjusted for share splits, consolidations, share dividends, bonus share issuances and other recapitalizations of our shares;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Sale or transfer of all of substantially all of our intellectual property assets;
| | - |  | ---------------------------------------------------------------------------------



| |  |  | Voluntary dissolution or cessation of our operations;
| | - |  | -----------------------------------------------------



| |  |  | Any material change of the nature of our business;
| | - |  | --------------------------------------------------



| |  |  | Incur indebtedness (including any guarantees other than guarantees in the normal course of business, it being understood that such exclusion shall not include guarantees for
borrowed monies) exceeding an aggregate principal amount of $3,000,000 outstanding at any time, except for bank debt which, when combined with other debt, may be incurred for up to $10,000,000 outstanding at any time;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Create or incur any material lien on our assets (other than liens for current taxes not yet payable or liens pursuant to permitted indebtedness);
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Transaction with any director, officer, employee or affiliate (other than customary employment arrangements and benefit plans);
| | - |  | -------------------------------------------------------------------------------------------------------------------------------



| |  |  | Enter into an agreement that would limit the our ability to perform our obligations in respect of the Series A Preferred Shares or the ordinary shares issued upon conversion of the
Series A Preferred Shares;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Any other action, which pursuant to our Articles of Association or the Companies Law requires the vote of the Series A Preferred Shares as a separate class or series;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Create any subsidiary other than a wholly-owned subsidiary or permit any existing subsidiary to issue equity securities to any person or entity other than TTI; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Take any action relating to the above.
| | - |  | --------------------------------------



| |  |  | the right to share pro rata in any distributions of dividends;
| | - |  | --------------------------------------------------------------



| |  |  | in the event of any voluntary or involuntary liquidation, dissolution or winding up of TTI, the holders of Series A Preferred Shares then outstanding shall be
entitled to be paid out of the assets of TTI available for distribution to our shareholders, before any payment shall be made to the holders of our ordinary shares or any other class or series of stock ranking on liquidation junior to the Series A
Preferred Shares by reason of their ownership thereof, an amount equal to the greater of: (i) $2.20 per share (subject to appropriate adjustment in the event of any stock dividend, stock split, combination or other similar recapitalization affecting
such shares), plus any dividends declared but unpaid thereon, or (ii) such amount per share as would have
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



78



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| | been payable had each such share been converted into ordinary shares immediately prior to such liquidation, dissolution or winding up;
| | --------------------------------------------------------------------------------------------------------------------------------------



| |  |  | payment of liquidated damages if a registration statement on Form F-3 is not declared effective within the timeframe specified in our agreements with the investors following the
closing of the private placement transaction; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | rights of first offer in the event we propose to offer or sell any of our ordinary shares in one or more transactions not including a public offering prior to the first anniversary
of the date upon which the registration statement filed in connection with the private placement in which the Series A Preferred Shares were issued is declared effective by the SEC (which has not occurred as of yet).
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Dividends



Our board of directors may from time to time declare and cause the payment of dividends as it views justified. Dividends may be paid in
assets or shares, debentures, or debentures stock of our company or of other companies. Our board of directors may decide to distribute our profits among our shareholders. Dividends that remain unclaimed after seven years will be forfeited and
returned to our company. Unless there are shareholders with special dividend rights, any dividend declared will be distributed among our shareholders in proportion to their respective holdings of our shares for which the dividend is being declared.



Redeemable Shares



Our articles of association allow us to create redeemable shares, but at the present time,
we do not have any redeemable shares.



Changing the Rights Attached to
Shares



We may only change the rights of shares with the approval of a
majority of the holders of that class of shares present and voting at the separate general meeting called for that class of shares. An enlargement of a class of shares is not considered changing the rights of such class of shares.



Shareholders Meetings



We have two types of shareholders meetings: the annual general meetings and extraordinary general meetings. An annual general meeting must
be held once in every calendar year, but not more than 15 months after the last annual general meeting. Our board of directors may convene an extraordinary general meeting whenever it sees fit, at any place within or outside of the State of Israel.



A quorum in a general meeting consists of two or more holders of ordinary
shares, present in person or by proxy, who hold together at least a majority of the voting power of our company. If there is no quorum within an hour of the time set, the meeting is postponed until the following week, or any other time that the
chairman of the board of directors and the shareholders present agree to. At the postponed meeting, any two shareholders will constitute a quorum. Every ordinary share entitles the holder thereof to one vote. A shareholder may only vote the shares
for which all calls have been paid up on, except in separate general meetings of a particular class. A shareholder may vote in person or by proxy, or if the shareholder is a corporate body, by its representative.



79



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Duties of Shareholders



Under the Companies Law, the disclosure requirements which apply to an office holder also apply to a controlling shareholder of a public company. A controlling
shareholder is a shareholder who has the ability to direct the activities of a company, including a shareholder that holds 25% or more of the voting rights if no other shareholder owns more than 50% of the voting rights in the company, but excluding
a shareholder whose power derives solely from his or her position as a director of the company or any other position with the company. Extraordinary transactions with a controlling shareholder or in which a controlling shareholder has a personal
interest, and the engagement of a controlling shareholder as an office holder or employee, require the approval of the audit committee, the board of directors and the shareholders of the company, in that order. The shareholder approval must be by a
majority vote, provided that either:



| |  |  | at least one-third of the shares of shareholders who have no personal interest in the transaction and are present and voting, in person, by proxy or by written ballot, at the
meeting, vote in favor; or
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the shareholders who have no personal interest in the transaction who vote against the transaction do not represent more than one percent of the voting rights in the company.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



In addition, under the Companies Law, each shareholder has a
duty to act in good faith in exercising his rights and fulfilling his obligations toward the company and other shareholders and to refrain from abusing his power in the company, such as in shareholder votes. In addition, specified shareholders have
a duty of fairness toward the company. These shareholders include any controlling shareholder, any shareholder who knows that it possesses the power to determine the outcome of a shareholder vote and any shareholder who, pursuant to the provisions
of the articles of association, has the power to appoint or to prevent the appointment of an office holder or any other power toward the company. However, the Companies Law does not define the substance of this duty of fairness.



Exculpation, Insurance and Indemnification of Office Holders



Exculpation of Office Holders



Under the Companies Law, an Israeli company may not exempt an office holder from liability
with respect to a breach of his duty of loyalty, but may exempt 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 (except in connection with distributions), provided that
the articles of association of the company allow it to do so. Our articles of association allow us to exempt our office holders to the fullest extent permitted by law.



Insurance of Office Holders



Our articles of association provide that, subject to the provisions of the Companies Law, we may enter into a contract for the insurance of the liability of any of our
office holders with respect to an act performed in his capacity of an office holder, for:



| |  |  | a breach of his duty of care to us or to another person;
| | - |  | --------------------------------------------------------



| |  |  | a breach of his fiduciary duty 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
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | a financial liability imposed upon him in favor of another person.
| | - |  | ------------------------------------------------------------------



80



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Indemnification of Office Holders



Under the Companies Law, we may indemnify an office holder with respect to an act performed in his capacity as an office holder against:



| |  |  | a financial liability imposed on him in favor of another person by any judgment, including a settlement or an arbitration award approved by a court; such indemnification may be
approved (i) after the liability has been incurred or (ii) in advance, provided that our undertaking to indemnify is limited to events that our board of directors believes are foreseeable in light of our actual operations at the time of providing
the undertaking and to a sum or criterion that our board of directors determines to be reasonable under the circumstances.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | reasonable litigation expenses, including attorneys fees, expended by the office holder as a result of an investigation or proceeding instituted against him by a competent
authority, provided that such investigation or proceeding concluded without the filing of an indictment against him and either (A) concluded without the imposition of any financial liability in lieu of criminal proceedings or (B) concluded with the
imposition of a financial liability in lieu of criminal proceedings but relates to a criminal offense that does not require proof of criminal intent; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | reasonable litigation expenses, including attorneys fees, expended by the office holder or charged to him by a court, in proceedings we institute against him or instituted on
our behalf or by another person, a criminal indictment from which he was acquitted, or a criminal indictment in which he was convicted for a criminal offense that does not require proof of criminal intent.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Limitations on Exculpation, Insurance and Indemnification



The Companies Law provides that a company may not exculpate or indemnify an office holder
nor enter into an insurance contract which would provide coverage for any monetary liability incurred as a result of any of the following:



| |  |  | a breach by the office holder of his duty of loyalty, unless, with respect to insurance coverage or indemnification, the office holder acted in good faith and had a reasonable basis
to believe that the act would not prejudice the Companys interests;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | a breach by the office holder of his duty of care if the breach was done intentionally or recklessly;
| | - |  | -----------------------------------------------------------------------------------------------------



| |  |  | any act or omission done with the intent to derive an illegal personal benefit; or
| | - |  | ----------------------------------------------------------------------------------



| |  |  | any fine levied against the office holder.
| | - |  | ------------------------------------------



In addition, under the Companies Law, indemnification of, and procurement of insurance coverage for, our office holders must be approved by our audit committee and board
of directors and, if the beneficiary is a director, by our shareholders.



We
have agreed to indemnify our office holders to the fullest extent permitted under Israeli law, but up to a maximum aggregate amount for all indemnified office holders equal to 25% of our total shareholders equity at the time of actual
indemnification. We currently maintain directors and officers liability insurance for the benefit of our office holders.



81



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Mergers and Acquisitions under Israeli Law



The Companies Law includes provisions that allow a merger transaction and requires that each company that is a party to a merger have the
transaction approved by its board of directors and a vote of the majority of its shares. For purposes of the shareholder vote, unless a court rules otherwise, the merger will not be deemed approved if shares, representing a majority of the voting
power present at the shareholders meeting and which are not held by the other party to the merger (or by any person who holds 25% or more of the shares or the right to appoint 25% or more of the directors of the other party), vote against the
merger. Upon the request of a creditor of either party to the proposed merger, the court may delay or prevent the merger if it concludes that there exists a reasonable concern that as a result of the merger, the surviving company will be unable to
satisfy the obligations of any of the parties to the merger. In addition, a merger may not be completed unless at least (1) 50 days have passed from the time that a proposal of the merger has been filed with the Israeli Registrar of Companies by
each merging company and (2) 30 days have passed since the merger was approved by the shareholders of each merging company.



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 the acquisition the purchaser
would become a 25% or greater shareholder of the company and there is no existing 25% or greater shareholder in the company. 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% or greater shareholder of the company and there is no existing 45% or greater shareholder of the company. These requirements do not apply if, in general, the acquisition (1) was made in a private placement that received
shareholder approval, (2) was from a 25% or greater shareholder of the company which resulted in the acquirer becoming a 25% or greater shareholder of the company, or (3) was from a 45% or greater shareholder of the company which resulted in the
acquirer becoming a 45% or greater shareholder of the company. The tender offer must be extended to all shareholders, but the offeror is not required to purchase more than 5% of the companys outstanding shares, regardless of how many shares
are tendered by shareholders. The tender offer may be consummated only if (i) at least 5% of the companys outstanding shares will be acquired by the offeror and (ii) the number of shares tendered in the offer exceeds the number of shares whose
holders objected to the offer.



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



Finally, Israeli tax law treats stock-for-stock acquisitions between an Israeli company and a
foreign company less favorably than U.S. tax laws. For example, Israeli tax law may, under certain circumstances, subject a shareholder who exchanges his ordinary shares for shares in another corporation to taxation prior to the sale of the shares
received in such stock-for-stock swap.



C. Material Contracts



Private Placement of
Series A Preferred Shares



On January 3, 2005, we completed a private
placement transaction in which we issued (i) 6,636,389 Series A Convertible Preferred Shares, par value NIS 0.50 each, or the Series A Preferred Shares, at a



82



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purchase price of $2.20 per share, resulting in aggregate proceeds (before expenses) of approximately $14.6 million and (ii) warrants to purchase up to
2,654,556 of our ordinary shares, pursuant to a Purchase Agreement dated as of November 29, 2004.



The rights of the holders of Series A Preferred Shares include:



| |  |  | weighted-average anti-dilution protection in the event that following the closing of the transaction we issue or are deemed to have issued (subject to certain exceptions) ordinary
shares at a price per share that is lower than the conversion price in effect at the time of such issuance or deemed issuance;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | a preference in the event of liquidation of TTI;
| | - |  | ------------------------------------------------



| |  |  | veto rights over certain material actions by TTI; and
| | - |  | -----------------------------------------------------



| |  |  | the right to nominate one member of our board of directors.
| | - |  | -----------------------------------------------------------



The Series A Preferred Shares will automatically convert into ordinary shares in the event that, at any time commencing two years from the effective date of the
registration statement we filed in connection with the private placement transaction, our ordinary shares trade at a closing bid price of 100% above the price per share of $2.20 (i.e., $4.40) for a 20 consecutive trading day period, with an average
daily trading volume of at least 100,000 shares per day during such period.



The warrants are exercisable for a period of 6 years, at an exercise price of $2.50 per ordinary share, and have weighted average anti-dilution protection in the event that during the 6 year period following the closing of the transaction
we issue or are deemed to have issued (subject to certain exceptions) ordinary shares at a price per share that is lower than the exercise price in effect at the time of such issuance or deemed issuance.



In addition, the purchasers of our Series A Preferred Shares have rights of first offer in
the event we propose to offer or sell any of our ordinary shares in one or more transactions not including a public offering prior to the first anniversary of the date upon which the registration statement filed in connection with the private
placement is declared effective by the SEC (which has not occurred as of yet). Finally, the investors have the right to receive payment for liquidated damages if a registration statement on Form F-3 is not declared effective within 90 days (or 120
days in the event the SEC conducts a review) following the closing of the private placement transaction. We did not obtain effectiveness of the registration statement within the timeframe set forth in our agreements with the investors. Therefore,
since May 4, 2005, we have been accruing liquidated damages at a rate equal to 2% of each investors investment in the Company for each 30 day period, or pro rata for any portion thereof, during the period for which the registration statement
is not declared effective.



Pursuant to a Registration Rights Agreement dated
as of November 29, 2004, we agreed with the purchasers of our Series A Preferred Shares and warrants to register for public resale 9,954,584 ordinary shares for issuance upon conversion of the Series A Preferred Shares, representing 150% of the
initial number of issued Series A Preferred Shares issued to them in the private placement, and the 2,654,556 ordinary shares issuable to them upon exercise of the warrants.



In addition, we agreed to register 371,638 ordinary shares underlying the same number of warrants issued to Oppenheimer & Co., the
placement agent for the private placement transaction. These warrants are exercisable for a period of 4 years, at an exercise price of $2.64 per ordinary share, and have weighted-average anti-dilution protection in the event that during the 6 year
period following the closing of the transaction we issue or are deemed to have issued (subject to certain exceptions)



83



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ordinary shares at a price per share that is lower than the exercise price in effect at the time of such issuance or deemed issuance.



Agreements with Team Computers



For a description of the agreements we have entered into with Team Computers, please refer
to Item 7B  Related Party Transactions.



D. Exchange Controls



There are currently no
Israeli currency control restrictions on payments of dividends or other distributions with respect to our ordinary shares or the proceeds from the sale of the shares, except for the obligation of Israeli residents to file reports with the Bank of
Israel regarding some transactions. However, legislation remains in effect under which currency controls can be imposed by administrative action at any time.



The ownership or voting of our ordinary shares by non-residents of Israel, except with respect to citizens of countries which are in a state of war with Israel, is not
restricted in any way by our memorandum of association or articles of association or by the laws of the State of Israel.



E. Taxation



The following is a general
summary only and should not be considered as income tax advice or relied upon for tax planning purposes. 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.



U.S. TAX CONSIDERATIONS REGARDING SHARES ACQUIRED BY U.S. TAXPAYERS 



Subject to the limitations described in the next paragraph, the following discussion describes the material United States federal income tax
consequences to a U.S. holder arising from the purchase, ownership and disposition of our ordinary shares. A U.S. holder is a holder of ordinary shares that is: (1) an individual citizen or resident of the United States, (2) a corporation created or
organized under the laws of the United States or any political subdivision thereof, or (3) an estate, the income of which is includable in gross income for United States federal income tax purposes regardless of its source, (4) a trust if a court
within the U.S. is able to exercise primary supervision over the administration of the trust, and one or more U.S. persons have the authority to control all substantial decisions of the trust, or (5) a trust that has a valid election in effect to be
treated as a U.S. person. This summary is for general information purposes only and does not purport to be a comprehensive description of all of the federal income tax considerations that may be relevant to a decision to purchase ordinary shares.
This summary generally considers only U.S. holders that will own ordinary shares as capital assets. Except to the limited extent discussed herein, this summary does not consider the United States tax consequences to a person that is not a U.S.
holder, nor does it describe the rules applicable to determine a taxpayers status as a U.S. holder.



This discussion is based on current provisions of the Internal Revenue Code of 1986, as amended, current and proposed Treasury regulations promulgated thereunder, and administrative and judicial interpretations
thereof, all as in effect on the date hereof and all of which are subject to change, possibly on a retroactive basis. This discussion does not address all aspects of United States federal income taxation that may be relevant to any particular
shareholder based on such shareholders



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particular circumstances. In particular, this discussion does not address the tax treatment of U.S. holders who are broker-dealers or who own, directly,
indirectly or constructively, 10% or more of our outstanding voting stock, U.S. holders holding the ordinary shares as a hedge or as part of a hedging, straddle or conversion transaction, and certain U.S. holders, including, without limitation,
insurance companies, tax-exempt organizations, financial institutions and persons subject to the alternative minimum tax who may be subject to special rules not discussed below. Additionally, the tax treatment of persons who hold ordinary shares
through a partnership or other pass-through entity is not considered, nor is the application of United States federal gift or estate taxes or any aspect of state, local or non-United States tax laws considered. Each prospective investor is advised
to consult such persons own tax advisor with respect to the specific United States federal income tax consequences to such person of purchasing, holding or disposing of the ordinary shares.



Distributions on Ordinary Shares



We have never paid cash dividends on our ordinary shares, and we do not intend to pay cash
dividends in the foreseeable future. In the event that we do pay dividends, and subject to the discussion under the headings Passive Foreign Investment Companies below, a U.S. holder will be required to include in gross income as
ordinary income the amount of any distribution paid on ordinary shares on the date, the distribution to the extent that such distribution does not exceed our current and accumulated earnings and profits, as determined for U.S. federal income tax
purposes. The amount of a distribution which exceeds our earnings and profits will be treated first as a non-taxable return of capital, reducing the U.S. holders tax basis for the ordinary shares to the extent thereof, and then as capital
gain. Preferential tax rates for long-term capital gains are applicable for U.S. holders that are individuals, estates or trusts. Corporate holders generally will not be allowed a deduction for dividends received.



The amount of a distribution with respect to our ordinary shares will be measured by the
amount of fair market value of any property distributed, and for U.S. federal income tax purposes, the amount of any Israeli taxes withheld therefrom. Cash distributions paid by us in NIS will be included in the income of U.S. holders at a U.S.
dollar amount based upon the spot rate of exchange in effect on the date the dividend is includible in the income of the U.S. holder, and U.S. holders will have a tax basis in such NIS for U.S. federal income tax purposes equal to such U.S. dollar
value. If the U.S. holder subsequently converts the NIS, any subsequent gain or loss in respect of such NIS arising from exchange rate fluctuations will be U.S. source ordinary exchange income or loss.



Distributions paid by us will generally be foreign source passive income for U.S. foreign tax
credit purposes. Subject to limiting rules set forth in the Internal Revenue Code, U.S. holders may elect to claim a foreign tax credit against their U.S. income tax liability for Israeli income tax withheld from distributions received in respect of
ordinary shares. One such rule generally limits the amount of allowable foreign tax credits in any year to the amount of regular U.S. tax liability for the year attributable to foreign taxable income. This limitation on foreign taxes eligible for
the foreign tax credit is calculated separately with respect to specific classes of income. Also, this limitation on the use of foreign tax credits generally will not apply to an electing individual U.S. holder whose creditable foreign taxes during
the year do not exceed $300, or $600 for joint filers, if such individuals gross income for the tax year from non-U.S. sources consists solely of certain passive income. A U.S. holder will be denied a foreign tax credit with respect to Israeli
income tax withheld from dividends received with respect to the ordinary shares if such U.S. holder has not held the ordinary shares for at least 16 days out of the 30-day period beginning on the date that is 15 days before the ex-dividend date or
to the extent that such U.S. holder is under an obligation to make certain related payments with respect to substantially similar or related property. Any day during which a U.S. holder has substantially diminished its risk of loss with respect to
the ordinary shares will not count toward meeting the 16-day holding period referred to above. A U.S. holder may also be denied a foreign tax credit if the U.S. holder holds ordinary shares in an arrangement in which the



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U.S. holders reasonably expected economic profit is insubstantial compared to the foreign taxes expected to be paid or accrued. The rules relating to
the determination of the foreign tax credit are complex, and U.S. holders should consult their own tax advisors to determine whether and to what extent they would be entitled to such credit. U.S. holders that do not elect to claim a foreign tax
credit may instead claim a deduction for Israeli income tax withheld, provided such holders itemize their deductions.



Disposition of Shares



Except as provided under the passive foreign investment company rules, upon the sale, exchange or other disposition of ordinary shares, a U.S. holder generally will recognize capital gain or loss in an amount equal to
the difference between such U.S. holders tax basis for the ordinary shares and the amount realized on the disposition (or its U.S. dollar equivalent, determined by reference to the spot rate of exchange on the date of disposition, if the
amount realized is denominated in a foreign currency). The gain or loss realized on the sale, exchange or other disposition of ordinary shares will be long-term capital gain or loss if the U.S. holder has a holding period of more than one year at
the time of disposition.



Gain realized by a U.S. holder on a sale, exchange or
other disposition of ordinary shares generally will be treated as United States source income for United States foreign tax credit purposes. A loss realized by a U.S. holder on the sale, exchange or other disposition of ordinary shares is generally
allocated to U.S. source income. However, these rules require the loss to be allocated to foreign source income to the extent certain dividends were received by the taxpayer within the 24-month period preceding the date on which the taxpayer
recognized the loss. The deductibility of a loss realized on the sale, exchange or other disposition of ordinary shares is subject to limitations.



Passive Foreign Investment Companies



We would be a passive foreign investment company, or PFIC, if:



| |  |  | 75% or more of our gross income, including the pro rata share of our gross income for any company, United States or foreign, in which we are considered to own 25% or more of the
shares by value, in a taxable year is passive income; or
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | at least 50% of the assets, averaged over the year and generally determined based upon value, including the pro rata share of the assets of any company of which we are considered to
own 25% or more of the shares by value, in a taxable year are held for the production of, or produce, passive income.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Passive income generally consists of dividends, interest, rents, royalties, annuities, and income from certain commodities transactions and from national principal
contracts. Cash is treated as generating passive income.



If we become a PFIC,
each U.S. holder who has not elected to treat us as a qualified electing fund (the QEF election), or who has not elected to mark the stock to market as discussed below, would, upon receipt of certain distributions by us and upon disposition of the
ordinary shares at a gain, be liable to pay tax at the then prevailing highest tax rates on ordinary income plus interest on the tax, as if the distribution or gain had been recognized ratably over the taxpayers holding period for the ordinary
shares. In addition, when stock of a PFIC is acquired by reason of death from a decedent that is a U.S. holder, the tax basis of the shares does not receive a step-up to fair market value as of the date of the decedents death, but instead
would be equal to the decedents basis if lower, unless



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all gain is recognized by the decedent. Indirect investments in a PFIC may also be subject to special tax rules.



The PFIC rules above would not apply to a U.S. holder who makes a QEF election for all
taxable years that such shareholder has held the ordinary shares while we are a PFIC, provided that we comply with certain reporting requirements. Instead, each U.S. holder who has made such a QEF election is required for each taxable year that we
are a PFIC to include in income a pro rata share of our ordinary earnings as ordinary income and a pro rata share of our net capital gain as long-term capital gain, regardless of whether we make any distributions of such earnings or gain. In
general, a QEF election is effective only if we make available certain required information. The QEF election is made on a shareholder-by-shareholder basis and generally may be revoked only with the consent of the Internal Revenue Service. Although
we have no obligation to do so, we intend to notify U.S. holders if we believe we will be treated as a PFIC for any tax year in order to enable U.S. holders to consider whether to make a QEF election. In addition, we intend to comply with the
applicable information reporting requirements for U.S. holders to make a QEF election. U.S. holders should consult with their own tax advisers regarding eligibility, manner and advisability of making the QEF election if we are treated as a PFIC.



A U.S. holder of PFIC stock which is publicly traded could elect to mark the
stock to market annually, recognizing as ordinary income or loss each year an amount equal to the difference as of the close of the taxable year between the fair market value of the PFIC stock and the U.S. holders adjusted tax basis in the
PFIC stock. Losses would be allowed only to the extent of net mark-to-market gain previously included by the U.S. holder under the election for prior taxable years. If the mark-to-market election were made, then the rules set forth above would not
apply for periods covered by the election.



We believe that we will not be a
PFIC for 2004. The tests for determining PFIC status, however, are applied annually, and it is difficult to make accurate predictions of future income and assets which are relevant to this determination. Accordingly, there can be no assurance that
we will not be a PFIC. U.S. holders who hold ordinary shares during a period when we are a PFIC will be subject to the foregoing rules, even if we cease to be a PFIC, subject to certain exceptions for U.S. holders who made a mark-to-market or QEF
election. U.S. holders are strongly urged to consult their tax advisors about the PFIC rules, including the eligibility, manner and consequences to them of making a mark-to-market or QEF election with respect to our ordinary shares in the event that
we qualify as a PFIC.



Backup Withholding



A U.S. holder may be subject to backup withholding at a rate of 28% with respect to cash
dividend payments and proceeds from a disposition of ordinary shares. In general, backup withholding will apply only if a U.S. holder fails to comply with certain identification procedures. Backup withholding will not apply with respect to payments
made to certain exempt recipients, such as corporations and tax-exempt organizations. Backup withholding is not an additional tax and may be claimed as a credit against the U.S. federal income tax liability of a U.S. holder, provided that the
required information is furnished to the Internal Revenue Service.



Non-U.S.
holders of Ordinary Shares



Except as provided below, a taxpayer that is
not a U.S. holder generally will not be subject to U.S. federal income or withholding tax on the payment of dividends on, and the proceeds from the disposition of, an ordinary share.



A non-U.S. holder may be subject to U.S. federal income or withholding tax on the proceeds from the disposition of an ordinary share if (1)
such item is effectively connected with the conduct by the



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non-U.S. holder of a trade or business in the United States and, in the case of a resident of a country which has an income tax treaty with the United
States, such item is attributable to a permanent establishment or, in the case of gain realized by an individual non-U.S. holder, a fixed place of business in the United States; or (2) the individual non-U.S. holder is present in the United States
for 183 days or more in the taxable year of the sale and certain other conditions are met or (3) the non-U.S. holder is subject to tax pursuant to the provisions of the U.S. tax law applicable to U.S. expatriates.



In general, non-U.S. holders will not be subject to the 28% rate of backup withholding with
respect to the payment of dividends on ordinary shares unless payment is made through a paying agent, or office, in the United States. After January 1, 2001, however, if payment is made in the United States or by a U.S. related person, non-U.S.
holders will be subject to backup withholding. In general, if a non-U.S. holder provides a taxpayer identification number, certifies to its foreign status, or otherwise establishes an exemption, the non-U.S. holder will not be subject to backup
withholding. A U.S. related person for these purposes is a person with one or more current relationships with the United States.



Non-U.S. holders generally will be subject to backup withholding at a rate of 28% on the payment of the proceeds from the disposition of ordinary shares to or through the
United States office of a broker, whether domestic or foreign, unless the holder provides a taxpayer identification number, certifies to its foreign status or otherwise establishes an exemption. Non-U.S. holders will not be subject to backup
withholding with respect to the payment of proceeds from the disposition of ordinary shares by a foreign office of a broker. However, non-U.S. holders will be subject to backup withholding at a rate of 28% with respect to the payment of proceeds
from the disposition of ordinary shares effected outside the United States if the broker is a U.S. related person, unless the holder provides a taxpayer identification number, certifies to its foreign status or otherwise establishes an exemption.



The amount of any backup withholding from a payment to a non-U.S. holder will
be allowed as a credit against such holders U.S. federal income tax liability and may entitle such holder to a refund, provided that the required information is furnished to the Internal Revenue Service.



ISRAELI TAXATION



The following is a summary of the current tax structure applicable to companies incorporated in Israel, with special reference to its effect
on us. The following also contains a discussion of the material Israeli tax consequences to purchasers of our ordinary shares and Israeli government programs benefiting us. To the extent that the discussion is based on new tax legislation which has
not been subject to judicial or administrative interpretation, we cannot assure you that the views expressed in the discussion below will be accepted by the Israel tax authorities or courts. This discussion is not intended, and should not be
construed, as legal or professional tax advice, and is not exhaustive of all possible tax considerations.



Holders of our ordinary shares should consult his or her own tax advisors as to the particular tax consequences of an investment in the ordinary shares including the effects of applicable Israeli or foreign or other
tax laws and possible changes in the tax laws.



General Corporate Tax
Structure



Israeli companies are generally subject to corporate tax on
their taxable income at the rate of 35% for the 2004 tax year, 34% for the 2005 tax year, 32% for the 2006 tax year and 30% for the 2007 tax year and thereafter, and are subject to Capital Gains Tax at a rate of 25% for capital gains, other than
gains deriving from the sale of listed securities, derived after January 1, 2003. However, the effective



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tax rate payable by a company that derives income from an approved enterprise (as defined below) may be considerably less, as further discussed below.



Stamp Duty



The Israeli Stamp Duty on Documents Law, 1961, or the Stamp Duty Law, provides that any
document (or part thereof) that is signed in Israel or that is signed outside of Israel and refers to an asset or other thing in Israel or to an action that is executed or will be executed in Israel, is subject to a stamp duty, generally at a rate
of between 0.4% and 1% of the value of the subject matter of such document. De facto, it has been common practice in Israel not to pay such stamp duty unless a document is filed with a governmental authority. An amendment to the Stamp Duty Law, that
came into effect on June 1, 2003, determines the party liable for payment of stamp duty with respect to each type of document subject to such law. Following such amendment, Section 15(5) of the Stamp Duty Law generally provides that stamp duty on
most agreements shall be paid by the parties that signed such agreement, jointly or severally, or by the party that undertook under such agreement to pay the stamp duty.



As a result of the aforementioned amendment to the Stamp Duty Law, the Israeli tax authorities have approached many companies in Israel,
including us, and required disclosure of all agreements signed by such companies since June 1, 2003, with the aim of collecting stamp duty with respect to such agreements. The legitimacy of the aforementioned amendment to the Stamp Duty Law and of
said actions by the Israeli tax authorities are currently under review by the Israeli High Court of Justice. Based on advice from our Israeli counsel, we believe that we may only be required to pay stamp duty on documents signed on or after August
2004. However, we cannot assure you that the tax authorities or the courts will accept such view. Although at this stage it is not yet possible to evaluate the effect, if any, on us of the amendment to the Stamp Duty Law, the same could materially
adversely affect our results of operations.



In January 2005, an order was
signed in accordance with which the said requirement to pay stamp duty is cancelled with effect from January 1, 2008. Furthermore, pursuant to such order, as of January 1, 2005, stamp duty is no longer chargeable on, among others, loan agreements.



Tax Benefits and Grants for Research and Development



Israeli tax law allows, under certain conditions, a tax deduction in the year incurred for
expenditures, including depreciation on capital expenditures, in 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 enterprise and is carried out by, or on behalf of, the company seeking such deduction. However, the amount of such deductible expenses must be reduced by the sum of any funds received through government grants
for the finance of such scientific research and development projects. Expenditures not so approved or funded, are deductible over a three-year period.



Law for the Encouragement of Capital Investments, 1959



Our facilities currently enjoy approved enterprise status under the Investments Law.



The Investments Law, as amended, provides that a proposed capital investment in eligible facilities may, upon application to the Investment
Center of the Ministry of Industry and Trade 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,



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and by its physical characteristics, for example, the equipment to be purchased and utilized pursuant to the program.



The tax benefits derived from any such certificate of approval relate only to taxable income
attributable to the specific approved enterprise. Under an amendment to the Investments Law that was made within the framework of the Tax Reform, it was clarified that tax benefits under the Investments Law shall also apply to income generated by a
company from the grant of a usage right with respect to know-how developed by the approved enterprise, income generated from royalties, and income derived from a service which is auxiliary to such usage right or royalties, provided that such income
is generated within the approved enterprises ordinary course of business. The tax benefits under the Investment Law are not available with respect to income derived from products manufactured outside of Israel.



Taxable income of a company derived from an approved enterprise is subject to company tax at
the rate of 25%, rather than regular corporate tax rates as stated above, for the benefit period, a period of seven years commencing with the year in which the approved enterprise first generated taxable income, limited to twelve years from the year
of commencement of production or 14 years from the beginning of the year of approval, whichever is earlier, and, under certain circumstances, as further detailed below, extending to a maximum of ten years from the commencement of the benefit period.
In the event that a company is operating under more than one approval or that its capital investments are only partly approved, its effective company tax rate is the result of a weighted combination of the various applicable rates.



A company owning an approved enterprise may elect to forego certain government grants
extended to approved enterprises in return for an alternative package of tax benefits, which we have done. Under the alternative package, 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 under the Investments Law for the
remainder of the benefits period.



For our approved enterprise we have elected
the alternative benefits. Accordingly, we have waived grants in exchange for tax exemptions. Therefore, our income derived from our 1992 approved enterprise program is tax exempt for a period of four years, and was and will be subject to a reduced
company tax rate of between 10-25%, depending on the percentage of our ordinary shares held by non-Israeli residents, for the following six years. Our income derived from our 1996 approved enterprise program is tax exempt for a period of four years
commencing in 1996 and will be subject to a reduced company tax rate of between 10-25%, depending on the percentage of our ordinary shares held by non-Israeli residents, for the following six years. Our income derived from our 1998 approved
enterprise program will be tax exempt for a period of two years and will be subject to a reduced company tax rate of between 10-25%, depending on the percentage of our ordinary shares held by non-Israeli residents, for the following eight years. Our
income derived from our 2000 approved enterprise program will be tax exempt for a period of two years and will be subject to a reduced company tax rate of between 10-25%, depending on the percentage of our ordinary shares held by non-Israeli
residents, for the following eight years. We may apply for additional programs or for extensions of our existing programs. However, there can be no assurance that our application will be approved or that we will receive future benefits. Most of our
income has been generated through our approved enterprise.



A company that has
elected the alternative benefits and that subsequently pays a dividend out of income derived from the approved enterprises during the tax exemption period will be subject to company tax in respect of the grossed-up equivalent of the amount
distributed, including the recipients tax thereon, applying the rate which would have been applicable had the company not



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elected the alternative benefits. This is generally 10% to 25%, depending upon the extent to which non-Israeli shareholders hold our shares. The dividend
recipient is taxed at the reduced rate of 15% applicable to dividends from approved enterprises, if the dividend is distributed during the tax exemption period or within a specified period thereafter. This tax must be withheld by us at the source,
regardless of whether the dividend is converted into foreign currency. Subject to certain provisions concerning income, under the alternative benefits, all dividends are considered to be attributable to the entire company and their effective tax
rate is the result of a weighted combination of the various applicable tax rates. However, we are not obligated to distribute exempt retained profits under the alternative benefits, and we may generally decide from which annual profits to declare
dividends.



The Investments Law also provides that an approved enterprise is
entitled to accelerated depreciation on its property and equipment that are included in an approved investment program. We have not utilized this benefit.



Grants and other incentives received by a company in accordance with the Investments Law remain subject to final ratification by the Investment Center of the Israeli
Ministry of Industry and Trade, such ratification being conditional upon fulfillment of all terms of the approved program.



The benefits available to an approved enterprise are conditional upon the fulfillment of certain conditions stipulated in the Investments Law and its regulations and the
criteria set forth in the specific certificate of approval, as described above. In the event that these conditions are violated, in whole or in part, we would be required to refund the amount of tax benefits, with the addition of the Israel consumer
price index linkage adjustment and interest. We believe our approved enterprise operates in substantial compliance with all such conditions and criteria.



On April 1, 2005, an amendment to the Investments Law came into force. Pursuant to the amendment, a companys facility will be granted the status of
Approved Enterprise only if it is proven to be an industrial facility (as defined in the Investments Law) that contributes to the economic independence of the Israeli economy and is a competitive facility that contributes to the Israeli
gross domestic product. The amendment provides that the Israeli Tax Authority and not the Investment Center will be responsible for an Approved Enterprise under the alternative package of benefits, referred to as a Benefiting Facility. A company
wishing to receive the tax benefits afforded to a Benefiting Facility is required to select the tax year from which the period of benefits under the Investment Law are to commence by notifying the Israeli Tax Authority within 12 months of the end of
that year. In order to be recognized as owning a Benefiting Facility, a company is required to meet a number of conditions set forth in the amendment, including making a minimal investment in manufacturing assets for the Benefiting Facility and
having completed a cooling-off period of no less than two to four years from the companys previous year of commencement of benefits under the Investments Law.



Pursuant to the amendment, a company with a Benefiting Facility is entitled, in each tax year, to accelerated depreciation
for the manufacturing assets used by the Benefiting Facility and to certain tax benefits, provided that no more than 12 to 14 years have passed since the beginning of the year of commencement of benefits under the Investments Law. The tax benefits
granted to a Benefiting Factory are determined according one of the following new tax routes:



| |  |  | Similar to the currently available alternative route, exemption from corporate tax on undistributed income for a period of two to ten years, depending on the
geographic location of the Benefiting Facility within Israel, and a reduced corporate tax rate of 10 to 25% for the remainder of the benefits period, depending on the level of foreign investment in each year. Benefits may be granted for a term of
from seven to ten years, depending on the level of foreign investment in the company. If the company pays a
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| | dividend out of income derived from the Benefiting Facility during the tax exemption period, such income will be subject to corporate tax at the applicable
rate (10%-25%). The company is required to withhold tax at the source at a rate of 15% from any dividends distributed from income derived from the Benefiting Facility.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | A special tax route enabling companies owning facilities in certain geographical locations in Israel to pay corporate tax at the rate of 11.5% on income of the Benefiting Facility.
The benefits period is ten years. Upon payment of dividends, the company is required to withhold tax at source at a rate of 15% for Israeli residents and at a rate of 4% for foreign residents.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | A special tax route that provides a full exemption from corporate tax and from tax with respect to dividends for companies with an annual income of at least NIS 13-20 billion that
have invested a total of between NIS 600900 million in facilities in certain geographical locations in Israel.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Generally, a company that is Abundant in Foreign Investment (as defined in the Investments Law) is entitled to an extension of the benefits period by an
additional five years, depending on the rate of its income that is derived in foreign currency.



The amendment changes the definition of foreign investment in the Investments Law so that instead of an investment of foreign currency in the
company, the definition now requires a minimal investment of NIS 5 million by foreign investors. Furthermore, such definition now also includes the purchase of shares of a company from another shareholder, provided that the companys
outstanding and paid-up share capital exceeds NIS 5 million. Such changes to the aforementioned definition will take effect retroactively from 2003.



The amendment will apply to Approved Enterprise programs in which the year of commencement of benefits under the Investments Law is 2004 or later, unless
such programs received approval from the Investment Center on or prior to December 31, 2004 in which case the provisions of the amendment will not apply.



Taxation under Inflationary Conditions



The Income Tax Law (Inflationary Adjustments), 1985, or the Inflationary Adjustments Law, is intended to adjust the corporate tax system to the rate of inflation, i.e.,
to tax profits on an inflation-adjusted basis.



Under the Inflationary
Adjustments Law, results for tax purposes are measured in historical cost terms and are subject to a series of adjustments based on movements in the Israel consumer price index. We are taxed under this law. The discrepancy between the change in (1)
the Israel consumer price index and (2) the exchange rate of the NIS to the dollar, each year and cumulatively, may result in a significant difference between taxable income and the income denominated in dollars as reflected in our financial
statements. In addition, subject to certain limitations, depreciation of fixed assets and losses carried forward are adjusted for inflation on the basis of changes in the Israel consumer price index.



The salient features of the Inflationary Adjustments Law can be described generally as
follows:



| | (a) | A special tax adjustment for the preservation of equity whereby certain corporate assets are classified broadly into fixed (inflation immune) assets and non-fixed
assets. Where a companys equity, as defined in such law, exceeds the depreciated
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| | 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, linked to the increase in the consumer price index. 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.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (b) | Subject to certain limitation set forth in the Inflationary Adjustments Law, depreciation deductions on fixed assets and losses carried forward are adjusted for inflation based on
the increase in the Israel consumer price index.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (c) | Gains on the sale of certain listed securities which are taxed at a reduced rate with respect to individuals following the Tax Reform (and which were previously exempt from tax) are
taxable at a company tax rate in certain circumstances. However, dealers in securities are subject to the regular tax rules applicable to business income in Israel.
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



However, the Minister of Finance may, with the approval of the Knesset Finance Committee, determine by order, during a certain fiscal year
(or until February 28thof the following year) in which the rate of the increase of the price index would not exceed
or shall not have exceeded, as applicable, 3%, that all or some of the provisions of this law shall not apply to such fiscal year, or, that the rate of increase of the price index relating to such fiscal year shall be deemed to be 0%, and to make
the adjustments required to be made as a result of such determination.



Law
for the Encouragement of Industry (Taxes), 1969



We believe that we
currently qualify as an Industrial Company within the definition of the Law for the Encouragement of Industry (Taxes), 1969. According to the Industry Encouragement Law, an Industrial Company is a company resident in Israel, at least 90% of the
income of which in any tax year, determined in NIS, exclusive of income from defense loans, capital gains, interest and dividends, is derived from an Industrial Enterprise owned by it. An Industrial Enterprise is defined as an enterprise owned by an
Industrial Company and whose major activity in a given tax year is industrial production activity.



The following preferred corporate tax benefits are available to Industrial Companies, among others, including us:



| | (a) | Deduction of purchases of know-how and patents over an eight-year period for tax purposes.
| | --- | ------------------------------------------------------------------------------------------



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



| | (c) | An election under certain conditions to file a consolidated tax return with additional related Israeli Industrial Companies that satisfy conditions set forth in the law.
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (d) | Accelerated depreciation rates on equipment and buildings.
| | --- | ----------------------------------------------------------



Eligibility for the benefits under the Industry Encouragement Law is not subject to receipt of prior approval from any governmental authority. No assurance can be given
that we will continue to qualify as an Industrial Company or that the benefits described above will be available in the future.



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Capital Gains Tax



Israeli law generally imposes a capital gains tax on the sale of any capital assets by residents of Israel, as defined for Israeli tax purposes, and on the sale of assets
located in Israel, including shares in Israeli companies by both residents and non-residents of Israel, unless a specific exemption is available or unless a tax treaty between Israel and the shareholders country of residence provides
otherwise. The law distinguishes between the real gain and the inflationary surplus. The real gain is the excess of the total capital gain over the inflationary surplus, computed on the basis of the increase in the Israel consumer price index
between the date of purchase and the date of sale.



Generally, generally
capital gains tax is imposed on Israeli residents at a rate of 15% on real gains derived on or after January 1, 2003 from the sale of shares in, among others, Israeli companies publicly traded on Nasdaq or on a recognized stock exchange or regulated
market in a country that has a treaty for the prevention of double taxation with Israel (such as our company). This tax rate is contingent upon the shareholder not claiming a deduction for financing expenses in connection with such shares (in which
case the gain will be taxed at a rate of 25%), and does not apply to: (i) the sale of shares to a relative (as defined in the Israeli Income Tax Ordinance); (ii) the sale of shares by dealers in securities; (iii) the sale of shares by shareholders
that report in accordance with the Inflationary Adjustment Law (that will be taxed at corporate tax rates for corporations and at marginal rates for individuals); or (iv) the sale of shares by shareholders who acquired their shares prior to an
initial public offering (that may be subject to a different tax arrangement). The tax basis of shares acquired prior to January 1, 2003 will be determined in accordance with the average closing share price in the three trading days preceding January
1, 2003. However, a request may be made to the tax authorities to consider the actual adjusted cost of the shares as the tax basis if it is higher than such average price.



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



In some instances where our shareholders may be subject to Israeli tax on the sale of their ordinary shares, the payment of the consideration may be subject to the withholding of Israeli tax at the source.



94



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U.S.-Israel Tax Treaty



Under the U.S.-Israel Tax Treaty, the sale, exchange or disposition of shares by a person who holds the ordinary shares as a capital asset and 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 resident by the U.S.-Israel Tax Treaty will generally not be subject to the Israeli capital gains tax unless
such U.S. resident holds, directly or indirectly, shares representing 10% or more of the voting power of our company during any part of the 12-month period preceding such sale, exchange or disposition. A sale, exchange or disposition of shares by a
U.S. resident who holds, directly or indirectly, shares representing 10% or more of the voting power of our company 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 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 state or local taxes.



Tax on Dividends



Non-residents of
Israel are subject to income tax on income accrued or derived from sources in Israel. These 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 stock dividends, income tax at the rate of 25% is withheld at the 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 shares who is a resident of the United States will be 25% or 12.5% if such U.S. resident is a corporation which holds, directly or indirectly, shares representing at least 10% or more of our
issued voting power during the part of the tax year which precedes the date of payment of the dividend and during the whole of its prior tax year. However, under the U.S.-Israel Tax Treaty and the Investments Law, dividends generated by an approved
enterprise are taxed at the rate of 15%.



F. Dividends and Paying Agents



Not applicable.



G. Statement by Experts



Not applicable.



H. Documents on Display



We are subject to the
informational requirements of the Securities Exchange Act of 1934, as amended, applicable to foreign private issuers and fulfill the obligations with respect to such requirements by filing reports with the Securities and Exchange Commission. You may
read and copy any document we file with the Securities and Exchange Commission without charge at the Securities and Exchange Commissions public reference room at 450 Fifth Street, N.W., Washington, D.C. 20549. Copies of such material may be
obtained by mail from the Public Reference Branch of the Securities and Exchange Commission at such address, at prescribed rates. Please call the Securities and Exchange Commission at 1-800-SEC-0330 for further information on the public reference
room.



As a foreign private issuer, we are exempt from the rules under the
Exchange Act prescribing the furnishing and content of proxy statements, and our officers, directors and principal shareholders are exempt from the reporting and short-swing profit recovery provisions contained in Section 16 of



95



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the Exchange Act. In addition, we are not required under the Exchange Act to file periodic reports and financial statements with the Securities and Exchange
Commission as frequently or as promptly as United States companies whose securities are registered under the Exchange Act.



I. Subsidiary Information



Not applicable.



|Item 11. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|-------- | ----------------------------------------------------------



Since the majority of our revenues are paid in or linked to U.S. dollars, we believe that inflation and fluctuations in the NIS/U.S. dollar exchange rate have no material
effect on our revenues. Inflation in Israel and U.S. dollar exchange rate fluctuations, however, have some influence on our expenses and, as a result, on our net income. The cost of our Israel operations, as expressed in U.S. dollars, is influenced
by the extent to which any increase in the rate of inflation in Israel is not offset, or is offset on a lagging basis, by a devaluation of the NIS in relation to the U.S. dollar.



A significant portion of our expenditures are employee compensation-related. Salaries are paid in NIS. Annual salary increases during the
first quarter of the year and are adjusted for changes in the Israel consumer price index through annual salary increases during the first quarter of the year and bi-annual partial adjustments. This increases salary expenses in United States dollar
terms. The devaluation of the NIS against the U.S. dollar decreases employee compensation expenditures as expressed in dollars proportionally. Some of our other NIS-based expenses are either currently adjusted to U.S. dollars or are adjusted to the
Israel consumer price index.



Our results of operations are adversely affected
by increases in the rate of inflation in Israel when such increases are not offset, or are offset on a lagging basis, by a devaluation of the NIS against the U.S. dollar. A devaluation of the NIS in relation to the U.S. dollar will have the effect
of decreasing the U.S. dollar value of our assets, mostly current assets, to the extent of the underlying value of which is NIS-based. Such a devaluation would also have the effect of reducing the dollar amount of any of our liabilities which are
payable in NIS, unless such payables are linked to the dollar.



We do not
presently engage in any hedging or other transactions intended to manage risks relating to foreign currency exchange rate or interest rate fluctuations. However, we may in the future undertake hedging transactions if management determines that it is
necessary to offset such risks.



|Item 12. | DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
|-------- | ------------------------------------------------------



Not applicable.



PART II



|Item 13. | DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
|-------- | -----------------------------------------------



Not applicable.



96



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



Modification of Rights



In December 2004, our shareholders approved a private placement transaction in which the Company issued 6,636,391 shares of a new class of Series A Convertible Preferred
Shares (as described elsewhere in this annual report) and approved related amendments to our Articles of Association to give effect to such transaction, as described in Items 4 and 5 of our Notice and Proxy Statement for the Annual General Meeting
of our shareholders held on December 29, 2004, included in our report on Form 6-K, filed with the SEC on December 2, 2004, which is incorporated herein by reference. For additional details regarding the Series A Preferred Shares, see Item 10B.



Use of Proceeds



Not applicable.



|Item 15. | CONTROLS AND PROCEDURES
|-------- | -----------------------



In 2003, we established a Disclosure Controls Procedure Committee and adopted Disclosure Controls and Procedures.



We carried out an evaluation, under the supervision and with the participation of our
principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2004. Based on this evaluation, our principal executive officer and principal
financial officer have concluded that our disclosure controls and procedures are effective to reasonably assure that information required to be included in our periodic reports to the Securities and Exchange Commission is recorded, processed,
summarized and reported within the time period specified in the SECs rules and forms.



In addition, there were no changes in the Companys internal control over financial reporting that occurred during the year ended December 31, 2004 that have materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting.



|Item 16. | RESERVED
|-------- | --------



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



Our board of directors has determined that Meir Dvir, one of the members of our audit committee, qualifies as a financial expert under the applicable regulations.



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



In February 2004, we adopted a Code of Ethics and Business Conduct that applies to the Companys principal executive officer, principal financial officer, principal accounting officer or controller and persons
performing similar functions.



|Item 16C. | PRINCIPAL ACCOUNTANT FEES AND SERVICES
|--------- | --------------------------------------



Audit Fees



For 2003 and 2004, our principal accountant, Kost Forer Gabbay & Kasierer, a member of Ernst & Young Global, billed us aggregate amounts of approximately $120,000 and $118,500, respectively,



97



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for the audit of our annual financial statements, review of our quarterly financial results, consultations on various accounting issues and performance of
local statutory audits.



Audit Related Fees



Not applicable.



Tax Fees



For 2003 and 2004, our principal accountant billed us aggregate amounts of approximately $43,000 and $17,800, respectively, for services relating to tax compliance, tax
advice and tax planning.



All Other Fees



Not applicable.



Pre-approval Policies and Procedures



Our audit committee approves each audit and non-audit service to be performed by our independent accountant before the accountant is engaged.



|Item 16D. | EXEMPTIONS FROM LISTING STANDARDS FOR AUDIT COMMITTEES
|--------- | ------------------------------------------------------



Not applicable.



|Item 16E. | PURCHASE OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
|--------- | ---------------------------------------------------------------------



Not applicable.



|Item 17. | FINANCIAL STATEMENTS
|-------- | --------------------



We have responded to Item 18 in lieu of this item.



|Item 18. | FINANCIAL STATEMENTS
|-------- | --------------------



The Financial Statements required by this item are found at the end of this annual report, beginning on page F-1.



|Item 19. | EXHIBITS
|-------- | --------



The exhibits list required by this Item is incorporated by reference to the Exhibit Index which appears before the first exhibit filed with this document.



98



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SIGNATURES



Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant certifies that it has reasonable grounds to believe that it meets
all of the requirements for filing on Form 20-F and has duly caused this annual report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Petach Tikva, Israel on the 23rd day of May, 2005.



TTI TEAM TELECOM INTERNATIONAL LTD.By:

/S/ MEIR LIPSHESMeir LipshesActing Chief Executive Officer




99



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EXHIBIT INDEX



|(a) | Financial Statements
|--- | --------------------



| | 1. | Report of Independent Auditors
| | -- | ------------------------------



| | 2. | Consolidated Balance Sheets
| | -- | ---------------------------



| | 3. | Consolidated Statements of Income
| | -- | ---------------------------------



| | 4. | Statements of Changes in Shareholders Equity
| | -- | ---------------------------------------------



| | 5. | Consolidated Statements of Cash Flows
| | -- | -------------------------------------



| | 6. | Notes to Consolidated Financial Statements
| | -- | ------------------------------------------



|(b) | Exhibits
|--- | --------



|           |  |                                                                                        
|---------- |  | ---------------------------------------------------------------------------------------
|ExhibitNo. |  | Exhibit                                                                                
|1.1        |  | Articles of Association of Registrant, as amended through December 29, 2004.           
|           | 
|1.2        |  | Memorandum of Association of Registrant, as amended through December 29, 2004.         
|           | 
|4.6(1)     |  | The Registrants Share Option Plan, dated November 15, 1996.                           
|           | 
|4.8        |  | 2004 Employee Share Option Plan, adopted December 29, 2004                             
|           | 
|4.9(2)     |  | Agreement, dated October 9, 1996, between the Registrant and Team.                     
|           | 
|4.10(2)    |  | Registration Rights Agreement, dated October 22, 1996, between the Registrant and TSIL.
|           | 
|4.12(3)    |  | Lease, dated February 1, 1998, between the Registrant and Team.                        
|           | 
|4.13(4)    |  | Amendment to Lease Agreement dated September 2, 2002.                                  
|           | 
|4.15(5)    |  | Purchase Agreement, dated November 29, 2004.                                           
|           | 
|4.16(5)    |  | Form of Registration Rights Agreement, dated November 29, 2004.                        
|           | 
|4.17(5)    |  | Form of Warrant issued on January 3, 2005.                                             
|           | 
|4.18(5)    |  | Specimen Certificate for Series A Convertible Preferred Shares.                        
|           | 
|8          |  | Subsidiaries                                                                           
|           | 
|10.11      |  | Consent of Independent Auditors of the Registrant                                      



100



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|      |  |                                                                                            
|----- |  | -------------------------------------------------------------------------------------------
|11(6) |  | Code of Ethics and Business Conduct                                                        
|      | 
|12.1  |  | Certification of the Principal Executive Officer pursuant to §302 of the Sarbanes-Oxley Act
|      | 
|12.2  |  | Certification of the Principal Financial Officer pursuant to §302 of the Sarbanes-Oxley Act
|      | 
|13.1  |  | Certification of the Principal Executive Officer pursuant to §906 of the Sarbanes-Oxley Act
|      | 
|13.2  |  | Certification of the Principal Financial Officer pursuant to §906 of the Sarbanes-Oxley Act



|    |  |                                                                                                                                                                                               
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    | 
|(1) |  | English summary from Hebrew original was previously filed as an exhibit to TTIs Registration Statement on Form F-1 (Registration No. 333-5902), and incorporated herein by
reference.        
|    | 
|(2) |  | Previously filed as an exhibit to TTIs Registration Statement on Form F-1 (Registration No. 333-5902), and incorporated herein by reference.                                                 
|    | 
|(3) |  | English summary from Hebrew original was previously filed as an exhibit to TTIs annual report on Form 20-F for the fiscal year ended December 31, 1998, and incorporated herein by
reference.
|    | 
|(4) |  | English translation from Hebrew original previously filed as an exhibit to TTIs annual report on Form 20-F for the fiscal year ended December 31, 2002, and incorporated herein by
reference.
|    | 
|(5) |  | Previously filed as an exhibit to TTIs Registration Statement on Form F-3, and incorporated herein by reference.                                                                             
|    | 
|(6) |  | Previously filed on TTIs Form 20-F for the year ended December 31, 2003, and incorporated herein by reference.                                                                               



101



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| |  |  | veto rights over certain material actions taken by us, which could be exercised by the holders of the Series A Preferred Shares in a manner detrimental to the interests of the
holders of our ordinary shares; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the right to nominate one member to our board of directors, which could result in such member voting on matters brought before our board of directors in a manner detrimental to the
interests of the holders of our ordinary shares.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



In addition,
the investors have rights of first offer in the event we propose to offer or sell any of our ordinary shares in one or more transactions not involving a public offering prior to the first anniversary of the date upon which the registration statement
we filed in connection with the private placement is declared effective by the SEC. Finally, the investors have the right to receive payment for liquidated damages if a registration statement on Form F-3 is not declared effective within 90 days (or
120 days in the event the SEC conducts a review) following the closing of the private placement transaction. We did not obtain effectiveness of the registration statement within the timeframe set forth in our agreements with the investors.
Therefore, since May 4, 2005, we have been accruing liquidated damages at a rate equal to 2% of each investors investment in the Company for each 30 day period, or pro rata for any portion thereof, during the period for which the registration
statement is not declared effective.



We do not intend to pay dividends.



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



If we are characterized as a passive foreign investment company, our U.S. shareholders may suffer adverse tax consequences.



If, for any taxable year, our passive income, or our assets which produce
passive income, exceed specified levels, we may be characterized as a passive foreign investment company, or PFIC, for U.S. federal income tax purposes. This characterization could result in adverse U.S. tax consequences for our U.S. shareholders,
which may include having gains realized on the sale of our ordinary shares treated as ordinary income, rather than as capital gains income, having potentially punitive interest charges apply to those gains, and the denial of the taxation of certain
dividends paid by us at the lower rates applicable to long-term capital gains. Although we do not believe that we have been a PFIC for any tax year through and including 2004, the tests for determining PFIC status are applied annually and are based
in part on reference to the market value of our shares and valuing our intangible assets, and it is difficult to make accurate determinations about these items. Accordingly, we cannot make any assurances to you about our status. U.S. shareholders
are urged to consult with their own U.S. tax advisors with respect to the U.S. tax consequences of investing in our ordinary shares. For a discussion of the rules relating to PFIC and related tax consequences, please see the section of this annual
report entitled Taxation  United States Federal Income Tax Considerations.



Our share price has decreased significantly and could continue to fluctuate significantly.



The market price for our ordinary shares, as well as the prices of shares of other technology companies, has been volatile. Our share price has decreased significantly
since late 2002. Numerous factors, many of which are beyond our control, may cause the market price of our ordinary shares to fluctuate significantly, such as:



| |  |  | fluctuations in our quarterly revenues and earnings and those of our publicly held competitors;
| | - |  | -----------------------------------------------------------------------------------------------



17



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TTI TEAM TELECOM INTERNATIONAL LTD. AND ITS SUBSIDIARIES



CONSOLIDATED FINANCIAL STATEMENTS



AS OF DECEMBER 31, 2004



IN U.S DOLLARS



INDEX



|                                                        |  |           
|------------------------------------------------------- |  | ----------
|                                                        |  | Page      
|Report of Independent Registered Public Accounting Firm |  | F-2       
|                                                        | 
|Consolidated Balance Sheets                             |  | F-3 - F-4 
|                                                        | 
|Consolidated Statements of Operations                   |  | F-5       
|                                                        | 
|Statements of Changes in Shareholders Equity           |  | F-6       
|                                                        | 
|Consolidated Statements of Cash Flows                   |  | F-7       
|                                                        | 
|Notes to Consolidated Financial Statements              |  | F-8 - F-34





---

LOGO



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



To the Shareholders of



TTI TEAM TELECOM INTERNATIONAL LTD.



We have
audited the accompanying consolidated balance sheets of TTI Team Telecom International Ltd. (the Company) and its subsidiaries as of December 31, 2003 and 2004 and the related consolidated statements of operations, shareholders
equity and cash flows for each of the three years in the period ended December 31, 2004. These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements
based on our audits.



We conducted our audits in accordance
with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.
We were not engaged to perform an audit of the Companys internal control over financial reporting. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in
the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Companys internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.



In our
opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company and its subsidiaries at December 31, 2003 and 2004, and the consolidated results of their
operations and their cash flows for each of the three years in the period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles.



|                 |  |  |  |                                 
|---------------- |  |  |  | --------------------------------
|Tel-Aviv, Israel |  |  |  | KOST FORER GABBAY & KASIERER    
|March 30, 2005   |  |  |  | A Member of Ernst & Young Global



F-2



---

TTI TEAM TELECOM INTERNATIONAL LTD.

AND ITS SUBSIDIARIES



CONSOLIDATED BALANCE SHEETS

U.S. dollars in thousands



|                                                                                                           |  |              |        |      |   |       
|---------------------------------------------------------------------------------------------------------- |  | ------------ | ------ | ---- | - | ------
|                                                                                                           |  | December 31,
|                                                                                                           |  | 2003         |        | 2004
|ASSETS                                                                                                     |  |              |        |      |   |       
|CURRENT ASSETS:                                                                                            |  |              |        |      |   |       
|Cash and cash equivalents                                                                                  |  | $            | 13,901 |      | $ | 5,472 
|Short-term bank deposits                                                                                   |  |              | 4,365  |      |   | 4,426 
|Marketable securities (Note 3)                                                                             |  |              | 15,767 |      |   | 10,572
|Trade receivables (net of allowance for doubtful accounts - $ 8,070 in 2003 and $ 8,020 in 2004) (Note 1c) |  |              | 10,738 |      |   | 6,755 
|Unbilled receivables                                                                                       |  |              | 6,590  |      |   | 1,491 
|Related party (Note 12)                                                                                    |  |              |       |      |   | 150   
|Other accounts receivable and prepaid expenses (Note 4)                                                    |  |              | 2,728  |      |   | 3,265 
|                                                                                                           |  |              |        |      |   |       
|Total current assets                                                                                       |  |              | 54,089 |      |   | 32,131
|                                                                                                           |  |              |        |      |   |       
|LONG-TERM INVESTMENTS:                                                                                     |  |              |        |      |   |       
|Long-term bank deposits                                                                                    |  |              | 973    |      |   | 923   
|Investment in a company                                                                                    |  |              | 165    |      |   | 165   
|Severance pay fund                                                                                         |  |              | 4,075  |      |   | 3,855 
|Long-term prepaid expenses                                                                                 |  |              | 200    |      |   |      
|Deferred tax assets (Note 10)                                                                              |  |              | 1,647  |      |   |      
|Long-term trade and unbilled receivables (Note 1c)                                                         |  |              | 3,038  |      |   | 3,268 
|                                                                                                           |  |              |        |      |   |       
|Total long-term investments                                                                                |  |              | 10,098 |      |   | 8,211 
|                                                                                                           |  |              |        |      |   |       
|PROPERTY AND EQUIPMENT, NET (Note 5)                                                                       |  |              | 7,838  |      |   | 5,874 
|                                                                                                           |  |              |        |      |   |       
|INTANGIBLE ASSETS, NET (Note 6)                                                                            |  |              | 4,581  |      |   | 281   
|                                                                                                           |  |              |        |      |   |       
|Total assets                                                                                               |  | $            | 76,606 |      | $ | 46,497
|                                                                                                           |  |              |        |      |   |       



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



F-3



---

TTI TEAM TELECOM INTERNATIONAL LTD.

AND ITS SUBSIDIARIES



CONSOLIDATED BALANCE SHEETS

U.S. dollars in thousands, except share and per share data



|                                                                                                                                                                                                        |  |              |        |   |      |   |         |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | ------ | - | ---- | - | ------- | -
|                                                                                                                                                                                                        |  | December 31, |       
|                                                                                                                                                                                                        |  | 2003         |        |   | 2004 |  
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                                                                                    |  |              |        |   |      |   |         |  
|CURRENT LIABILITIES:                                                                                                                                                                                    |  |              |        |   |      |   |         |  
|Short-term bank credit (Note 7)                                                                                                                                                                         |  | $            |       |   |      | $ | 967     |  
|Trade payables                                                                                                                                                                                          |  |              | 4,588  |   |      |   | 3,545   |  
|Related parties (Note 12)                                                                                                                                                                               |  |              | 1,176  |   |      |   |        |  
|Deferred revenues                                                                                                                                                                                       |  |              | 3,591  |   |      |   | 4,642   |  
|Other accounts payable and accrued expenses (Note 8)                                                                                                                                                    |  |              | 6,164  |   |      |   | 6,171   |  
|                                                                                                                                                                                                        |  |              |        |   |      |   |         |  
|Total current liabilities                                                                                                                                                                               |  |              | 15,519 |   |      |   | 15,325  |  
|                                                                                                                                                                                                        |  |              |        |   |      |   |         |  
|ACCRUED SEVERANCE PAY                                                                                                                                                                                   |  |              | 5,298  |   |      |   | 4,879   |  
|                                                                                                                                                                                                        |  |              |        |   |      |   |         |  
|COMMITMENTS AND CONTINGENT LIABILITIES (Note 9)                                                                                                                                                         |  |              |        |   |      |   |         |  
|SHAREHOLDERS EQUITY:                                                                                                                                                                                   |  |              |        |   |      |   |         |  
|Share capital (Note 11):                                                                                                                                                                                |  |              |        |   |      |   |         |  
|Ordinary shares of NIS 0.5 par value- Authorized: 30,000,000 shares at December 31, 2003 and 2004; Issued and outstanding: 11,872,052 and
11,872,941 shares at December 31, 2003 and 2004, respectively |  |              | 1,794  |   |      |   | 1,794   |  
|Additional paid-in capital                                                                                                                                                                              |  |              | 58,871 |   |      |   | 58,881  |  
|Accumulated other comprehensive loss                                                                                                                                                                    |  |              | (214   | ) |      |   | (226    | )
|Accumulated deficit                                                                                                                                                                                     |  |              | (4,662 | ) |      |   | (34,156 | )
|                                                                                                                                                                                                        |  |              |        |   |      |   |         |  
|Total shareholders equity                                                                                                                                                                              |  |              | 55,789 |   |      |   | 26,293  |  
|                                                                                                                                                                                                        |  |              |        |   |      |   |         |  
|Total liabilities and shareholders equity                                                                                                                                                              |  | $            | 76,606 |   |      | $ | 46,497  |  
|                                                                                                                                                                                                        |  |              |        |   |      |   |         |  



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



F-4



---

TTI TEAM TELECOM INTERNATIONAL LTD.

AND ITS SUBSIDIARIES



CONSOLIDATED STATEMENTS OF OPERATIONS

U.S. dollars in thousands, except per share data



|                                                                                          |  |                         |            |   |      |   |            |      |  |   |            |  
|----------------------------------------------------------------------------------------- |  | ----------------------- | ---------- | - | ---- | - | ---------- | ---- |  | - | ---------- | -
|                                                                                          |  | Year ended December 31, |           
|                                                                                          |  | 2002                    |            |   | 2003 |   |            | 2004 | 
|Revenues (Note 13):                                                                       |  |                         |            |   |      |   |            |      |  |   |            |  
|Products                                                                                  |  | $                       | 47,021     |   |      | $ | 33,831     |      |  | $ | 21,670     |  
|Services                                                                                  |  |                         | 11,320     |   |      |   | 12,036     |      |  |   | 16,128     |  
|                                                                                          |  |                         |            |   |      |   |            |      |  |   |            |  
|Total revenues                                                                            |  |                         | 58,341     |   |      |   | 45,867     |      |  |   | 37,798     |  
|                                                                                          |  |                         |            |   |      |   |            |      |  |   |            |  
|Cost of revenues:                                                                         |  |                         |            |   |      |   |            |      |  |   |            |  
|Products                                                                                  |  |                         | 27,398     |   |      |   | 29,619     |      |  |   | 16,645     |  
|Services                                                                                  |  |                         | 5,675      |   |      |   | 6,368      |      |  |   | 9,719      |  
|Impairment of capitalized software development costs (Note 6)                             |  |                         |           |   |      |   | 5,864      |      |  |   | 3,597      |  
|                                                                                          |  |                         |            |   |      |   |            |      |  |   |            |  
|Total cost of revenues                                                                    |  |                         | 33,073     |   |      |   | 41,851     |      |  |   | 29,961     |  
|                                                                                          |  |                         |            |   |      |   |            |      |  |   |            |  
|Gross profit                                                                              |  |                         | 25,268     |   |      |   | 4,016      |      |  |   | 7,837      |  
|                                                                                          |  |                         |            |   |      |   |            |      |  |   |            |  
|Operating expenses:                                                                       |  |                         |            |   |      |   |            |      |  |   |            |  
|Research and development, net (Note 14a)                                                  |  |                         | 7,958      |   |      |   | 10,318     |      |  |   | 10,744     |  
|Selling and marketing                                                                     |  |                         | 17,725     |   |      |   | 19,465     |      |  |   | 19,220     |  
|General and administrative                                                                |  |                         | 6,980      |   |      |   | 6,333      |      |  |   | 6,636      |  
|Allowance for doubtful accounts and write-off of bad debts (Note 1c)                      |  |                         | 7,456      |   |      |   | 177        |      |  |   | (50        | )
|Goodwill write-off                                                                        |  |                         |           |   |      |   | 1,052      |      |  |   |           |  
|                                                                                          |  |                         |            |   |      |   |            |      |  |   |            |  
|Total operating expenses                                                                  |  |                         | 40,119     |   |      |   | 37,345     |      |  |   | 36,550     |  
|                                                                                          |  |                         |            |   |      |   |            |      |  |   |            |  
|Operating loss                                                                            |  |                         | (14,851    | ) |      |   | (33,329    | )    |  |   | (28,713    | )
|Financial income, net (Note 14b)                                                          |  |                         | 3,412      |   |      |   | 2,793      |      |  |   | 1,326      |  
|                                                                                          |  |                         |            |   |      |   |            |      |  |   |            |  
|Loss before income taxes                                                                  |  |                         | (11,439    | ) |      |   | (30,536    | )    |  |   | (27,387    | )
|Income taxes (Note 10)                                                                    |  |                         | (585       | ) |      |   | (456       | )    |  |   | 2,107      |  
|                                                                                          |  |                         |            |   |      |   |            |      |  |   |            |  
|Net loss                                                                                  |  | $                       | (10,854    | ) |      | $ | (30,080    | )    |  | $ | (29,494    | )
|                                                                                          |  |                         |            |   |      |   |            |      |  |   |            |  
|Net loss per share:                                                                       |  |                         |            |   |      |   |            |      |  |   |            |  
|Basic and diluted net loss per Ordinary share                                             |  | $                       | (0.92      | ) |      | $ | (2.53      | )    |  | $ | (2.48      | )
|                                                                                          |  |                         |            |   |      |   |            |      |  |   |            |  
|Weighted average number of shares used for computing basic and diluted net loss per share |  |                         | 11,852,808 |   |      |   | 11,872,052 |      |  |   | 11,872,941 |  
|                                                                                          |  |                         |            |   |      |   |            |      |  |   |            |  



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



F-5



---

TTI TEAM TELECOM INTERNATIONAL LTD.

AND ITS SUBSIDIARIES



STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY

U.S. dollars in thousands, except share data



|                                                                                               |  |                 |  |               |       |                          |   |                                              |  |   |                                      |   |  |                        |         |   |                           |   |         |   |  |   |         |  
|---------------------------------------------------------------------------------------------- |  | --------------- |  | ------------- | ----- | ------------------------ | - | -------------------------------------------- |  | - | ------------------------------------ | - |  | ---------------------- | ------- | - | ------------------------- | - | ------- | - |  | - | ------- | -
|                                                                                               |  | Number ofshares |  | Share capital |       | Additionalpaid-incapital |   | Accumulatedothercomprehensiveincome(loss)**) |  |   | Retainedearnings(accumulateddeficit) |   |  | Totalcomprehensiveloss |         |   | Totalshareholders equity |  
|Balance as of January 1, 2002                                                                  |  | 11,752,600      |  | $             | 1,781 |                          | $ | 56,932                                       |  | $ | (100                                 | ) |  | $                      | 36,272  |   |                           |   |         |   |  | $ | 94,885  |  
|Exercise of stock options                                                                      |  | 119,452         |  |               | 13    |                          |   | 1,720                                        |  |   |                                     |   |  |                        |        |   |                           |   |         |   |  |   | 1,733   |  
|Tax benefit related to exercise of options                                                     |  |                |  |               |      |                          |   | 219                                          |  |   |                                     |   |  |                        |        |   |                           |   |         |   |  |   | 219     |  
|Comprehensive loss:                                                                            |  |                 |  |               |       |                          |   |                                              |  |   |                                      |   |  |                        |         |   |                           |   |         |   |  |   |         |  
|Other comprehensive income - unrealized gains on available-for-sale marketable securities, net |  |                |  |               |      |                          |   |                                             |  |   | 285                                  |   |  |                        |        |   |                           | $ | 285     |   |  |   | 285     |  
|Net loss                                                                                       |  |                |  |               |      |                          |   |                                             |  |   |                                     |   |  |                        | (10,854 | ) |                           |   | (10,854 | ) |  |   | (10,854 | )
|                                                                                               |  |                 |  |               |       |                          |   |                                              |  |   |                                      |   |  |                        |         |   |                           |   |         |   |  |   |         |  
|Total comprehensive loss                                                                       |  |                 |  |               |       |                          |   |                                              |  |   |                                      |   |  |                        |         |   |                           | $ | (10,569 | ) |  |   |         |  
|                                                                                               |  |                 |  |               |       |                          |   |                                              |  |   |                                      |   |  |                        |         |   |                           |   |         |   |  |   |         |  
|Balance as of December 31, 2002                                                                |  | 11,872,052      |  |               | 1,794 |                          |   | 58,871                                       |  |   | 185                                  |   |  |                        | 25,418  |   |                           |   |         |   |  |   | 86,268  |  
|Comprehensive loss:                                                                            |  |                 |  |               |       |                          |   |                                              |  |   |                                      |   |  |                        |         |   |                           |   |         |   |  |   |         |  
|Other comprehensive loss - unrealized losses on available-for-sale marketable securities, net  |  |                |  |               |      |                          |   |                                             |  |   | (399                                 | ) |  |                        |        |   |                           | $ | (399    | ) |  |   | (399    | )
|Net loss                                                                                       |  |                |  |               |      |                          |   |                                             |  |   |                                     |   |  |                        | (30,080 | ) |                           |   | (30,080 | ) |  |   | (30,080 | )
|                                                                                               |  |                 |  |               |       |                          |   |                                              |  |   |                                      |   |  |                        |         |   |                           |   |         |   |  |   |         |  
|Total comprehensive loss                                                                       |  |                 |  |               |       |                          |   |                                              |  |   |                                      |   |  |                        |         |   |                           | $ | (30,479 | ) |  |   |         |  
|                                                                                               |  |                 |  |               |       |                          |   |                                              |  |   |                                      |   |  |                        |         |   |                           |   |         |   |  |   |         |  
|Balance as of December 31, 2003                                                                |  | 11,872,052      |  |               | 1,794 |                          |   | 58,871                                       |  |   | (214                                 | ) |  |                        | (4,662  | ) |                           |   |         |   |  |   | 55,789  |  
|Exercise of stock options                                                                      |  | 889             |  |               | *)   |                          |   | 10                                           |  |   |                                     |   |  |                        |        |   |                           |   |         |   |  |   | 10      |  
|Comprehensive loss:                                                                            |  |                 |  |               |       |                          |   |                                              |  |   |                                      |   |  |                        |         |   |                           |   |         |   |  |   |         |  
|Other comprehensive loss - unrealized losses on available-for-sale marketable securities, net  |  |                |  |               |      |                          |   |                                             |  |   | (12                                  | ) |  |                        |        |   |                           | $ | (12     | ) |  |   | (12     | )
|Net loss                                                                                       |  |                |  |               |      |                          |   |                                             |  |   |                                     |   |  |                        | (29,494 | ) |                           |   | (29,494 | ) |  |   | (29,494 | )
|                                                                                               |  |                 |  |               |       |                          |   |                                              |  |   |                                      |   |  |                        |         |   |                           |   |         |   |  |   |         |  
|Total comprehensive loss                                                                       |  |                 |  |               |       |                          |   |                                              |  |   |                                      |   |  |                        |         |   |                           | $ | (29,506 | ) |  |   |         |  
|                                                                                               |  |                 |  |               |       |                          |   |                                              |  |   |                                      |   |  |                        |         |   |                           |   |         |   |  |   |         |  
|Balance as of December 31, 2004                                                                |  | 11,872,941      |  | $             | 1,794 |                          | $ | 58,881                                       |  | $ | (226                                 | ) |  | $                      | (34,156 | ) |                           |   |         |   |  | $ | 26,293  |  
|                                                                                               |  |                 |  |               |       |                          |   |                                              |  |   |                                      |   |  |                        |         |   |                           |   |         |   |  |   |         |  



|*) | Represents an amount lower than $ 1.
|-- | ------------------------------------



|**) | Accumulated other comprehensive income (loss) on account of unrealized gains (losses) on available-for-sale marketable securities.
|--- | ----------------------------------------------------------------------------------------------------------------------------------



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



F-6



---

TTI TEAM TELECOM INTERNATIONAL LTD.

AND ITS SUBSIDIARIES



CONSOLIDATED STATEMENTS OF CASH FLOWS

U.S. dollars in thousands



|                                                                                                      |  |                         |         |   |      |   |         |      |  |   |         |  
|----------------------------------------------------------------------------------------------------- |  | ----------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                                                      |  | Year ended December 31, |        
|                                                                                                      |  | 2002                    |         |   | 2003 |   |         | 2004 | 
|Cash flows from operating activities:                                                                 |  |                         |         |   |      |   |         |      |  |   |         |  
|Net loss                                                                                              |  | $                       | (10,854 | ) |      | $ | (30,080 | )    |  | $ | (29,494 | )
|Adjustments required to reconcile net loss to net cash provided by (used in) operating activities:    |  |                         |         |   |      |   |         |      |  |   |         |  
|Depreciation and amortization                                                                         |  |                         | 5,868   |   |      |   | 5,821   |      |  |   | 3,530   |  
|Impairment of capitalized software development costs                                                  |  |                         |        |   |      |   | 5,864   |      |  |   | 3,597   |  
|Impairment of goodwill                                                                                |  |                         |        |   |      |   | 1,052   |      |  |   |        |  
|Loss (gain) from sale of property and equipment                                                       |  |                         |        |   |      |   | 232     |      |  |   | (5      | )
|Realized loss (gain) on available-for-sale marketable securities                                      |  |                         | 56      |   |      |   | (543    | )    |  |   | (271    | )
|Impairment of available-for-sale marketable securities                                                |  |                         | 2,505   |   |      |   |        |      |  |   |        |  
|Amortization of premium and accretion of accrued interest on available-for-sale marketable securities |  |                         | 61      |   |      |   | 111     |      |  |   | 184     |  
|Long-term prepaid expenses write-off                                                                  |  |                         | 535     |   |      |   |        |      |  |   |        |  
|Accrued interest on short-term bank deposits                                                          |  |                         | (2      | ) |      |   | 15      |      |  |   | 36      |  
|Severance pay, net                                                                                    |  |                         | (119    | ) |      |   | 25      |      |  |   | (199    | )
|Deferred tax assets, net                                                                              |  |                         | (957    | ) |      |   | (459    | )    |  |   | 1,647   |  
|Decrease (increase) in trade receivables, net                                                         |  |                         | 3,787   |   |      |   | (940    | )    |  |   | 3,983   |  
|Decrease in unbilled receivables                                                                      |  |                         | 3,168   |   |      |   | 3,867   |      |  |   | 5,099   |  
|Decrease (increase) in other accounts receivable and prepaid expenses                                 |  |                         | 1,862   |   |      |   | 2,084   |      |  |   | (327    | )
|Increase in long-term trade and unbilled receivables                                                  |  |                         | (2,855  | ) |      |   | (183    | )    |  |   | (230    | )
|Increase (decrease) in trade payables                                                                 |  |                         | 715     |   |      |   | 1,130   |      |  |   | (1,043  | )
|Increase (decrease) in related parties                                                                |  |                         | (1,942  | ) |      |   | 463     |      |  |   | (1,326  | )
|Increase (decrease) in deferred revenues                                                              |  |                         | (284    | ) |      |   | 2,326   |      |  |   | 1,051   |  
|Increase (decrease) in other accounts payable and accrued expenses                                    |  |                         | 347     |   |      |   | (1,970  | )    |  |   | 7       |  
|                                                                                                      |  |                         |         |   |      |   |         |      |  |   |         |  
|Net cash provided by (used in) operating activities                                                   |  |                         | 1,891   |   |      |   | (11,185 | )    |  |   | (13,761 | )
|                                                                                                      |  |                         |         |   |      |   |         |      |  |   |         |  
|Cash flows from investing activities:                                                                 |  |                         |         |   |      |   |         |      |  |   |         |  
|Investment in short-term and long-term bank deposits                                                  |  |                         | (1,228  | ) |      |   | (5,706  | )    |  |   | (2,801  | )
|Proceeds from short-term bank deposits                                                                |  |                         | 194     |   |      |   | 1,582   |      |  |   | 2,754   |  
|Investment in available-for-sale marketable securities                                                |  |                         | (16,021 | ) |      |   | (11,610 | )    |  |   | (1,096  | )
|Proceeds from sale and redemption of available-for-sale marketable securities                         |  |                         | 18,977  |   |      |   | 8,765   |      |  |   | 6,366   |  
|Capitalization of software development costs                                                          |  |                         | (2,000  | ) |      |   |        |      |  |   |        |  
|Investment in another company                                                                         |  |                         | (165    | ) |      |   |        |      |  |   |        |  
|Increase in long-term prepaid expenses                                                                |  |                         | (635    | ) |      |   |        |      |  |   |        |  
|Purchase of property and equipment                                                                    |  |                         | (3,143  | ) |      |   | (2,080  | )    |  |   | (925    | )
|Proceeds from sale of property and equipment                                                          |  |                         |        |   |      |   | 163     |      |  |   | 67      |  
|                                                                                                      |  |                         |         |   |      |   |         |      |  |   |         |  
|Net cash provided by (used in) investing activities                                                   |  |                         | (4,021  | ) |      |   | (8,886  | )    |  |   | 4,365   |  
|                                                                                                      |  |                         |         |   |      |   |         |      |  |   |         |  
|Cash flows from financing activities:                                                                 |  |                         |         |   |      |   |         |      |  |   |         |  
|Short-term bank credit                                                                                |  |                         | (1,742  | ) |      |   |        |      |  |   | 967     |  
|Proceeds from exercise of options, net                                                                |  |                         | 1,733   |   |      |   |        |      |  |   |        |  
|                                                                                                      |  |                         |         |   |      |   |         |      |  |   |         |  
|Net cash provided by (used in) financing activities                                                   |  |                         | (9      | ) |      |   |        |      |  |   | 967     |  
|                                                                                                      |  |                         |         |   |      |   |         |      |  |   |         |  
|Decrease in cash and cash equivalents                                                                 |  |                         | (2,139  | ) |      |   | (20,071 | )    |  |   | (8,429  | )
|Cash and cash equivalents at the beginning of the year                                                |  |                         | 36,111  |   |      |   | 33,972  |      |  |   | 13,901  |  
|                                                                                                      |  |                         |         |   |      |   |         |      |  |   |         |  
|Cash and cash equivalents at the end of the year                                                      |  | $                       | 33,972  |   |      | $ | 13,901  |      |  | $ | 5,472   |  
|                                                                                                      |  |                         |         |   |      |   |         |      |  |   |         |  
|Supplemental disclosure of cash flows information:                                                    |  |                         |         |   |      |   |         |      |  |   |         |  
|Cash paid during the year for:                                                                        |  |                         |         |   |      |   |         |      |  |   |         |  
|Taxes                                                                                                 |  | $                       | 107     |   |      | $ | 1,269   |      |  | $ | 289     |  
|                                                                                                      |  |                         |         |   |      |   |         |      |  |   |         |  



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



F-7



---

TTI TEAM TELECOM INTERNATIONAL LTD.

AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands



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



|a. | TTI Team Telecom International Ltd. (TTI or the Company), an Israeli corporation, was incorporated in 1990 and commenced its operations in September 1992.
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------



The Company designs, develops, markets and
supports network management and operations support system software for the communications industry.



The Companys Netrac family of products performs and manages functions critical to the operations of telecommunications service providers, such as
fault management - monitoring equipment performance to detect and analyze failures, performance management - providing traffic analysis and quality of statistics service, configuration management - managing physical and logical connectivity within
the network and security management - controlling and protecting access to data and applications.



The Company has wholly-owned subsidiaries in the U.S., the Netherlands, the U.K., India, Malta, Costa-Rica, Australia and in Hong-Kong.



As of December 31, 2004, the Company is 50.22% held by Team Software
Industries Ltd., a wholly-owned subsidiary of Team Computers and System Ltd. (Team), a public company listed for trade on the Tel-Aviv Stock exchange (also refer to Note 15).



As to principal markets and customers, see Note 13.



|b. | Acquisition of Axarte Limited (Axarte):
|-- | -----------------------------------------



On January 31, 2001, TTI invested $ 4,000 in Axarte U.K., a software company. The acquisition was accounted for under the purchase accounting method as of
January 31, 2001 and accordingly, the purchase price has been allocated to the identifiable assets and liabilities acquired based on their relative fair values as of January 31, 2001. The acquisition resulted in recording goodwill and acquired
technology of approximately $ 1,211 and $ 4,119, respectively. The goodwill was written off during 2003. Acquired technology refers to software development costs developed by Axarte for which technological feasibility was established in accordance
with Statement of Financial Accounting Standards No. 86, Accounting for Costs of Computer Software to be Sold, Leased or Otherwise Marketed (SFAS No. 86) and is amortized over a period of six years.



F-8



---

TTI TEAM TELECOM INTERNATIONAL LTD.

AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands



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



|c. | Termination of agreements:
|-- | --------------------------



On November 13, 2002, the Company received a letter of termination from a major customer, regarding an agreement signed on January 30, 2002. The customer
also obtained, after a court hearing, the payment of a performance bond issued by a bank on the Companys behalf under the agreement. On January 23, 2003, the bond in the amount of approximately £1,000 , was paid to the customer.



The Company believes that this customer terminated the
agreement unlawfully, and in violation of the termination provisions set out in the agreement.



The Companys management believes, in light of the facts surrounding its relationship with this customer, and based on consultations with and
opinions of its legal counsel, that the Company has reasonably good prospects of establishing that the customer was not entitled to terminate the agreement and by its conduct repudiated the agreement. The Company cannot currently quantify the amount
of damages that it would receive if it were to succeed in a lawsuit against the customer, and the Company cannot estimate the amount of damages that could be sought by the customer in a potential counterclaim. The Company is currently considering
its options with respect to the best manner in which to pursue damages from this customer.



In 2002, the Company also signed an agreement for a similar project with an affiliate of the customer referred to the above. Following a dispute that arose between the Company and such affiliate in 2002, the parties
signed a settlement agreement at the beginning of 2004, pursuant to which the parties agreed to terminate the agreement, the Company repaid an amount of £100 to the customer and the parties waived all claims against each other.



In 2002, the Company has recorded trade and unbilled receivables
in the amount of £ 7,312 ($ 10,311), as due from these customers. Due to the letter of termination received from the first customer and managements concerns about termination by the second customer, as described above, the Company has
classified the receivables in an amount of £ 1,695 (as of December 31, 2004 $ 3,268) thousand as long-term trade and unbilled receivables, which represents the amount whose collection is probable, in the managements opinion.
The remaining balance was expensed in 2002 to doubtful accounts in the statement of operations.



In 2002, an amount of $ 7,456 was expensed as an allowance for doubtful accounts.



F-9



---

TTI TEAM TELECOM INTERNATIONAL LTD.

AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands



|NOTE 2:- | SIGNIFICANT ACCOUNTING POLICIES
|-------- | -------------------------------



The consolidated financial statements have been prepared according to United States generally accepted accounting principles (U.S. GAAP), applied on a
consistent basis, as follows:



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 these estimates.



Financial statements in United States dollars:



A majority of the revenues of the Company and its subsidiaries is generated in United States
dollars (dollar). In addition, a substantial portion of the costs of the Company and its subsidiaries is incurred in dollars. The Companys management believes that the dollar is the primary currency of the economic environment in
which the Company and its subsidiaries operate. Thus, the functional and reporting currency of the Company and its subsidiaries is the dollar.



Accordingly, monetary accounts maintained in currencies other than the dollar are remeasured into U.S. dollars in accordance with Statement of Financial Accounting
Standards (SFAS) No. 52, Foreign Currency Translation. All transaction gains and losses of the remeasured monetary balance sheet items are reflected in the statement of operations as financial income or expenses, as
appropriate.



Principles of consolidation:



The consolidated financial statements include the accounts of the Company and its
wholly-owned subsidiaries. Intercompany transactions and balances have been eliminated upon consolidation.



Cash and Cash equivalents:



Cash and
cash equivalents include short-term, highly liquid investments that are readily convertible to cash with maturities of three months or less at the date acquired.



Short-term and long-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 1.64% and 2.19% for 2003 and 2004, respectively. The short-term deposits are presented at their cost, including accrued interest.



Long-term bank deposits are deposits with maturities of more than one year, are included in long-term investments and presented at their cost. The deposits are in U.S.
dollars and bear interest at an average rate of 4.05% and 1.14% for 2003 and 2004, respectively.



F-10



---

TTI TEAM TELECOM INTERNATIONAL LTD.

AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands



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



Marketable securities:



Management determines the classification of investments in marketable obligations with fixed maturities at the time of purchase and
reevaluates such designations as of each balance sheet date. At December 31, 2004 and 2003, all marketable securities covered by SFAS No. 115 Accounting for Certain Investments in Debt and Equity Securities, (SFAS No. 115)
were designated as available-for-sale.



Accordingly, these securities are
stated at fair value, with unrealized gains and losses reported in accumulated other comprehensive income (loss), a separate component of shareholders equity. Realized gains and losses on sales of investments, as determined on a specific
identification basis, are included in the consolidated statement of operations.



According to the SECs issued Staff Accounting Bulletin No. 59 (SAB No. 59), management is required to evaluate in each period whether the decline in value for a security is other than temporary.



The Company accounts for its structured notes in accordance with the provisions of FASB
Emerging Issues Task Force (EITF) Issue No. 96-12, Recognition of Interest Income and Balance Sheet Classification of Structured Notes, according to which the Company uses the retrospective interest method to
recognize interest income (expenses).



Investment in another company:



The investment in this company is stated at cost since the Company does
not have the ability to exercise significant influence over operating and financial policies of the investee.



The Companys investment in the other company is reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an investment may not be recoverable, in accordance with
Accounting Principle Board Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock (APB No. 18). As of December 31, 2004, based on managements most recent analysis, no impairment losses have been
identified.



Property and equipment:



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



|                                   |  |                                                
|---------------------------------- |  | -----------------------------------------------
|                                   |  | %                                              
|Computers and peripheral equipment |  | 33                                             
|Office furniture and equipment     |  | 6 - 20                                         
|Motor vehicles                     |  | 15                                             
|Leasehold improvements             |  | Over the lesser term of thelease or useful life





F-11



---

TTI TEAM TELECOM INTERNATIONAL LTD.

AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands



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



Impairment of long-lived assets and identifiable intangibles:



The long-lived assets of the Company and its subsidiaries are reviewed for impairment in
accordance with SFAS No. 144 Accounting for the Impairment for Disposal of Long-Lived Assets 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, 2004, no impairment losses have been identified.



Goodwill:



Goodwill represents the excess of the costs over the fair value of net assets of businesses acquired. Under SFAS No. 142 Goodwill and Other Intangible Assets (SFAS No. 142), goodwill is not
amortized. However, SFAS No. 142 requires goodwill to be tested for impairment on adoption and at least annually thereafter or between annual tests in certain circumstances, and written down when impaired. Goodwill is tested for impairment by
comparing the fair value of the reporting unit with its carrying value. Fair value is determined using discounted cash flows, market multiples and market capitalization. Significant estimates used in such methodology include estimates of future cash
flows, future short-term and long-term growth rates, weighted average cost of capital and estimates of market multiples.



During 2003, the sharp downturn in capital spending in the Companys major markets continued to negatively impact the Companys core business, resulting in
substantially lower revenues than expected and additional operating losses.



Based upon these indications, the Companys management believed that these indications would reduce the fair value of the Company below its carrying value. As a result, the Company performed an interim test during the year 2003 for
goodwill impairment and, as a result, recorded a $ 1,052 write-off of the remaining goodwill.



Income taxes:



The Company and its
subsidiaries account for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes. This statement prescribes the use of the liability method whereby deferred tax asset and liability account balances are determined based
on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The Company and its subsidiaries provide a
valuation allowance, if necessary, to reduce deferred tax assets to their estimated realizable value. As of December 31, 2004, a full valuation allowance was provided by the Company.



F-12



---

TTI TEAM TELECOM INTERNATIONAL LTD.

AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands



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



Revenue recognition:



The Company and its subsidiaries market their products to telecommunications service providers both directly and through alliances with leading vendors of computer
hardware, telecommunications equipment, test systems, and probes. The Companys products have been licensed to various types of telecommunications operators. The Company also generates revenues from maintenance and customer support services.



The Company divides each project into three distinct periods which occur
during the process of providing a solution to a customer: (i) a functional specification period, (ii) an implementation period and (iii) a stabilization period, also referred to from time to time as the warranty period.



Revenues from the Companys software licenses, which require significant customization,
integration, installation and development services, are recognized based on Statement of Position No. 81-1 Accounting for Performance of Construction - Type and Certain Production - Type Contracts (SOP 81-1), using contract
accounting on a percentage of completion method based on the relationship of actual labor days incurred to total labor days estimated to be incurred over the duration of the project to which the contract relates. In general, the Company divides each
project into three distinct periods: (i) a functional specification period, (ii) an implementation period and (iii) a stabilization period. A project is considered completed when the stabilization period is over.



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



According to SOP
81-1, costs that are incurred for a specific anticipated contract prior to the existence of a persuasive evidence of an agreement are deferred, subject to evaluation of their probable recoverability, and only if the costs can be directly associated
with a specific anticipated contract. Such deferred costs are recorded as pre-contract costs, in other accounts receivable and prepaid expenses.



Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are determined in the amount of the estimated loss on the entire
contract. As of December 31, 2004, no such estimated losses were identified.



Service revenues primarily consist of fees from maintenance and customer support. Revenues from maintenance and support contracts are recognized ratably over the life of the agreement, which is typically one year, or at the time when
services are rendered.



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



F-13



---

TTI TEAM TELECOM INTERNATIONAL LTD.

AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands



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



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



Unbilled receivables include all
amounts that had not been billed as of the balance sheet date due to contractual or other arrangements with customers.



Research and development costs:



Research and development costs incurred in the process of developing product improvements or new products, are generally charged to expenses, as incurred.



SFAS No. 86 Accounting for the Costs of Computer Software to be Sold Leased or
Otherwise Marketed (SFAS No. 86), requires capitalization of certain software development costs, subsequent to the establishment of technological feasibility. Based on the Companys product development process, technological
feasibility is established upon completion of a working model.



Significant
costs incurred by the Company, between completion of the working model and the point at which the product is ready for general release, have been capitalized during the years 2001 and 2002.



No software development costs were capitalized in 2003 and 2004.



Capitalized software costs are amortized by the greater of the amount computed using the: (i)
ratio that current gross revenues from sales of the software to the total of the current and anticipated future gross revenues from sales of that software, or (ii) the straight-line method over the estimated useful life of the product (three to five
years).



The Company and its subsidiaries assess the recoverability of
capitalized software development costs in accordance with SFAS No. 86 at each balance sheet date by determining whether the amount by which the unamortized capitalized cost of a computer software product exceeds the net realizable value. The net
realizable value is the estimated future gross revenues from that product reduced by the estimated future costs of completing and disposing of that product, including the cost of performing maintenance and customer support required to satisfy the
Companys responsibility set forth at the time of sale. Based on its most recent analyses, management believes that no further impairment of capitalized software development costs exists as of December 31, 2004.



Royalty and non-royalty bearing grants:



Royalty-bearing grants from the Government of Israel and others for the funding of 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 reduction in research and development costs.



F-14



---

TTI TEAM TELECOM INTERNATIONAL LTD.

AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands



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



During 2002, the Company has received non-royalty-bearing grants from the European Union as part of participation in
a consortium of companies engaged in the development of a platform for the management and control of IP over optical networks (DWDM). In addition, during 2002 and 2003, the Company also received non-royalty-bearing grants for its participation in
the MAGNET project financed by the Government of Israel (see Note 16a). Grants from the European Union and MAGNET project are not required to be repaid and are recognized at the time the Company is entitled to such grants on
the basis of the related costs incurred and recorded as a reduction in research and development costs.



Concentrations of credit risk:



Financial instruments that potentially subject the Company and its subsidiaries to concentrations of credit risk consist principally of cash and cash equivalents, short-term and long-term bank deposits, trade and unbilled receivables,
long-term trade receivables and unbilled receivables and investments in marketable securities.



The Companys and its subsidiaries cash and cash equivalents, short-term and long-term bank deposits are invested in U.S. dollar deposits with major Israeli and U.S. banks. Such deposits in the United
States may be in excess of insured limits and are not insured in other jurisdictions. Management believes that the financial institutions that hold the Companys and its subsidiaries investments are financially sound, and accordingly,
minimal credit risk exists with respect to these investments.



The
Companys marketable securities include investments in government and corporate debentures that are considered by management to be financially sound. Minimal credit risk exists with respect to these marketable securities, since management
believes that the portfolio is well diversified and the institutions that issued the Companys investments are well established.



The Companys and its subsidiaries trade and unbilled receivables and long-term trade and unbilled receivables are derived from sales to large and solid
customers. An allowance for doubtful accounts is determined with respect to those specific amounts that the Company and its subsidiaries have determined to be doubtful of collection. The Company and its subsidiaries perform ongoing credit evaluation
of its customers (see Note 1c).



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



Basic and diluted net loss per share:



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



F-15



---

TTI TEAM TELECOM INTERNATIONAL LTD.

AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data



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



All outstanding stock options have been excluded from the calculation of the diluted net loss per share since all
such securities had an anti-dilutive effect for all years presented.



The total
weighted average number of shares related to the outstanding options excluded from the calculations of diluted net loss per share were 297,704, 0 and 0 for the years ended December 31, 2002, 2003 and 2004, respectively.



Accounting for stock-based compensation:



The Company has elected to follow Accounting Principles Board Statement No. 25,
Accounting for Stock Options 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 an employee stock option is equivalent to or is above the market price of the underlying stock on the date of grant, no compensation expense is recognized.



The Company adopted the disclosure provisions of Financial SFAS No. 148, Accounting for
Stock-Based CompensationTransition and Disclosure (SFAS No. 148), which amended certain provisions of SFAS No. 123 Accounting for Stock-Based Compensation and continues to apply the provisions of APB No. 25, in
accounting for stock-based compensation.



Pro forma information regarding the
Companys net loss and net loss per share is required by SFAS No. 123 and has been determined as if the Company had accounted for its employee stock options under the fair value method prescribed by SFAS No. 123.



The fair value for these options was estimated at the date of grant using the Black-Scholes
Option Valuation Model with the following weighted-average assumptions for 2004 (no options were granted to employees in 2002 and 2003): average risk-free interest rates of 3%; dividend yields of 0%; expected volatility of the Companys
Ordinary shares of 60% and weighted average expected life of the options of two years.



Stock compensation for pro-forma purposes, is amortized on a straight line basis over the vesting period.



F-16



---

TTI TEAM TELECOM INTERNATIONAL LTD.

AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data



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



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



|                                                                                   |  |                         |         |   |      |   |         |      |  |   |         |  
|---------------------------------------------------------------------------------- |  | ----------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                                   |  | Year ended December 31, |        
|                                                                                   |  | 2002                    |         |   | 2003 |   |         | 2004 | 
|Net loss - as reported                                                             |  | $                       | (10,854 | ) |      | $ | (30,080 | )    |  | $ | (29,494 | )
|Add - total stock-based compensation expense determined under APB 25               |  |                         |        |   |      |   |        |      |  |   |        |  
|Deduct - total stock-based compensation expense determined under fair value method |  |                         | (1,101  | ) |      |   | (262    | )    |  |   | (88     | )
|                                                                                   |  |                         |         |   |      |   |         |      |  |   |         |  
|Pro forma - net loss                                                               |  | $                       | (11,955 | ) |      | $ | (30,342 | )    |  | $ | (29,582 | )
|                                                                                   |  |                         |         |   |      |   |         |      |  |   |         |  
|Basic and diluted net loss per share, as reported                                  |  | $                       | (0.92   | ) |      | $ | (2.53   | )    |  | $ | (2.48   | )
|                                                                                   |  |                         |         |   |      |   |         |      |  |   |         |  
|Basic and diluted net loss per share, pro forma                                    |  | $                       | (1.01   | ) |      | $ | (2.53   | )    |  | $ | (2.49   | )
|                                                                                   |  |                         |         |   |      |   |         |      |  |   |         |  



The Company applies SFAS No. 123 and
Emerging Issues Task Force Issue No. 96-18 Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services (EITF 96-18), with respect to options and
warrants issued to non-employees. SFAS No. 123 requires the use of option valuation models to measure the fair value of the options and warrants at the date of grant.



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 amount reported in the balance sheet for cash and cash equivalents, short-term
bank credit, short-term bank deposits, trade receivables, unbilled receivables, trade payables and related parties approximates their fair value due to the short-term maturities of such instruments.



The carrying amount of the Companys long-term bank deposits is estimated by discounting
the future cash flows using the current interest rates for long-term bank deposit of similar terms and maturities. The carrying amount of the long-term bank deposit does not significantly differ from its fair value.



The carrying amounts and the fair value of marketable securities is based on the quoted
market prices.



Severance pay:



The Companys liability for severance pay is calculated pursuant to Israels
Severance Pay Law based on the most recent salary of the employees multiplied by the number of years of employment, as of the balance sheet date. Employees are entitled to one months salary for each year of employment or a portion thereof. The
Companys liability for all of its employees is fully provided by monthly deposits with insurance policies and by an accrual.



F-17



---

TTI TEAM TELECOM INTERNATIONAL LTD.

AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share data



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



The deposited funds include profits accumulated up to the balance sheet date. The deposited funds may be withdrawn
only upon the fulfillment of the obligation pursuant to Israels Severance Pay Law or labor agreements. The value of the deposited funds is based on the cash surrendered value of these policies, and includes immaterial profits.



Severance pay expenses for the years ended December 31, 2002, 2003 and 2004 were $ 1,120, $
1,196 and $ 1,381, respectively.



Advertising expenses:



Advertising expenses are charged to the statements of operations as incurred. Advertising
expenses for the years ended December 31, 2002, 2003 and 2004 were $ 220, $ 186 and $ 125, respectively.



Impact of recently issued accounting standards:



On December 16, 2004, the Financial Accounting Standards Board (FASB) issued FASB Statement No. 123 (revised 2004), Share-Based Payment, which is a revision of FASB Statement No. 123, Accounting for Stock-Based Compensation. Statement
123(R) supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and amends FASB Statement No. 95, Statement of Cash Flows. Generally, the approach in Statement 123(R) is similar to the approach described in Statement 123. However,
Statement 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an alternative. Early adoption will
be permitted in periods in which financial statements have not yet been issued. The new standard will be effective for the Company in the first interim period beginning after January 1, 2006.



As permitted by Statement 123, the company currently accounts for share-based payments to
employees using Opinion 25s intrinsic value method and, as such, generally recognizes no compensation cost for employee stock options. In addition, non-compensatory plans under APB 25 will be considered compensatory for FAS 123(R) purposes.
Accordingly, the adoption of Statement 123(R)s fair value method will have a significant impact on the Companys result of operations, although it will have no impact on the Companys overall financial position. The impact of
adoption of Statement 123(R) cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. However, had the Company adopted Statement 123(R) in prior periods, the impact of that standard would have
approximated the impact of Statement 123 as described in the disclosure of pro forma net income and earnings per share.



In March 2005, the SEC staff issued Staff Accounting Bulletin No. 107 (SAB 107) to give guidance on implementation of SFAS 123R, which the Company plans to consider in
implementing SFAS 123R.



F-18



---

TTI TEAM TELECOM INTERNATIONAL LTD.

AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands



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



In March 2004, the FASB approved the consensus reached on the Emerging Issues Task Force Issue No. 03-1, The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments (EITF 03-1). The objective of this Issue is to provide guidance for identifying impaired investments. EITF 03-1 also provides new disclosure
requirements for investments that are deemed to be temporarily impaired. In FASB Staff Position on EITF 03-1, the Board directed the FASB staff to delay the effective date for the measurement and recognition guidance contained in EITF 03-1. The
disclosure requirements are effective only for annual periods ending after June 15, 2004. The Company does not believe that the impact of adopting EITF 03-1 will be significant to the Companys overall results of operations or financial
position.



|NOTE 3:- | MARKETABLE SECURITIES
|-------- | ---------------------



The following is a summary of available-for-sale marketable securities:



|                        |  |               |        |                      |   |                       |  |   |                          |   |               |   |                      |  |                       |        |  |                          |    |  |   |      |   |  |   |       
|----------------------- |  | ------------- | ------ | -------------------- | - | --------------------- |  | - | ------------------------ | - | ------------- | - | -------------------- |  | --------------------- | ------ |  | ------------------------ | -- |  | - | ---- | - |  | - | ------
|                        |  | December 31, 
|                        |  | 2003          |        | 2004                
|                        |  | Amortizedcost |        | Grossunrealizedgains |   | Grossunrealizedlosses |  |   | Estimatedfairmarketvalue |   | Amortizedcost |   | Grossunrealizedgains |  | Grossunrealizedlosses |        |  | Estimatedfairmarketvalue
|Available-for-sale:     |  |               |        |                      |   |                       |  |   |                          |   |               |   |                      |  |                       |        |  |                          |    |  |   |      |   |  |   |       
|Government debentures   |  | $             | 2,104  |                      | $ | 105                   |  | $ |                         |   |               | $ | 2,209                |  | $                     |       |  | $                        |   |  | $ |     |   |  | $ |      
|Corporate debentures *) |  |               | 13,877 |                      |   | 263                   |  |   | (582                     | ) |               |   | 13,558               |  |                       | 10,798 |  |                          | 85 |  |   | (311 | ) |  |   | 10,572
|                        |  |               |        |                      |   |                       |  |   |                          |   |               |   |                      |  |                       |        |  |                          |    |  |   |      |   |  |   |       
|                        |  | $             | 15,981 |                      | $ | 368                   |  | $ | (582                     | ) |               | $ | 15,767               |  | $                     | 10,798 |  | $                        | 85 |  | $ | (311 | ) |  | $ | 10,572
|                        |  |               |        |                      |   |                       |  |   |                          |   |               |   |                      |  |                       |        |  |                          |    |  |   |      |   |  |   |       



|*) | Included in the Companys portfolio investments are structured notes with an estimated fair value of approximately $ 4,706 as of December 31, 2004. Such investments are used by
management to enhance yields, diversify the portfolio investments, and manage the Companys exposure to interest rate fluctuations. The notes were acquired from several banks and were categorized as available for sale. The notes bear interest
based upon the rate of the LIBOR. For each day on which the six months dollar Libor is below an agreed annual fixed rate, the investment bear coupon interest at the rate of 8%, 7% and 5%-12% per annum. On all other days, the investments do no bear
any interest at all.
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



F-19



---

TTI TEAM TELECOM INTERNATIONAL LTD.

AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands



|NOTE 3:- | MARKETABLE SECURITIES (Cont.)
|-------- | -----------------------------



The net adjustment to unrealized holding gains (losses) on available-for-sale marketable securities included as a
separate component of shareholders equity, accumulated other comprehensive income (loss) amounted to $ 285, $ (399) and $ 12 in 2002, 2003 and 2004, respectively.



During 2002, the Company recorded an impairment expense in the amount of $ 2,505 as a decline in market value of available-for-sale
securities (including mutual funds) deemed to be other than temporary. The amount was recorded as financial expenses in the statement of operations.



The Companys management believes that the unrealized losses as of December 31, 2004 are considered temporary as the decline per bond is considered insignificant.
The unrealized losses on the Companys investments in all types of securities are caused due to interest rate increases. Since the Company has the ability and intent to hold these investments until a recovery of fair value, the Company does not
consider these investments to be other-than-temporarily impaired as of December 31, 2004. In addition, the unrealized losses are in continuous position for a period not more than twelve months.



Aggregate maturities of available-for-sale securities for years subsequent to December 31,
2004 are:



|     |  |               |        |                           |   |       
|---- |  | ------------- | ------ | ------------------------- | - | ------
|     |  | Amortizedcost |        | Estimatedfair marketvalue
|2013 |  | $             | 4,006  |                           | $ | 4,006 
|2015 |  |               | 2,744  |                           |   | 2,653 
|2016 |  |               | 2,148  |                           |   | 2,176 
|2018 |  |               | 1,900  |                           |   | 1,737 
|     |  |               |        |                           |   |       
|     |  | $             | 10,798 |                           | $ | 10,572
|     |  |               |        |                           |   |       



|NOTE 4:- | OTHER ACCOUNTS RECEIVABLE AND PREPAID EXPENSES
|-------- | ----------------------------------------------



|                              |  |              |       |      |   |      
|----------------------------- |  | ------------ | ----- | ---- | - | -----
|                              |  | December 31,
|                              |  | 2003         |       | 2004
|Prepaid expenses              |  | $            | 877   |      | $ | 1,688
|Pre-contract costs            |  |              | 112   |      |   |     
|Office of the Chief Scientist |  |              | 273   |      |   | 442  
|Loans to employees            |  |              | 505   |      |   | 426  
|Others                        |  |              | 961   |      |   | 709  
|                              |  |              |       |      |   |      
|                              |  | $            | 2,728 |      | $ | 3,265
|                              |  |              |       |      |   |      



F-20



---

TTI TEAM TELECOM INTERNATIONAL LTD.

AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands



|NOTE 5:- | PROPERTY AND EQUIPMENT, NET
|-------- | ---------------------------



|                                   |  |              |        |      |   |       
|---------------------------------- |  | ------------ | ------ | ---- | - | ------
|                                   |  | December 31,
|                                   |  | 2003         |        | 2004
|Cost:                              |  |              |        |      |   |       
|Computers and peripheral equipment |  | $            | 12,214 |      | $ | 12,873
|Office furniture and equipment     |  |              | 1,184  |      |   | 1,208 
|Motor vehicles                     |  |              | 4,980  |      |   | 4,982 
|Leasehold improvements             |  |              | 3,570  |      |   | 3,522 
|                                   |  |              |        |      |   |       
|                                   |  |              | 21,948 |      |   | 22,585
|                                   |  |              |        |      |   |       
|Accumulated depreciation:          |  |              |        |      |   |       
|Computers and peripheral equipment |  |              | 9,416  |      |   | 11,039
|Office furniture and equipment     |  |              | 616    |      |   | 744   
|Motor vehicles                     |  |              | 2,556  |      |   | 3,087 
|Leasehold improvements             |  |              | 1,522  |      |   | 1,841 
|                                   |  |              |        |      |   |       
|                                   |  |              | 14,110 |      |   | 16,711
|                                   |  |              |        |      |   |       
|Depreciated cost                   |  | $            | 7,838  |      | $ | 5,874 
|                                   |  |              |        |      |   |       



Depreciation expenses for the years
ended December 31, 2002, 2003 and 2004 are $ 3,474, $ 3,299 and $ 2,827, respectively.



|NOTE 6:- | INTANGIBLE ASSETS, NET
|-------- | ----------------------



|                                                     |  |              |        |      |   |       
|---------------------------------------------------- |  | ------------ | ------ | ---- | - | ------
|                                                     |  | December 31,
|                                                     |  | 2003         |        | 2004
|a.      Original amounts:                            |  |              |        |      |   |       
|Capitalized software development costs               |  | $            | 11,242 |      | $ | 11,242
|Acquired technology (see Note 1)                     |  |              | 4,119  |      |   | 4,119 
|                                                     |  |              |        |      |   |       
|                                                     |  |              | 15,361 |      |   | 15,361
|                                                     |  |              |        |      |   |       
|Accumulated amortization and impairment:             |  |              |        |      |   |       
|Capitalized software development costs               |  |              | 3,714  |      |   | 4,417 
|Acquired technology                                  |  |              | 1,202  |      |   | 1,202 
|Impairment of capitalized software development costs |  |              | 5,864  |      |   | 9,461 
|                                                     |  |              |        |      |   |       
|                                                     |  |              | 10,780 |      |   | 15,080
|                                                     |  |              |        |      |   |       
|Amortized cost                                       |  | $            | 4,581  |      | $ | 281   
|                                                     |  |              |        |      |   |       



|b. | During 2001, in the context of the acquisition of Axarte, the Company purchased technology. In addition, the Company capitalized software development costs. The technology purchased
and the capitalized software development costs amounted to $ 13,361 (the Netrac2 Technology).
|-- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The Netrac2 Technology was amortized from January 1, 2002, using the straight-line method over the estimated economic life of the technology, which is six
years.



F-21



---

TTI TEAM TELECOM INTERNATIONAL LTD.

AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands



|NOTE 6:- | INTANGIBLE ASSETS, NET (Cont.)
|-------- | ------------------------------



During the first quarter of 2002, the Company developed a new technology (ServiceView
Technology) in respect of which the Company capitalized software development costs in the amount of $ 2,000. On October 1, 2002, the Company began to amortize the ServiceView Technology using the straight-line method over the estimated
economic life of the technology, which was three years. No software development costs were capitalized in 2003 and 2004.



The evaluation of the net realizable value of the abovementioned capitalized software development costs that was preformed by management during the years
ended December 31, 2003 and 2004, indicated that the net realizable value of the Netrac2 Technology and the ServiceView Technology exceed the unamortized capitalized costs. The evaluation was based on the estimated future gross revenues from such
technologies reduced by the estimated future costs for completing and disposing each of them. In 2003 and 2004, the amounts of $ 5,864 and $ 3,597, respectively, have been recorded as an impairment of capitalized software costs included in the cost
of revenues.



|c. | Amortization expenses for the years ended December 31, 2002, 2003 and 2004 amounted to $ 2,394, $ 3,783 and $ 703, respectively.
|-- | --------------------------------------------------------------------------------------------------------------------------------



|d. | Estimated amortization expenses for the years ended December 31:
|-- | ----------------------------------------------------------------



|     |  |   |    
|---- |  | - | ---
|2005 |  | $ | 104
|2006 |  |   | 104
|2007 |  |   | 73 
|     |  |   |    
|     |  | $ | 281
|     |  |   |    



|NOTE 7:- | SHORT-TERM BANK CREDIT
|-------- | ----------------------



As of December 31, 2004, the Company utilized all of the short-term bank credit line in the amount of $ 232, and in addition the Company utilized an amount of $ 735 of
short-term bank credit in excess of its short-term bank credit line. The weighted average interest rate of the short-term bank credit line and of the borrowing in excess of the credit line for the year ended December 31, 2004 was approximately 8.2%
and 11.7%, respectively. The short-term bank credit line and the borrowing in excess of the credit line were fully repaid after the balance sheet date. The Company fully repaid all of the short-term bank credit line and excess after balance sheet
date.



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



|                               |  |              |       |      |   |      
|------------------------------ |  | ------------ | ----- | ---- | - | -----
|                               |  | December 31,
|                               |  | 2003         |       | 2004
|Employees and payroll accruals |  | $            | 3,745 |      | $ | 3,327
|Accrued expenses               |  |              | 1,366 |      |   | 962  
|Government authorities         |  |              | 428   |      |   | 1,192
|Others                         |  |              | 625   |      |   | 690  
|                               |  |              |       |      |   |      
|                               |  | $            | 6,164 |      | $ | 6,171
|                               |  |              |       |      |   |      



F-22



---

TTI TEAM TELECOM INTERNATIONAL LTD.

AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands



|NOTE 9:- | COMMITMENTS AND CONTINGENT LIABILITIES
|-------- | --------------------------------------



|a. | Lease commitments:
|-- | ------------------



In April 1998, the Company entered into an agreement with Team according to which the Company will lease its facilities in Israel from Team for a period
of five years, effective February 1, 1998. In 2003, the Company exercised its renewal option for an additional four and a half years up until August 2007. The Company and its subsidiaries rent their facilities and motor vehicles under various
operating lease agreements, which expire on various dates, the latest of which is in 2007.



Aggregate minimum rental commitments under non-cancelable leases at December 31, 2004 are as follows:



|                        |  |            |       |               |   |       |  |   |      
|----------------------- |  | ---------- | ----- | ------------- | - | ----- |  | - | -----
|Year ended December 31, |  | Facilities |       | Motorvehicles |   | Total
|2005                    |  | $          | 1,452 |               | $ | 21    |  | $ | 1,473
|2006                    |  |            | 1,162 |               |   | 14    |  |   | 1,176
|2007                    |  |            | 521   |               |   |      |  |   | 521  
|                        |  |            |       |               |   |       |  |   |      
|                        |  | $          | 3,135 |               | $ | 35    |  | $ | 3,170
|                        |  |            |       |               |   |       |  |   |      



Facilities lease
expenses for the years ended December 31, 2002, 2003 and 2004 were $ 1,320, $ 1,689 and $ 1,072, respectively.



Motor vehicles lease expenses for the years ended December 31, 2002, 2003 and 2004 were approximately $ 593, $ 435 and $ 211, respectively.



|b. | Royalties commitments:
|-- | ----------------------



Under the Companys research and development agreements with the Office of the Chief Scientist (OCS) and the Binational Industrial
Research and Development Foundation (BIRD-F), and pursuant to applicable laws, the Company is required to pay royalties at the rate of 3%-5% of sales of products developed with funds provided by the OCS and BIRD-F, up to an amount equal
to 100%-150% of the research and development grants (dollar-linked) received from the OCS and BIRD-F. The obligation to pay these royalties is contingent on actual sales of the products and, in the absence of such sales, no payment is required.
Royalties payable with respect to grants received under programs approved by the OCS after January 1, 1999, are subject to interest on the U.S. dollar-linked value of the total grants received at the annual rate of LIBOR applicable to U.S. dollar
deposits. Royalties payable with respect to grants received from BIRD-F are linked to the Consumer Price Index in the United States.



F-23



---

TTI TEAM TELECOM INTERNATIONAL LTD.

AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands



|NOTE 9:- | COMMITMENTS AND CONTINGENT LIABILITIES (Cont.)
|-------- | ----------------------------------------------



The Company has paid or accrued royalties relating to the repayment of such grants in the amount of $
294, $ 223 and $ 10 for the years ended December 31, 2002, 2003 and 2004, respectively. The amounts were recorded in the cost of revenues. As of December 31, 2004, the Company has an outstanding contingent obligation to pay royalties in the amount
of approximately $ 2,930, in respect of these grants.



|c. | Guarantees:
|-- | -----------



The Company has obtained performance guarantees in favor of certain customers from several banks in Israel and in the U.S. amounting to $ 5,110, $ 4,242 and $ 2,896 for the years ended December 31, 2002, 2003 and
2004, respectively.



|d. | Litigation:
|-- | -----------



| | 1) | The Company has accounted for claims in regard to its regular course of business in a general provision in the amount of $ 87.
| | -- | ------------------------------------------------------------------------------------------------------------------------------



| | 2) | Securities class action:
| | -- | ------------------------



A shareholder class action lawsuit was filed in September 2004 against the Company, Team Software Industries Ltd. and certain of the Companys
executive officers. The lawsuit purports to be a class action filed on behalf of persons who held the Companys shares during the period between May 15, 2001 and November 14, 2002. The complaint alleges that material misrepresentations and
omissions concerning the Companys operations and performance artificially inflated the Companys stock price, causing damages to investors. Based on the Companys preliminary review of the complaint, the Company believes that the
claims are without merit and intends to vigorously defend itself against the actions. However, this class action is in a very preliminary stage, and the Companys management cannot predict the outcome of this dispute.



|e. | Termination of agreement:
|-- | -------------------------



See Note 1c.



|NOTE 10:- | INCOME TAXES
|--------- | ------------



|a. | Measurement of results for tax purposes under the Income Tax Law (Inflationary Adjustments), 1985.
|-- | --------------------------------------------------------------------------------------------------



Results for tax purposes in Israel are measured in terms of earnings in NIS after certain adjustments for changes in
Israels Consumer Price Index (CPI). As explained in Note 2, the financial statements are presented in U.S. dollars. The difference between the annual change in the CPI and in the NIS\dollar exchange rate causes a difference between
taxable income and the income before taxes shown in the financial statements.



F-24



---

TTI TEAM TELECOM INTERNATIONAL LTD.

AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands



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



In accordance with paragraph 9(f) of SFAS No. 109, the Company has not recorded deferred taxes on the
difference between the reporting currency and the tax bases of assets and liabilities.



|b. | tax Rates:
|-- | ----------



On June 29, 2004 the Israeli Government approved the amendment to the Income Tax Ordinance (No. 140 and Temporary Provision), 2004, which progressively reduces the tax rates applicable to companies from 35% in 2004 to
a rate of 30% in 2007.



|c. | Tax benefits under the Law for the Encouragement of Capital Investments, 1959 (the law):
|-- | ------------------------------------------------------------------------------------------



Most of the Companys production facilities have been granted approved enterprise status under five separate investment
programs and, as such, are entitled to tax benefits, under the above law. According to the law, the Company has elected the alternative benefits track, and has waived Government grants, in return for a tax exemption.



Upon the Companys Initial Public Offering that occurred in 1996, the
Company became a foreign investment Company for the purposes of the aforementioned law. Accordingly, the Company is entitled to a 10-year period of benefits. Income derived from the Companys investment programs, is tax-exempt for
the first two to four years and is entitled to a reduced tax rate of 10% to 25%, during the remaining benefit period of six to eight years (subject to the percentage of foreign ownership in each tax year).



The primary tax benefits available in respect of the approved enterprises
are:



| | 1. | As of December 31, 2004, the benefits from the first program have expired.
| | -- | --------------------------------------------------------------------------



| | 2. | Income derived from the Companys second approved enterprise was tax exempt for four years (1996-1999) after which it is taxable at the rate of 20%-25% for six years ending in
2005.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 3. | Income derived from the Companys third approved enterprise was tax exempt for two years (1998-1999) after which it is taxable at the rate of 20%-25% for eight years ending in
2007.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 4. | Income derived from the Companys fourth approved enterprise was tax exempt for two years (2000-2001) after which it is taxable at the rate of 20%-25% for eight years ending in
2009.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 5. | Income derived from the Companys fifth approved enterprise was tax exempt for two years (2002-2003) after which it is taxable at the rate of 20%-25% for eight years ending in
2011.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The period of tax benefits detailed above
is subject to limits of 12 years from the year of commencement of production, or 14 years from the date of granting the approval, whichever is earlier.



F-25



---

TTI TEAM TELECOM INTERNATIONAL LTD.

AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands



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



Income from sources other than the approved enterprise will be subject to the tax at the regular
rate.



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 investments in the 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, 2004, management believes that the Company is meeting all of the
aforementioned conditions.



|d. | Tax benefits under the Law for the Encouragement of Industry (Taxation), 1969:
|-- | ------------------------------------------------------------------------------



The Company is an industrial company under the above law and, as such, is entitled to certain tax benefits
including accelerated depreciation rates and deduction of public offering expenses.



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



Deferred income 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 and its subsidiaries deferred tax assets are as follows:



|                                                                                                    |  |              |         |   |      |   |         |  
|--------------------------------------------------------------------------------------------------- |  | ------------ | ------- | - | ---- | - | ------- | -
|                                                                                                    |  | December 31, |        
|                                                                                                    |  | 2003         |         |   | 2004 |  
|Deferred tax assets:                                                                                |  |              |         |   |      |   |         |  
|Reserves and allowances                                                                             |  | $            | 2,705   |   |      | $ | 542     |  
|Net operating loss carryforward - foreign                                                           |  |              | 6,882   |   |      |   | 8,651   |  
|Net operating loss carryforward - domestic                                                          |  |              | 7,448   |   |      |   | 14,285  |  
|                                                                                                    |  |              |         |   |      |   |         |  
|Total deferred tax assets before valuation allowance                                                |  |              | 17,035  |   |      |   | 23,478  |  
|Valuation allowance                                                                                 |  |              | (15,388 | ) |      |   | (23,478 | )
|                                                                                                    |  |              |         |   |      |   |         |  
|Net deferred tax assets (included in other accounts receivable and prepaid expenses) - all domestic |  | $            | 1,647   |   |      | $ |        |  
|                                                                                                    |  |              |         |   |      |   |         |  



A valuation allowance
for the entire balance was recorded due to the uncertainty of the future realization of the tax asset.



F-26



---

TTI TEAM TELECOM INTERNATIONAL LTD.

AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands



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



| | As of December 31, 2003 the Companys management believed that it was more likely than not that the remaining net deferred tax assets of $ 1,647 related
to the Companys carryforward tax losses would be realized, principally based upon the Companys earning history and forecasted income. In 2004, several developments were considered in determining the need for an increase in the valuation
allowance, including a continuing market decline, increasing uncertainty and a decrease of visibility in the market as a whole, a significant decrease in sequential quarterly revenue levels and the failure to achieve managements forecasted
results for 2004. As a result of managements assessment, the Company increased the valuation allowance on the deferred tax asset and recorded a valuation allowance on the entire amount.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|f. | Reconciliation of the theoretical tax expenses:
|-- | -----------------------------------------------



A reconciliation between the theoretical tax expense, assuming all income is taxed at the statutory rate applicable in Israel to income of the Company and
the actual income tax as reported in the statements of operations, is as follows:



|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|--------------------------------------------------------------------------- |  | ----------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                            |  | Year ended December 31, |        
|                                                                            |  | 2002                    |         |   | 2003 |   |         | 2004 | 
|Loss before taxes, as reported in the consolidated statements of operations |  | $                       | (11,439 | ) |      | $ | (30,536 | )    |  | $ | (27,387 | )
|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|Statutory tax rate                                                          |  |                         | 36      | % |      |   | 36      | %    |  |   | 35      | %
|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|Theoretical tax benefit on the above                                        |  | $                       | (4,118  | ) |      | $ | (10,993 | )    |  | $ | (9,585  | )
|Amount at the Israeli statutory tax rate:                                   |  |                         |         |   |      |   |         |      |  |   |         |  
|Tax adjustment in respect of foreign subsidiaries different tax rate        |  |                         | 122     |   |      |   | 1,150   |      |  |   | 489     |  
|Deferred taxes on losses for which a valuation allowance was provided       |  |                         | 5,299   |   |      |   | 10,089  |      |  |   | 8,090   |  
|Taxes in respect of prior years                                             |  |                         |        |   |      |   | (141    | )    |  |   | 460     |  
|Other                                                                       |  |                         | (1,888  | ) |      |   | (561    | )    |  |   | 2,653   |  
|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|Income taxes (tax benefit), as reported in the statements of operations     |  | $                       | (585    | ) |      | $ | (456    | )    |  | $ | 2,107   |  
|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  



|g. | The Israeli company has received final tax assessments until 1999, and is currently assessed for the tax years 2000 - 2002. The Company believes that it has adequate provisions to
cover these exposures in accordance with SFAS No. 5.
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



F-27



---

TTI TEAM TELECOM INTERNATIONAL LTD.

AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share data



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



|h. | Taxes on income are comprised as follows:
|-- | -----------------------------------------



|                                                    |  |                         |         |   |      |   |         |      |  |   |         |  
|--------------------------------------------------- |  | ----------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                    |  | Year ended December 31, |        
|                                                    |  | 2002                    |         |   | 2003 |   |         | 2004 | 
|Current taxes                                       |  | $                       | 428     |   |      | $ | 42      |      |  | $ |        |  
|Taxes in respect of prior years                     |  |                         |        |   |      |   | (141    | )    |  |   | 460     |  
|Deferred income taxes (benefit)                     |  |                         | (1,013  | ) |      |   | (357    | )    |  |   | 1,647   |  
|                                                    |  |                         |         |   |      |   |         |      |  |   |         |  
|                                                    |  | $                       | (585    | ) |      | $ | (456    | )    |  | $ | 2,107   |  
|                                                    |  |                         |         |   |      |   |         |      |  |   |         |  
|Domestic                                            |  | $                       | (802    | ) |      | $ | (720    | )    |  | $ | 2,107   |  
|Foreign                                             |  |                         | 217     |   |      |   | 264     |      |  |   |        |  
|                                                    |  |                         |         |   |      |   |         |      |  |   |         |  
|                                                    |  | $                       | (585    | ) |      | $ | (456    | )    |  | $ | 2,107   |  
|                                                    |  |                         |         |   |      |   |         |      |  |   |         |  
|i.       Loss before taxes is comprised as follows: |  |                         |         |   |      |   |         |      |  |   |         |  
|                                                    |  |                         |        
|Domestic                                            |  | $                       | (9,409  | ) |      | $ | (11,371 | )    |  | $ | (17,605 | )
|Foreign                                             |  |                         | (2,030  | ) |      |   | (19,165 | )    |  |   | (9,782  | )
|                                                    |  |                         |         |   |      |   |         |      |  |   |         |  
|                                                    |  | $                       | (11,439 | ) |      | $ | (30,536 | )    |  | $ | (27,387 | )
|                                                    |  |                         |         |   |      |   |         |      |  |   |         |  



|NOTE 11:- | SHAREHOLDERS EQUITY
|--------- | --------------------



|a. | The Companys Ordinary shares have been listed for trade on the NASDAQ National Market since TTIs initial public offering (IPO) on December 4, 1996, under the
symbol TTIL.
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



In 1999 and 2000, the Company
effected two additional secondary offerings.



The Ordinary
shares confer upon their holders the right to receive notice to participate and vote in the Companys general meeting and the right to receive dividends, if declared.



|b. | Share options:
|-- | --------------



Employee Share Option Plans:



During 1995, 1996, 1999, 2000 and 2001, the Board of Directors of the Company adopted share option plans (as amended the Old Plans) pursuant
to which 2,325,515 Ordinary shares were reserved for issuance upon the exercise of options to be granted to certain directors and key employees of the Company and its subsidiaries. At the Companys annual general shareholders meeting in
December 2004 it was decided that there was no intention to grant any more options from the Old Plans and it was resolved to approve the 2004 share option plan (the New Plan), pursuant to which 1,000,000 Ordinary shares were reserved for
issuance.



F-28



---

TTI TEAM TELECOM INTERNATIONAL LTD.

AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data



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



The Board of Directors is empowered, among other things, to designate the options, dates of grant and
the exercise price of options. Unless otherwise decided by the Board, the options will vest over a period of one to three years of employment, and will be non-assignable.



Pursuant to the New Plan, as of December 31, 2004, an aggregate of 925,000 options of the Company are still available for
future grant.



Each option granted under the Plans to
employees expires no later than five years from the date of the grant. Any options which are canceled or forfeited before expiration become available for future grants.



A summary of the stock options activities in 2002, 2003 and 2004 is as follows:



|                                         |  |                         |   |      |                              |       |                 |         |   |                              |   |                  |  |          |                              |  |   |      
|---------------------------------------- |  | ----------------------- | - | ---- | ---------------------------- | ----- | --------------- | ------- | - | ---------------------------- | - | ---------------- |  | -------- | ---------------------------- |  | - | -----
|                                         |  | Year ended December 31,
|                                         |  | 2002                    |   | 2003 |                              | 2004 
|                                         |  | Amountof options        |   |      | Weightedaverageexerciseprice |       | Amountofoptions |         |   | Weightedaverageexerciseprice |   | Amountof options |  |          | Weightedaverageexerciseprice
|Outstanding at the beginning of the year |  | 758,378                 |   |      | $                            | 17.37 |                 | 612,426 |   |                              | $ | 17.76            |  | 470,178  |                              |  | $ | 18.72
|Granted                                  |  |                        |   |      | $                            |      |                 |        |   |                              | $ |                 |  | 321,000  |                              |  | $ | 6.07 
|Exercised                                |  | (119,452                | ) |      | $                            | 14.51 |                 |        |   |                              | $ |                 |  | (889     | )                            |  | $ | 11.69
|Forfeited                                |  | (26,500                 | ) |      | $                            | 21.13 |                 | (87,414 | ) |                              | $ | 11.45            |  | (167,311 | )                            |  | $ | 10.69
|Expired                                  |  |                        |   |      | $                            |      |                 | (54,834 | ) |                              | $ | 19.60            |  | (248,845 | )                            |  | $ | 9.77 
|                                         |  |                         |   |      |                              |       |                 |         |   |                              |   |                  |  |          |                              |  |   |      
|Outstanding at the end of the year       |  | 612,426                 |   |      | $                            | 17.76 |                 | 470,178 |   |                              | $ | 18.72            |  | 374,133  |                              |  | $ | 10.13
|                                         |  |                         |   |      |                              |       |                 |         |   |                              |   |                  |  |          |                              |  |   |      
|Options exercisable at the end of year   |  | 445,648                 |   |      | $                            | 16.61 |                 | 464,178 |   |                              | $ | 18.71            |  | 123,883  |                              |  | $ | 18.27
|                                         |  |                         |   |      |                              |       |                 |         |   |                              |   |                  |  |          |                              |  |   |      



The options
outstanding as of December 31, 2004 have been separated into exercise prices, as follows:



|               |  |                                           |  |                                         |  |                                |       |                                           |         |                                                   |   |      
|-------------- |  | ----------------------------------------- |  | --------------------------------------- |  | ------------------------------ | ----- | ----------------------------------------- | ------- | ------------------------------------------------- | - | -----
|Exercise price |  | Optionsoutstanding as of December31, 2004 |  | Weightedaverageremainingcontractuallife |  | Weightedaverage exercise price |       | Optionsexercisable as of December31, 2004 |         | Weightedaverageexerciseprice ofexercisableoptions
|               |  |                                           |  | years                                   |  |                                |       |                                           |         |                                                  
|$3.00          |  | 75,000                                    |  | 4.50                                    |  | $                              | 5.88  |                                           | 18,750  |                                                   | $ | 3.00 
|$ 6.00-8.00    |  | 194,000                                   |  | 3.79                                    |  | $                              | 3.00  |                                           |        |                                                   |   |     
|$18.63-19.00   |  | 34,167                                    |  | 0.86                                    |  | $                              | 18.99 |                                           | 34,167  |                                                   | $ | 18.99
|$20.00-23.00   |  | 62,633                                    |  | 0.35                                    |  | $                              | 20.88 |                                           | 62,633  |                                                   | $ | 20.88
|$30.00         |  | 8,333                                     |  | 0.86                                    |  | $                              | 30.00 |                                           | 8,333   |                                                   | $ | 30.00
|               |  |                                           |  |                                         |  |                                |       |                                           |         |                                                   |   |      
|               |  | 374,133                                   |  | 3.25                                    |  | $                              | 10.13 |                                           | 123,883 |                                                   | $ | 18.27
|               |  |                                           |  |                                         |  |                                |       |                                           |         |                                                   |   |      



F-29



---

TTI TEAM TELECOM INTERNATIONAL LTD.

AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data



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



|c. | Weighted-average fair values and exercise prices of options, whose exercise price equals or is below the market price of the shares on the date of grant are $ 0.
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------



Weighted-average fair values and exercise
prices of options, whose exercise price exceeds the market price of the shares on the date of grant are $ 0.79.



|d. | Dividends:
|-- | ----------



In the event that cash dividends are declared in the future, such dividends will be paid in NIS or in foreign currency subject to any statutory limitations.



|NOTE 12:- | RELATED PARTY TRANSACTIONS AND BALANCES
|--------- | ---------------------------------------



Since the commencement of the Companys operations in 1992, Team has, from time to time, paid the Company commissions in respect of sales by the Company of certain
products represented and sold by Team. This relationship is reflected in an agreement between the Company and Team dated October 1996 (the Agreement). Team generally pays the Company a commission at the rate of 15% of the sales price of
these products, up to a maximum of 50% of the amount received by Team from these sales less the cost to Team.



In addition, Team provides to the Company certain administrative services, including computer servicing, salary administration, automotive fleet maintenance and basic insurance coverage, and the Company reimburses
Team for the actual cost of such services. The Company and Team have agreed to indemnify each other for liabilities resulting from acts or omissions of their respective employees constituting intellectual property violations. The Agreement is
automatically renewed for a successive terms of one year on each December 31, and can be terminated by either party at the end of any such term upon at least 60 days prior written notice. Regarding the rent commitment with Team, see also Note 10a.



Since 1992, the Company has also purchased property and equipment, such as
computer hardware, from Team and Omnitek-Eichut Ltd. (Omnitek-Eichut), a subsidiary of Team. The Company pays Team and Omnitek-Eichut prices for these assets that are no less favorable to the Company than those it could obtain from
unrelated third parties.



F-30



---

TTI TEAM TELECOM INTERNATIONAL LTD.

AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands



|NOTE 12:- | RELATED PARTY TRANSACTIONS AND BALANCES (Cont.)
|--------- | -----------------------------------------------



In addition, Team supplies the Company with hardware, related software and support services for such hardware for the
Companys projects, in accordance with the agreement referred to above. Under the agreement between the Company and Team, the Company is required to pay for such hardware, related software and support services when it receives payment from its
customers. In 2002, a disagreement arose between the Company and Team regarding whether the Company is required to pay Team for hardware and related software that it supplied to three of the Companys major customers as part of projects for
which the Company receives payments based on milestones which do not allocate specific amounts for hardware and related software. Following negotiations to achieve a compromise with Team on this issue, the Company agreed to pay Team the amount of $
1,047 in respect of hardware and related software supplied by Team as part of the Companys projects for these customers. When the Company will receive additional payments for these projects, it is required to pay Team an additional payment
based on Teams pro rata share of the project. The aggregate additional amount that the Company may have to pay to Team for all of these projects is $ 563.



In 2003, the Company paid Team $ 272 in respect of the above mentioned projects and executed a written agreement with Team.



Transactions between Team and its affiliates and the Company:



|                                                      |  |                         |       |      |   |       |  |   |      
|----------------------------------------------------- |  | ----------------------- | ----- | ---- | - | ----- |  | - | -----
|                                                      |  | Year ended December 31,
|                                                      |  | 2002                    |       | 2003 |   | 2004 
|Revenues:                                             |  |                         |       |      |   |       |  |   |      
|Commissions on product sales and payment for services |  | $                       | 520   |      | $ | 157   |  | $ | 249  
|                                                      |  |                         |       |      |   |       |  |   |      
|General and administrative expenses:                  |  |                         |       |      |   |       |  |   |      
|Rent and maintenance                                  |  | $                       | 1,292 |      | $ | 1,440 |  | $ | 1,421
|                                                      |  |                         |       |      |   |       |  |   |      
|Administrative and management services                |  | $                       | 583   |      | $ | 503   |  | $ | 207  
|                                                      |  |                         |       |      |   |       |  |   |      
|Purchase of equipment                                 |  | $                       | 884   |      | $ | 711   |  | $ | 555  
|                                                      |  |                         |       |      |   |       |  |   |      



Balances between Team and the Company:



|                             |  |              |        |   |      |   |    
|---------------------------- |  | ------------ | ------ | - | ---- | - | ---
|                             |  | December 31,
|                             |  | 2003         |        |   | 2004
|Current assets (liabilities) |  | $            | (1,176 | ) |      | $ | 150
|                             |  |              |        |   |      |   |    



F-31



---

TTI TEAM TELECOM INTERNATIONAL LTD.

AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands



|NOTE 13:- | GEOGRAPHIC INFORMATION AND SELECTED STATEMENTS OF OPERATIONS DATA
|--------- | -----------------------------------------------------------------



|a. | Summary information about geographic areas:
|-- | -------------------------------------------



The Company adopted Statement of Financial Accounting Standard No. 131, Disclosures About Segments of an Enterprise and Related Information
(SFAS No. 131). The Company operates in one reportable segment (see Note 1 for a brief description of the Companys business). The total revenues are attributed to geographic areas based on the location of the end customer.



The following presents total revenues and long-lived assets
as of and for the years ended December 31, 2002, 2003 and 2004:



|              |  |                         |        |                  |   |               |  |                  |        |               |   |                   |  |   |        |  |   |      
|------------- |  | ----------------------- | ------ | ---------------- | - | ------------- |  | ---------------- | ------ | ------------- | - | ----------------- |  | - | ------ |  | - | -----
|              |  | Year ended December 31,
|              |  | 2002                    |        | 2003             |   | 2004         
|              |  | Totalrevenues           |        | Long-livedassets |   | Totalrevenues |  | Long-livedassets |        | Totalrevenues |   | Long-lived assets
|Israel        |  | $                       | 6,098  |                  | $ | 20,371        |  | $                | 3,357  |               | $ | 11,791            |  | $ | 4,200  |  | $ | 5,578
|United States |  |                         | 17,908 |                  |   | 577           |  |                  | 18,091 |               |   | 734               |  |   | 14,112 |  |   | 533  
|Europe        |  |                         | 18,966 |                  |   | 2,419         |  |                  | 12,047 |               |   | 20                |  |   | 11,541 |  |   | 8    
|Australia     |  |                         | 4,328  |                  |   | 40            |  |                  | 1,913  |               |   | 42                |  |   | 3,310  |  |   | 34   
|South America |  |                         | 4,610  |                  |   |              |  |                  | 5,386  |               |   |                  |  |   | 2,712  |  |   |     
|Far East      |  |                         | 5,209  |                  |   | 64            |  |                  | 2,309  |               |   | 32                |  |   | 722    |  |   | 2    
|South Africa  |  |                         | 1,222  |                  |   |              |  |                  | 2,764  |               |   |                  |  |   | 1,201  |  |   |     
|              |  |                         |        |                  |   |               |  |                  |        |               |   |                   |  |   |        |  |   |      
|              |  | $                       | 58,341 |                  | $ | 23,471        |  | $                | 45,867 |               | $ | 12,619            |  | $ | 37,798 |  | $ | 6,155
|              |  |                         |        |                  |   |               |  |                  |        |               |   |                   |  |   |        |  |   |      



|b. | Major customers data as a percentage of total revenues:
|-- | -------------------------------------------------------



|           |  |                         |   |  |      |   |  |      |  
|---------- |  | ----------------------- | - |  | ---- | - |  | ---- | -
|           |  | Year ended December 31, |  
|           |  | 2002                    |   |  | 2003 |   |  | 2004 |  
|Customer A |  | 8                       | % |  | 10   | % |  | 9    | %
|Customer B |  | 3                       | % |  | 9    | % |  | 16   | %
|Customer C |  | 11                      | % |  | 11   | % |  | 4    | %
|Customer D |  | *)16                    | % |  | **)4 | % |  | 5    | %



|*) | In 2002, the Company also recorded total revenues of 13%, from two affiliates of Customer D.
|-- | --------------------------------------------------------------------------------------------



|**) | In 2003, the Company recorded revenues of 4% from an affiliate of Customer D.
|--- | -----------------------------------------------------------------------------



F-32



---

TTI TEAM TELECOM INTERNATIONAL LTD.

AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands



|NOTE 14:- | SELECTED STATEMENTS OF OPERATIONS DATA
|--------- | --------------------------------------



|a. | Research and development, net:
|-- | ------------------------------



|                                                    |  |                         |        |      |   |        |  |   |       
|--------------------------------------------------- |  | ----------------------- | ------ | ---- | - | ------ |  | - | ------
|                                                    |  | Year ended December 31,
|                                                    |  | 2002                    |        | 2003 |   | 2004  
|Total cost                                          |  | $                       | 11,314 |      | $ | 10,512 |  | $ | 11,324
|Less - grants and participations                    |  |                         | 1,356  |      |   | 194    |  |   | 580   
|Less - capitalization of software development costs |  |                         | 2,000  |      |   |       |  |   |      
|                                                    |  |                         |        |      |   |        |  |   |       
|Research and development, net                       |  | $                       | 7,958  |      | $ | 10,318 |  | $ | 10,744
|                                                    |  |                         |        |      |   |        |  |   |       



|b. | Financial income (expenses):
|-- | ----------------------------



|                                                       |  |   |        |   |  |   |        |   |  |   |       |  
|------------------------------------------------------ |  | - | ------ | - |  | - | ------ | - |  | - | ----- | -
|Financial expenses:                                    |  |   |        |   |  |   |        |   |  |   |       |  
|Foreign currency translation adjustments               |  | $ | (828   | ) |  | $ | (1,106 | ) |  | $ | (568  | )
|Impairment of available-for-sale marketable securities |  |   | (2,505 | ) |  |   |       |   |  |   |      |  
|                                                       |  |   |        |   |  |   |        |   |  |   |       |  
|                                                       |  |   | (3,333 | ) |  |   | (1,106 | ) |  |   | (568  | )
|                                                       |  |   |        |   |  |   |        |   |  |   |       |  
|Financial income:                                      |  |   |        |   |  |   |        |   |  |   |       |  
|Foreign currency translation adjustments               |  |   | 4,963  |   |  |   | 2,444  |   |  |   | 857   |  
|Gain (loss) from sales of marketable securities        |  |   | (56    | ) |  |   | 543    |   |  |   | 271   |  
|Interest and other                                     |  |   | 1,838  |   |  |   | 912    |   |  |   | 766   |  
|                                                       |  |   |        |   |  |   |        |   |  |   |       |  
|                                                       |  |   | 6,745  |   |  |   | 3,899  |   |  |   | 1,894 |  
|                                                       |  |   |        |   |  |   |        |   |  |   |       |  
|Financial income, net                                  |  | $ | 3,412  |   |  | $ | 2,793  |   |  | $ | 1,326 |  
|                                                       |  |   |        |   |  |   |        |   |  |   |       |  



F-33



---

TTI TEAM TELECOM INTERNATIONAL LTD.

AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data



|NOTE 15:- | SUBSEQUENT EVENTS (unaudited)
|--------- | -----------------------------



|a. | On November 29, 2004, the Company entered into definitive agreements (the Agreements) to obtain $ 14,600 in equity financing, through the sale of 6,636,391 shares of
Series A Convertible Preferred stock in a private placement to institutional investors (the Preferred Shares). The Preferred Shares are convertible into 6,636,391 Ordinary shares. In addition, holders of the Preferred Shares will be
granted one warrant to purchase 0.4 Ordinary shares at an exercise price of $ 2.50 per share for each Preferred Share owned. The closing of the investment took place on January 3, 2005. As a result, Teams holdings in the Company were reduced
from 50.22% to 32.21%.
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The rights of the holders
of the Preferred Shares include:



| | 1) | Weighted-average anti-dilution protection;
| | -- | ------------------------------------------



| | 2) | Preference in the event of liquidation of the Company;
| | -- | ------------------------------------------------------



| | 3) | Veto rights over certain material actions by the Company; and the right to nominate one member of the Companys Board of Directors.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------



According to the Agreements, the investors have the right to receive payment
for liquidated damages if a registration statement on Form F-3 is not declared effective within 90 days (or 120 days in the event the U.S. Securities and Exchange Commission conducts a review) following the closing of the private placement
transaction. The Company did not obtain effectiveness of the registration statement within the timeframe set forth in its agreements with the investors. Therefore, since May 4, 2005, the Company has been accruing liquidated damages at a rate equal
to 2% of each investors investment in the Company for each 30 day period, or pro rata for any portion thereof, during the period for which the registration statement is not declared effective. The Company expects that such liquidated damages
will total approximately $200.



|b. | On April 19, 2005, Team distributed to its shareholders 5,166,062 Ordinary Shares, such that immediately following the distribution, Team held 719,488 of the Companys ordinary
shares, representing approximately 3.9% of the Companys outstanding share capital. Of the 5,166,062 ordinary shares of the Companys distributed by Team, 3,714,435 will be distributed to Teams controlling shareholders (and will be
subject, under the U.S. securities laws, to a holding period of one year following the distribution, unless they are sold pursuant to a registration statement declared effective by the U.S. Securities and Exchange Commission or the existence of an
available exemption from the registration requirements).
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|c. | In March 2005, the Companys Chief Executive Officer resigned from his position. The chairman of the Board of Directors is serving as the Companys Chief Executive Officer
until it employs a new Chief Executive Officer.
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



F-34