##### Table of Contents





UNITED STATES

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

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

For the Fiscal year ended December 31, 2007

OR

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

COMMISSION FILE NUMBER





VIRYANET LTD.

(Exact Name of Registrant as specified in its charter)





STATE OF ISRAEL

(Jurisdiction of incorporation or organization)

8 HaMarpe St.

Har Hotzvim

P.O. Box 45041

Jerusalem 91450

Israel

(Address of principal
executive offices)

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



|                    |  |                                          
|------------------- |  | -----------------------------------------
|Title of each class |  | Name of each exchange on which registered
|NONE                |  | N/A                                      

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

Ordinary Shares, par value NIS 5.0 per share

(Title of Class)

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

N/A

(Title of Class)





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





As of December 31, 2007, the Registrant had 2,897,037 shares outstanding comprised of 2,570,240 Ordinary Shares and 326,797 Preferred A Shares.

Indicate by check mark if the registrant is a well known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes:   ̈    No:  x

If this report is an annual or transition
report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.    Yes:   ̈    No:  x

Indicate by check mark whether
the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.

Large accelerated filer:   ̈            Accelerated filer:    ̈            Non-accelerated filer:   x

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes:   ̈    No:  x

Indicate by check mark which financial statement
item the Registrant has elected to follow:    Item 17   ̈    Item 18  x

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in rule 12b-2 of the Exchange
Act).    Yes:   ̈    No:  x









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TABLE OF CONTENTS



|                                                                                      |  |         
|------------------------------------------------------------------------------------- |  | --------
|                                                                                      |  | Page No.
|ITEM                                                                                  |  |         
|PART I                                                                                |  |         
|Item 1. Identity of Directors, Senior Management and Advisors                         |  | 3       
|Item 2. Offer Statistics and Expected Timetable                                       |  | 3       
|Item 3. Key Information                                                               |  | 3       
|Selected Consolidated Financial Data                                                  |  | 3       
|Capitalization and Indebtedness                                                       |  | 4       
|Reasons for the Offer and Use of Proceeds                                             |  | 4       
|Risk Factors                                                                          |  | 5       
|Item 4. Information on our Company                                                    |  | 12      
|History and Development                                                               |  | 12      
|Business Overview                                                                     |  | 14      
|Organizational Structure                                                              |  | 18      
|Property, Plants and Equipment                                                        |  | 19      
|Item 5. Operating and Financial Review and Prospects                                  |  | 19      
|Overview                                                                              |  | 19      
|Operating Results                                                                     |  | 23      
|Liquidity and Capital Resources                                                       |  | 26      
|Research and Development                                                              |  | 29      
|Trend Information                                                                     |  | 30      
|Off-balance Sheet Arrangements                                                        |  | 30      
|Tabular Disclosure of Contractual Obligations                                         |  | 30      
|Item 6. Directors, Senior Management and Employees                                    |  | 31      
|Directors and Senior Management                                                       |  | 31      
|Compensation                                                                          |  | 32      
|Board Practices                                                                       |  | 32      
|External Directors; Independent Directors                                             |  | 33      
|Employees                                                                             |  | 34      
|Share Ownership                                                                       |  | 34      
|Item 7. Major Shareholders and Related Party Transactions                             |  | 35      
|Major Shareholders                                                                    |  | 35      
|Related Party Transactions                                                            |  | 37      
|Interests of Experts and Counsel                                                      |  | 38      
|Item 8. Financial Information                                                         |  | 38      
|Consolidated Statements and Other Financial Information                               |  | 38      
|Significant Changes                                                                   |  | 38      
|Item 9. The Offer and Listing                                                         |  | 38      
|Market Price Information                                                              |  | 38      
|Markets on Which our Ordinary Shares Trade                                            |  | 40      
|Item 10. Additional Information                                                       |  | 40      
|Share Capital                                                                         |  | 40      
|Memorandum and Articles of Association                                                |  | 40      
|Material Contracts                                                                    |  | 41      
|Exchange Controls                                                                     |  | 41      
|Taxation                                                                              |  | 42      
|Item 11. Quantitative and Qualitative Disclosures about Market Risk                   |  | 47      
|Item 12. Description of Securities other than Equity Securities                       |  | 47      
|PART II                                                                               |  | 47      
|Item 13. Defaults, Dividend Arrearages and Delinquencies                              |  | 47      
|Item 14. Material Modifications to the Rights of Security Holders and Use of Proceeds |  | 47      
|Item 15. Controls and Procedures                                                      |  | 48      
|Item 16. Audit Committee Financial Expert                                             |  | 48      
|Code of Ethics                                                                        |  | 48      
|Principal Accountant Fees and Services                                                |  | 48      
|Exemptions from the Listing Standards for the Audit Committee                         |  | 49      
|Purchases of Equity Securities by the Issuer and Affiliated Purchasers                |  | 49      
|PART III                                                                              |  | 49      
|Item 17. Financial Statements                                                         |  | 49      
|Item 18. Financial Statements                                                         |  | 49      
|Item 19. Exhibits                                                                     |  | 49      



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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

Unless the context otherwise requires, all reference in this annual report to ViryaNet, we, our, us and
the Company refer to ViryaNet Ltd. and its consolidated subsidiaries. Reference to dollars or $ are to United States dollars. All references to NIS are to New Israeli Shekels.

All references to Ordinary Shares and Preferred A Shares, including related share price, are made on a post reverse stock split basis, taking into
account the five (5) for one (1) reverse stock split of ViryaNets Ordinary Shares, which became effective on January 17, 2007.

Matters discussed in this document may constitute forward-looking statements. The Private Securities Litigation Reform Act of 1995 provides safe harbor protections for forward-looking statements in order to encourage companies to provide
prospective information about their businesses. Forward-looking statements include statements concerning plans, objectives, goals, strategies, future events or performance, and underlying assumptions and other statements, which are other than
statements of historical facts.

We desire to take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act
of 1995 and we are including this cautionary statement in connection with this safe harbor legislation. This document and any other written or oral statements made by us or on our behalf may include forward-looking statements, which reflect our
current views with respect to future events and financial performance. The words believe, expect, anticipate, intend, estimate, forecast, project and similar
expressions identify forward-looking statements.

The forward-looking statements in this document are based upon various assumptions, many
of which are based, in turn, upon further assumptions, including without limitation, managements examination of historical operating trends, data contained in our records and other data available from third parties. Although we believe that
these assumptions were reasonable when made, because these assumptions are inherently subject to significant uncertainties and contingencies which are difficult or impossible to predict and are beyond our control, we cannot assure you that we will
achieve or accomplish these expectations, beliefs or projections. In addition to these important factors and matters discussed elsewhere herein and in the documents incorporated by reference herein, important factors that, in our view, could cause
actual results to differ materially from those discussed in the forward-looking statements, including the achievement of the anticipated levels of profitability, growth, cost, the timely development and acceptance of new products, the impact of
competitive pricing, the impact of general business and global economic conditions and other important factors described from time to time in the reports filed by us with the Securities and Exchange Commission.

Except to the extent required by law, neither we, nor any of our respective agents, employees or advisors intends or has any duty or obligation to
supplement, amend, update or revise any of the forward-looking statements contained or incorporated by reference in this document.

PART I



|Item 1. | Identity Of Directors, Senior Management and Advisors
|------- | -----------------------------------------------------

Not applicable.



|Item 2. | Offer Statistics and Expected Timetable
|------- | ---------------------------------------

Not applicable.



|Item 3. | Key Information
|------- | ---------------

Selected Consolidated Financial Data

The tables that follow present portions of our financial
statements and are not complete. You should read the following selected financial data with our consolidated financial statements, notes to our consolidated financial statements and the Operating and Financial Review and Prospects section 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 below for the years ended December 31, 2005, 2006 and 2007, and the selected consolidated balance sheet data as of December 31, 2006 and 2007, 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, 2003 and 2004 and the selected consolidated balance sheet data as of December 31, 2003, 2004 and 2005 from audited consolidated financial statements that are not
included in this annual report.



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Summary Consolidated Financial Information

U.S. dollars in thousands (except share and per share data)



|                                                                                                  |  |                         |         |   |      |   |         |      |  |   |           |   |  |      |           |   |  |   |           |  
|------------------------------------------------------------------------------------------------- |  | ----------------------- | ------- | - | ---- | - | ------- | ---- |  | - | --------- | - |  | ---- | --------- | - |  | - | --------- | -
|                                                                                                  |  | Year Ended December 31, |        
|                                                                                                  |  | 2003                    |         |   | 2004 |   |         | 2005 |  |   | 2006      |   |  | 2007 |          
|Statement of Operations Data:                                                                     |  |                         |         |   |      |   |         |      |  |   |           |   |  |      |           |   |  |   |           |  
|Revenues:                                                                                         |  |                         |         |   |      |   |         |      |  |   |           |   |  |      |           |   |  |   |           |  
|Software licenses                                                                                 |  | $                       | 4,102   |   |      | $ | 3,114   |      |  | $ | 1,720     |   |  | $    | 1,520     |   |  | $ | 1769      |  
|Maintenance and services                                                                          |  |                         | 7,857   |   |      |   | 8,806   |      |  |   | 12,487    |   |  |      | 12,340    |   |  |   | 9,390     |  
|                                                                                                  |  |                         |         |   |      |   |         |      |  |   |           |   |  |      |           |   |  |   |           |  
|Total revenues                                                                                    |  |                         | 11,959  |   |      |   | 11,920  |      |  |   | 14,207    |   |  |      | 13,860    |   |  |   | 11,159    |  
|Cost of revenues:                                                                                 |  |                         |         |   |      |   |         |      |  |   |           |   |  |      |           |   |  |   |           |  
|Software licenses                                                                                 |  |                         | 482     |   |      |   | 288     |      |  |   | 358       |   |  |      | 356       |   |  |   | 358       |  
|Maintenance and services                                                                          |  |                         | 4,996   |   |      |   | 6,743   |      |  |   | 7,855     |   |  |      | 6,831     |   |  |   | 5,633     |  
|                                                                                                  |  |                         |         |   |      |   |         |      |  |   |           |   |  |      |           |   |  |   |           |  
|Total cost of revenues                                                                            |  |                         | 5,478   |   |      |   | 7,031   |      |  |   | 8,213     |   |  |      | 7,187     |   |  |   | 5,991     |  
|Gross profit                                                                                      |  |                         | 6,481   |   |      |   | 4,889   |      |  |   | 5,994     |   |  |      | 6,673     |   |  |   | 5,168     |  
|                                                                                                  |  |                         |         |   |      |   |         |      |  |   |           |   |  |      |           |   |  |   |           |  
|Operating expenses:                                                                               |  |                         |         |   |      |   |         |      |  |   |           |   |  |      |           |   |  |   |           |  
|Research and development, net                                                                     |  |                         | 2,098   |   |      |   | 2,069   |      |  |   | 2,504     |   |  |      | 2,121     |   |  |   | 2,290     |  
|Sales and marketing                                                                               |  |                         | 4,109   |   |      |   | 4,398   |      |  |   | 5,214     |   |  |      | 3,692     |   |  |   | 3,429     |  
|General and administrative                                                                        |  |                         | 1,927   |   |      |   | 2,214   |      |  |   | 3,004     |   |  |      | 2,735     |   |  |   | 2,485     |  
|Provision for doubtful accounts and write-off of bad debts                                        |  |                         | 40      |   |      |   |        |      |  |   |          |   |  |      |          |   |  |   |          |  
|                                                                                                  |  |                         |         |   |      |   |         |      |  |   |           |   |  |      |           |   |  |   |           |  
|Total operating expenses                                                                          |  |                         | 8,174   |   |      |   | 8,681   |      |  |   | 10,722    |   |  |      | 8,548     |   |  |   | 8,204     |  
|Operating loss                                                                                    |  |                         | (1,693  | ) |      |   | (3,792  | )    |  |   | (4,728    | ) |  |      | (1,875    | ) |  |   | (3,036    | )
|Financial expenses, net                                                                           |  |                         | (311    | ) |      |   | (363    | )    |  |   | (1,330    | ) |  |      | (44       | ) |  |   | (535      | )
|Other income (loss)                                                                               |  |                         | 350     |   |      |   |        |      |  |   |          |   |  |      |          |   |  |   | (239      | )
|                                                                                                  |  |                         |         |   |      |   |         |      |  |   |           |   |  |      |           |   |  |   |           |  
|Net loss                                                                                          |  | $                       | (1,654  | ) |      | $ | (4,155  | )    |  | $ | (6,058    | ) |  | $    | (1,919    | ) |  | $ | (3,810    | )
|                                                                                                  |  |                         |         |   |      |   |         |      |  |   |           |   |  |      |           |   |  |   |           |  
|Basic and diluted net loss per share                                                              |  | $                       | (2.71   | ) |      | $ | (4.25   | )    |  | $ | (4.68     | ) |  | $    | (1.03     | ) |  | $ | (1.66     | )
|Weighted average number of shares used in computing basic and diluted net loss per Ordinary Share |  |                         | 609,664 |   |      |   | 977,612 |      |  |   | 1,294,834 |   |  |      | 1,857,217 |   |  |   | 2,292,190 |  
|                                                                                                  |  |                         |         |   |      |   |         |      |  |   |           |   |  |      |           |   |  |   |           |  
|Balance Sheet Data:                                                                               |  |                         |         |   |      |   |         |      |  |   |           |   |  |      |           |   |  |   |           |  
|Cash and cash equivalents                                                                         |  | $                       | 5,087   |   |      | $ | 2,943   |      |  | $ | 2,040     |   |  | $    | 736       |   |  | $ | 413       |  
|Working capital (deficit)                                                                         |  |                         | 1,060   |   |      |   | (3,461  | )    |  |   | (4,004    | ) |  |      | (4,520    | ) |  |   | (6,098    | )
|Total assets                                                                                      |  |                         | 12,230  |   |      |   | 14,398  |      |  |   | 14,456    |   |  |      | 11,919    |   |  |   | 11,190    |  
|Long-term loan, including current maturities                                                      |  |                         | 2,343   |   |      |   | 1,306   |      |  |   | 1,991     |   |  |      | 1,292     |   |  |   | 738       |  
|Long-term convertible debt                                                                        |  |                         |        |   |      |   | 2,500   |      |  |   | 3,592     |   |  |      | 568       |   |  |   | 556       |  
|Shareholders equity                                                                              |  |                         | 2,786   |   |      |   | 1,678   |      |  |   | 183       |   |  |      | 2,534     |   |  |   | 50        |  

Capitalization and Indebtedness

Not applicable.

Reasons for the
Offer and Use of Proceeds

Not applicable.



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RISK FACTORS

You should carefully consider the risks described below and in the documents we have incorporated by reference into this prospectus before making an investment decision. The risks described below and in the
documents we have incorporated by reference into this prospectus are not the only ones facing our company. Our business, financial condition or 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.

Statements included or incorporated
by reference in this prospectus that are not historical facts are forward-looking statements within the meaning of the federal securities laws. These statements may contain works such as expects, anticipates,
intends, plans, believes, estimates, or other wording indicating future results or expectations. Forward-looking statements are subject to risks and uncertainties. Our actual results may differ
materially from the results discussed in forward-looking statements. Factors that could cause our results to differ materially include, but are not limited to, those discussed below, elsewhere in this prospectus and in the documents we have
incorporated by reference. We undertake no obligation to revise or update any forward-looking statements to reflect any event or circumstance that may arise or develop after the date of this prospectus.

Risks Related to our Business

We have incurred losses in the
past and may incur losses in the future.

We have incurred substantial net losses during each of the last five fiscal years and may
not achieve profitability in 2008 or in future years. As of December 31, 2007, we had an accumulated deficit of approximately $119.6 million. In order to achieve profitability we will need to increase our revenues while containing or reducing
our costs. However, a substantial portion of our expenses, including most product development and selling and marketing expenses, must be incurred in advance of when revenue is generated. Therefore, if our projected revenue does not meet our
expectations, we are likely to experience an even larger shortfall in our operating profit relative to our expectations. While our revenues in 2007, 2006, and 2005 were $11.2 million, $13.9 million, and $14.2 million, respectively, we incurred net
losses of $3.8 million, $1.9 million, and $6.1 million, respectively, during these years. We cannot assure you that we will be able to increase our revenues, or, that even if we are able to increase our revenues we will be able to achieve
profitability or maintain profitability, if achieved, on a consistent basis.

Our quarterly operating results have fluctuated significantly in the
past and may fluctuate significantly in the future which may adversely impact the price of our Ordinary Shares, making it difficult for investors to make reliable period-to-period comparisons and may contribute to volatility in the market price for
our Ordinary Shares.

Our quarterly revenues, gross profits and results of operations have fluctuated significantly in the past and
we expect them to continue to fluctuate significantly in the future. The following events may cause fluctuations in our operating results and/or cause our share price to decline:



| |  |  | changes in global economic conditions in general, and conditions in our industry and target markets in particular;
| | - |  | ------------------------------------------------------------------------------------------------------------------



| |  |  | changes in demand or timing of orders, especially large orders, for our products and services;
| | - |  | ----------------------------------------------------------------------------------------------



| |  |  | the length and unpredictability of our sales cycle;
| | - |  | ---------------------------------------------------



| |  |  | timing of product releases;
| | - |  | ---------------------------



| |  |  | the dollar value and timing of contracts;
| | - |  | -----------------------------------------



| |  |  | delays in implementation;
| | - |  | -------------------------



| |  |  | the mix of revenue generated by product licenses and professional services;
| | - |  | ---------------------------------------------------------------------------



| |  |  | price and product competition;
| | - |  | ------------------------------



| |  |  | changes in selling and marketing expenses, as well as other operating expenses;
| | - |  | -------------------------------------------------------------------------------



| |  |  | technological changes;
| | - |  | ----------------------



| |  |  | our ability to expand our workforce with qualified personnel, as may be needed;
| | - |  | -------------------------------------------------------------------------------



| |  |  | reductions in the level of our cash balance and our ability to raise cash;
| | - |  | --------------------------------------------------------------------------



| |  |  | consolidation of our customers;
| | - |  | -------------------------------



| |  |  | fluctuations in the economic factors impacting LIBOR which is the rate benchmark used to determine the interest expenses incurred by us on our bank borrowings per
our bank arrangement;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the geographic mix of revenue;
| | - |  | ------------------------------



| |  |  | integration and assimilation of management, employees and product lines of acquired companies;
| | - |  | ----------------------------------------------------------------------------------------------



| |  |  | effectiveness of our customer support, whether provided by our resellers or directly by us; and
| | - |  | -----------------------------------------------------------------------------------------------



| |  |  | foreign currency exchange rate fluctuations.
| | - |  | --------------------------------------------

As a result, we believe that period-to-period comparisons of our historical results of operations are not necessarily meaningful and that you should not rely on them as an indication for future performance. Also, it is possible that our
quarterly results of operations may be below the expectations of public market analysts and investors. If this happens, the price of our Ordinary Shares will likely decrease.

We delisted our shares from The Nasdaq Capital Market, which could adversely affect the market price and trading market of our Ordinary Shares.

Our Ordinary Shares had been listed on The Nasdaq Capital Market (formerly known as The Nasdaq SmallCap Market) since December 31, 2002. We were
previously listed on The Nasdaq National Market but were unable to comply with some of its maintenance standards.



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On June 4, 2007, we voluntarily requested from The NASDAQ Stock Market that our Ordinary Shares be delisted from The
NASDAQ Capital Market on June 11, 2007. We were subsequently advised by Nasdaq that our Ordinary Shares would be delisted from The NASDAQ Capital Market on June 12, 2007 and our Ordinary Shares became immediately eligible for quotation and
trading on the Pink Sheets. On December 14, 2007, our Ordinary Shares became eligible for trading on the Over-The-Counter Bulletin Board (OTCBB) under the ticker symbol VRYAF.OB. On September 11, 2008, due to our delinquency
with respect to the filing of our annual report on Form 20-F for the period ended December 31, 2007, our Ordinary shares ceased to be eligible for quotation on the OTC Bulletin Board (OTCBB) and have been removed from OTCBB.
Following the removal from OTCBB, our Ordinary shares became immediately eligible for quotation and trading on the Pink Sheets. After the filing of this Form 20-F we will review our alternatives for the reinstatement of our quotation on the OTC
Bulletin Board.

The delisting of our Ordinary Shares from The Nasdaq Capital Market and the OTCBB may materially impair the ability of our
shareholders to buy and sell our Ordinary Shares, , and could have an adverse effect on the market price and the trading market for our Ordinary Shares. In addition, the delisting of our Ordinary Shares from The Nasdaq Capital Market and OTCBB could
significantly impair our ability to raise capital should we desire to do so in the future or utilize our Ordinary Shares in consideration for acquisitions.

We may not be able to make our debt payments in the future.

We have $480,000 face value of convertible debt
outstanding with LibertyView Special Opportunities Fund, L.P. (LibertyView), which LibertyView has the option to request payment in full at any time during the months of July 2009 or July 2011. Our ability to meet our obligations under
the convertible debt and our other debt obligations will depend on whether we can successfully implement our strategy, as well as on financial, competitive, and other factors, including some factors that are beyond our control. If we are unable to
generate sufficient cash from operations to meet principal and interest payments on our debt, we may have to refinance all or part of our indebtedness. In addition, cash flows from our operations may be insufficient to repay in full at maturity the
convertible debts, in which case the convertible debts may need to be refinanced. Our ability to refinance our indebtedness, including the convertible debts, will depend on, among other things: our financial condition at the time; restrictions in
agreements governing our debt; and, other factors including market conditions.

We cannot ensure you that such refinancing would be
possible on terms that we could accept, or that we could obtain additional financing at all. If refinancing will not be possible or if additional financing will not be available, this would have a material adverse effect on our business.

We may need additional financing and may not be able to raise additional financing on favorable terms or at all.

We had negative cash flow from operations for each of the past few years. In the past five years, we had an aggregate negative operating cash flow in the
amount of $11.5 million. Over the past five years, we raised gross proceeds of approximately $5.0 million from private equity financing transactions during 2003, $2.5 million in a convertible debt financing in July 2004, approximately $3.5 million
in a combination of convertible debt and equity financings during 2005, approximately $1.4 million from private equity financing transactions during 2006, and approximately $1.0 million in a combination of equity and convertible debt financing
during 2007. However, we expect that we will need additional financing to fund our business operations. Any additional financing that is structured as a secured debt financing may require the consent of our main creditors, Bank Hapoalim and
LibertyView. Our ability to raise additional financing from third parties may be impacted by the delisting of our Ordinary Shares from The Nasdaq Capital Market and the OTCBB. We cannot assure you that additional financing will be available on terms
favorable to us, or at all. In the event that the market price of our Ordinary Shares declines, we may not be able to consummate a private equity financing transaction to raise additional financing. If adequate funds are not available or are not
available on acceptable terms, our ability to fund our day to day operations, expand our research and development, marketing and sales efforts, pursue potential acquisitions, take advantage of unanticipated opportunities, develop or enhance our
website content, features, services, or otherwise respond to competitive pressures would be severely constrained. If we raise additional funds through the issuance of equity or convertible debt securities, the percentage of ownership of our existing
shareholders will be reduced, and any newly issued securities may have rights, preferences or privileges senior to those of existing shareholders.

We will need sufficient funds to re-pay our loans from Bank Hapoalim, which may be subject to immediate repayment if we do not meet our repayment schedule or meet specified conditions.

As of June 30, 2008, our aggregate outstanding borrowings with Bank Hapoalim was approximately $2.2 million, which consisted of (i) short-term
borrowings of approximately $1.7 million of which $1.6 million is drawn in dollars with interest payable quarterly at a rate of LIBOR plus 2.25% and $0.1 million is drawn in NIS with interest payable quarterly at a rate of approximately 9% in NIS,
and (ii) the outstanding balance on our long-term loan arrangement with Bank Hapoalim of approximately $0.5 million with interest payable quarterly at a rate of LIBOR plus 2.25%.

Our overall bank financing arrangement with Bank Hapoalim was subject to the following covenants: (i) our shareholders equity, on a quarterly basis,
shall be at least the higher of (a) 17% of our total assets, or (b) $3.0 million, and (ii) our cash balance, on a quarterly basis, shall not be less than $1.0 million. With the exception of the second quarter of 2006 in which we were
in compliance with these covenants, we were not in compliance with these covenants for each quarterly period during 2006 and through the second quarter of 2007. However, we received a waiver from Bank Hapoalim for each period in which we were not in
compliance with these bank covenants.

On August 29, 2007, Bank Hapoalim agreed to modify our bank covenant requirements as part of
our overall bank financing arrangement such that on a quarterly basis starting August 1, 2007 (i) our shareholders equity shall be at least the higher of (a) 13% of our total assets, or (b) $1.5 million, and (ii) our
cash balance shall not be less than $0.5 million. In addition, Bank Hapoalim provided us with a waiver of these new bank covenant requirements for the remainder of 2007. In connection with the modification of these waiver and bank covenant
requirements, we agreed to pay $10,000 of fees and issue 10,000 Ordinary Shares to the bank.

We were not in compliance with these
covenants for each quarterly period during the first half of 2008. However, on September 28 we received a waiver of these covenants from Bank Hapoalim for each quarterly period during the first half of 2008. Bank Hapoalim also provided us with
a waiver of these covenants for the remainder of 2008 and for the first quarter of 2009. In addition, on September 29, 2008, Bank Hapoalim agreed to convert the $1.6 million of short term loan that was due on January 2, 2009 to a long-term
loan, such that $0.1 million will be paid on July 2, 2009 an additional $0.1 million will be paid on August 15, 2009 and the balance of $1.4 million will be paid over 14 quarterly payments starting October 2, 2009. The interest will
be paid quarterly at a rate of LIBOR plus 3.25%. In connection with these waivers and the conversion of the short-term loan to a long-term loan, we agreed to pay fees of $30,000 to the bank.

We may need to obtain funding from third parties to meet the payment obligations under the abovementioned loan arrangement in a timely manner, and there
is no assurance that Bank Hapoalim will grant us an extension to these payment dates in the future, if requested. Our ability to raise capital using convertible debt or equity financing instruments from third parties for the re-payment of our loans
with Bank Hapoalim may be impacted by the delisting of our Ordinary Shares from The Nasdaq Capital Market and the OTCBB. There can be no assurance that we will meet these covenants or that the bank will waive the compliance with any such covenants
in the event that we do not meet them. If we fail to meet the quarterly payments any repayment of loans to Bank Hapoalim or to meet these covenants, the bank may demand immediate repayment of the outstanding debts and all interest thereon and shall
be entitled to exercise the remedies available to it. This would have a material adverse effect on our business.



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##### Table of Contents

We have substantially reduced the number of our employees during 2005, 2006, and 2007 and may be unable to meet
certain revenue objectives and accordingly continue to incur losses.

During 2004, we substantially increased our overall headcount
from 86 at the beginning of 2004 to 126 at the end of 2004. Part of this increase was related to the assumption of 25 employees from the acquisition of Utility Partners. In June 2005, we added another 22 employees with the acquisition of e-Wise
Solutions, raising our headcount to 148. After the acquisition of e-Wise, we determined that we had an excess of resources resulting from these acquisitions and took action to reduce headcount. These actions resulted in a reduction of our headcount
to 120 at the end of December 2005, 98 at the end of December 2006, and 88 at the end of December 2007. Although we believe we currently have sufficient resources available to meet and support our current obligations in relation to our current
staff, we may not be able to maintain this headcount. If we are forced to reduce headcount further, our ability to meet our growth goals and our business and operations may be negatively impacted.

We may need to further expand our sales, marketing, research and development and professional services organizations but may lack the resources to do so, which may
hinder our ability to grow and meet customer demands.

We may need to substantially expand our headcount beyond our current staff in
order to increase market awareness and sales of our products. We may also need to increase our quality assurance, technical and customer support staff to support new customers and the expanding needs of existing customers. These positions require
training on the use of our products and we generally expect that the training period will take a significant amount of time before these personnel can support our customers. In addition, there is significant competition for qualified personnel.
Competition for qualified people may lead to increased labor and personnel costs. If we need to hire additional employees and are unable to attract, train and retain qualified personnel, we may not be able to achieve our objectives and our business
could be harmed.

If we are unable to attract, train and retain qualified personnel, we may not be able to achieve our objectives and our business
could be harmed.

Our future success depends on our ability to absorb and retain senior employees and to attract, motivate and
retain highly qualified professional employees. Competition for these employees can be intense, especially in a number of our key markets and locations, including Israel. The process of locating, training and successfully integrating qualified
personnel into our operations can be lengthy and expensive. The market for the qualified personnel we require is very competitive because of the limited number of people available with the necessary technical and sales skills and understanding of
our products and technology. This is particularly true in Israel where competition for qualified personnel is intense. We may not be able to compete effectively for the personnel we need. The delisting of our Ordinary Shares from The Nasdaq Capital
Market and OTCBB may impact our ability to retain and attract personnel as the delisting may impact the amount and liquidity of compensation in the form of share options and restricted shares granted to employees. Any loss of members of senior
management or key technical personnel, or any failure to attract or retain highly qualified employees as needed, could materially adversely affect our ability to achieve our research and development and sales objectives.

If we fail to maintain effective system of internal controls over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act of 2002, we may
not be able to report our financial results accurately. As a result, we could be subject to costly litigation, and current and potential shareholders could lose confidence in our financial reporting, which could harm our business and the trading
price of our Ordinary Shares.

Effective internal controls over financial reporting are required for us to provide reliable
financial reports. For the fiscal year ended December 31, 2003, we determined that a material weakness in our internal control over financial reporting existed as of December 31, 2003 consisting of ineffective controls to identify errors
in the application of complex accounting standards to our software licensing transactions. Since then, we believe that we have managed to eliminate the aforementioned material weakness. However, if we fail to implement and maintain an effective
system of internal controls, we could be subject to costly litigation, investors could lose confidence in our reported financial information and our brand and operating results could be harmed, which could have a negative effect on the trading price
of our Ordinary Shares.

We face risks relating to the restatement of our financial statements.

On two occasions we restated our 2000, 2001, 2002, and 2003 financial statements. The restatements were reported on December 9, 2004 and
March 17, 2005 and the impact on our financial statements was reported first in our Report on Form 20-F/A dated March 25, 2005 for the fiscal year ended December 31, 2003. These restatements or any other restatement of our financial
statements may lead to litigation claims against us. The defense of any claims which may arise in connection with these or any other restatement may cause the diversion of managements attention and resources, and we may be required to pay
damages if any such claims are not resolved in our favor. Any litigation, even if resolved in our favor, may cause us to incur significant legal and other expenses.

The market price of our Ordinary Shares may be volatile and you may not be able to resell your shares at or above the price you paid, or at all.

The stock market in general has recently experienced extreme price and volume fluctuations. The market prices of securities of technology companies have
been extremely volatile, and have experienced fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. These broad market fluctuations could adversely affect the market price of our Ordinary
Shares. The market price of the Ordinary Shares may fluctuate substantially due to a variety of factors, including:



| |  |  | the delisting of our Ordinary Shares from The Nasdaq Capital Market and OTCBB and subsequent availability for trading on the Pink Sheets;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------



| |  |  | any actual or anticipated fluctuations in our financial condition and operating results;
| | - |  | ----------------------------------------------------------------------------------------



| |  |  | our inability to meet any guidance or forward looking information, if provided;
| | - |  | -------------------------------------------------------------------------------



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



| |  |  | the introduction or market acceptance of new service offerings by us or our competitors;
| | - |  | ----------------------------------------------------------------------------------------



| |  |  | changes in security analysts financial estimates;
| | - |  | --------------------------------------------------



| |  |  | changes in accounting principles;
| | - |  | ---------------------------------



| |  |  | sales of our Ordinary Shares by existing shareholders;
| | - |  | ------------------------------------------------------



| |  |  | limited market for our shares;
| | - |  | ------------------------------



| |  |  | the use of our Ordinary Shares for the acquisition of the outstanding shares or certain assets of companies;
| | - |  | ------------------------------------------------------------------------------------------------------------



| |  |  | the need to raise additional capital through private or public debt or equity financings; and
| | - |  | ---------------------------------------------------------------------------------------------



| |  |  | changes in the political conditions in Israel.
| | - |  | ----------------------------------------------



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In the past, securities class action litigation has often been brought against companies following
periods of volatility in the market prices of their securities. We may be the target of similar litigation in the future. Securities litigation could result in substantial costs and divert our managements attention and resources, which could
cause serious harm to our business.

We have never paid cash dividends and have no intention to pay cash dividends in the foreseeable future.

We have never paid cash dividends on our Ordinary Shares and do not anticipate paying any cash dividends in the foreseeable future.
We intend to retain earnings, if any, for use in financing our operations and expanding our business, in particular to fund our research and development and sales and marketing activities, which are important to capitalize on technological changes
and new market opportunities. Any future dividends distributions are subject to the discretion of our board of directors and will depend on various factors, including our operating results, future earnings, capital requirements, financial condition,
tax implications of dividend distributions on our income, future prospects and any other factors deemed relevant by our board of directors. The distribution of dividends also may be limited by Israeli law, which allows the distribution of dividends
out of retained earnings or otherwise upon the permission of the court. You should not rely on an investment in our Ordinary Shares if you require dividend income from your investment.

Future sales of our Ordinary Shares in the public market or issuances of additional securities could cause the market price for our Ordinary Shares to fall.

Since August 4, 2003, commensurate with the timing of our initial need to raise additional capital, the amount of our outstanding shares has
increased substantially. The increase in the amount of outstanding shares is due primarily to (i) private equity and convertible debt financings which raised approximately $13.4 million since 2003 to the date hereof (See Liquidity and Capital
Resources section under Item 5  How We Have Financed Our Business; Source of Cash), excluding transaction related expenses, in exchange for our Ordinary Shares and debts convertible to Ordinary Shares, (ii) the acquisition of Utility
Partners, Inc. which resulted in the issuance of 179,697 Ordinary Shares in July 2004, and (iii) the acquisition of e-Wise Solutions which resulted in the issuance of an aggregate of 111,156 Ordinary Shares in June and August of 2005.

As of July 15, 2008, we also had outstanding warrants to purchase 673,199 Ordinary Shares at exercise prices ranging from $1.25 to
$10.50 per share, and we have reserved up to 528,000 Ordinary Shares for issuance under our share option plans, of which 36,531 options have been exercised and the restrictions on 107,353 restricted shares have lapsed as of July 15, 2008. In
addition, we have the balance of the convertible debt with LibertyView with a face value of $480,000 which may be converted by LibertyView at any time into Ordinary Shares at an exercise price of $11.025 per share. The sale, or availability for
sale, of substantial quantities of our Ordinary Shares may have the effect of further depressing their market price. A large number of our Ordinary Shares that were previously subject to resale restrictions are currently eligible or shall soon be
eligible for resale into the public market.

We may continue to issue equity or convertible securities and the issuance of these securities
could be dilutive to our shareholders. Certain warrants and options, when issued, may be valued at fair value and we may reflect the appropriate charges in our financial statements at that time. We have provided registration rights in the past to
certain shareholders and may continue to do so in the future.

Historically, our revenues have been concentrated in a few large orders and a small
number of customers. Our business could be adversely affected if we lose a key customer.

A significant portion of our revenues each
year has been derived from large orders from a small number of customers which are not necessarily the same customers each year. In 2005, three customers each accounted for approximately 8% or more of revenues, and represented an aggregate of 31% of
our total revenues. In 2006, three customers each accounted for approximately 7% or more of revenues, and represented an aggregate of 23% of our total revenues. In 2007, three customers each accounted for approximately 6% or more of revenues, and
represented an aggregate of 19% of our total revenues. We do not expect that these three customers accounting for 19% of our revenue during 2007 will represent a substantial percentage of our revenues in the future. However, we do expect that a
significant portion of our future revenues will continue to be derived from a relatively small number of customers. We cannot assure you that other customers will purchase our products and services in the future. The failure to secure new key
customers, the loss of key customers or the occurrence of significant reductions in sales from a key customer would cause our revenues to significantly decrease and make it significantly more difficult for us to be profitable.

Our sales cycle is variable and often long and involves investment of significant resources on our part, but may never result in actual sales and we may therefore
suffer additional losses.

Our sales cycle from our initial contact with a potential customer to the signing of a license and
related agreements has historically been lengthy and variable. We generally must educate our potential customers about the use and benefit of our products and services, which can require the investment of significant time and resources, causing us
to incur most of our product development and selling and marketing expenses in advance of a potential sale. In addition, a number of companies decide which products to buy through a request for proposal process. In those situations, we also run the
risk of investing significant resources in a proposal that results in a competitor obtaining the desired contract from the customer or in a decision by a customer not to proceed. The purchasing decisions of our customers are subject to the
uncertainties and delays of the budgeting, approval and competitive evaluation processes that typically accompany significant capital expenditures. If our sales cycle lengthens, our quarterly operating results may become less predictable and may
fluctuate more widely than in the past. Due to the relatively large size of some orders, a lost or delayed sale could have a material adverse effect on our quarterly revenue and operating results.

If we are unable to accurately predict and respond to market developments or demands, our business will be adversely affected.

The market for mobile workforce management software solutions is evolving. This makes it difficult to predict demand and market acceptance for our
products. Changes in technologies, industry standards, customer requirements and new product introductions by existing or future competitors could render our existing products obsolete and unmarketable, or require us to develop new products. We have
limited development resources to expend on product development. Therefore, we may be unable to timely develop products that meet the markets future needs. If we were to experience a significant increase in the number of customers, or were to
decide to effect a significant increase in our development of new product offerings, or both, we would need to expend significant amounts of money, time and other resources. This could strain our personnel and financial resources.

During the past few years, we have experienced fluctuation in the mix of our revenues from software licenses and services, and a reduction in the overall amount of
our services revenues. If either or both of these trends continue, it may adversely affect our gross margins and profitability.

Our
revenues from the sale of software licenses have fluctuated over the past three years, increasing to approximately $1.8 million in 2007 from approximately $1.5 million in 2006 and approximately $1.7 million in 2005. Our revenues from services have
also fluctuated over the past three years, decreasing to approximately $9.4 million in 2007 from approximately $12.3 million in 2006 and from approximately $12.5 million in 2005. Both of these trends have a direct impact on our gross margins and
profitability. Our gross margin from software licenses is substantially higher than our gross margin from services, since our cost of services, which includes expenses of salaries and related benefits of the employees engaged in providing the
services, is substantially higher than our cost of software licenses. However, a decline in the volume of services revenues we generate also has a direct impact on our overall gross margins and profitability if not accompanied by a similar increase
in the amount of revenue from software licenses. If the trend of decreases in software license revenues should reoccur or decreases in services revenues continues, our gross margins and profitability may be adversely affected.



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##### Table of Contents

If we fail to stabilize or improve our margins on service revenues in the future, our results of operations could
suffer.

Our margins on service revenues have not been consistent. In 2007, our margins on services revenues were 40% compared to
45% in 2006 and 37% in 2005. In order to stabilize or improve our margins on services revenues, we will need to maintain or increase the efficiency and utilization of our services personnel, consistently control our costs, and increase the volume of
our services revenues. There is no assurance that we will be able to maintain or improve our services margins, or, that they will not decline further in the future.

Our ability to maintain or increase our revenues may depend on our ability to make sales through third parties.

We are becoming more dependent upon resellers and channel partners to generate a substantial portion of our revenues. We expect this dependence to continue and potentially increase due to our limited internal sales
and marketing resources in existing markets and to increase due to our desire to penetrate new vertical markets for our products in North America, and expand into new geographic markets for our products outside of North America. As a result of the
limited resources and capacities of many resellers and channel partners, even if we manage to maintain and expand our relationship with such resellers and channel partners, we may be unable to attain sufficient focus and resources from those
resellers and channel partners so as to meet all of our customers needs. If anticipated orders from these resellers and channel partners fail to materialize, or if our current business agreements with resellers and channel partners are
terminated, our business, operating results and financial condition will be materially adversely affected.

Our channel and strategic partner
strategy may expose us to additional risks relating to intellectual property infringement.

Our increased reliance on our channel
and strategic partners may increase the likelihood of the infringement of our intellectual property. As we deepen our ties with our channel and strategic partners, the number of people who are exposed to and interact with our software and other
intellectual property will increase. Despite our best efforts to protect our intellectual property, our channel or strategic partners, or their employees or customers, may copy some portions of our products or otherwise obtain and use information
and technology that we regard as proprietary. Our channel or strategic partners might also improperly incorporate portions of our technology into their own products or otherwise exceed the authorized scope of their licenses to our technology. If we
are unable to successfully detect and prevent infringement and/or to enforce our rights to our technology, our revenues may be negatively impacted and we may lose competitive position in the market.

If we are unable to maintain or expand our relationships with third party providers of implementation and consulting services, we may be unable to increase our
revenues.

To focus more effectively on our core business of developing and licensing software solutions, we need to establish and
maintain additional relationships with third parties that can provide implementation and consulting services to our customers. Third-party implementation and consulting firms can also be influential in the choice of mobile workforce management
solutions by new customers. If we cannot establish and maintain effective, long-term relationships with implementation and consulting providers, or if these providers do not meet the needs or expectations of our customers, we may be unable to
increase our revenues and our business could be seriously harmed. As a result of the limited resources and capacities of many third-party implementation providers, we may be unable to attain sufficient focus and resources from the third-party
providers to meet all of our customers needs, even if we establish relationships with these third parties. If sufficient resources are unavailable, we will be required to provide these services internally, which could limit our ability to
expand our base of customers. We will be subject to significant risk as we cannot control the level and quality of service provided by these third parties.

Undetected defects may increase our costs and impair the market acceptance of our products and technology.

Our
software products are complex and may contain undetected defects, particularly when first introduced or when new versions or enhancements are released. Testing of our products is particularly challenging because it is difficult to simulate the wide
variety of customer environments in several geographic markets into which our products are deployed. Despite testing conducted by us and our customers, we have in the past shipped product releases with some defects, some customers have cited
possible defects, and have otherwise discovered other defects in our products after their commercial shipment. Our products are frequently more critical to our customers operations compared to other software solutions used by such customers,
and as a result, our customers may have a greater sensitivity to product defects relating to our products.

Defects may be found in current
or future products and versions after the start of commercial shipment. This could result in:



| |  |  | a delay or failure of our products to achieve market acceptance;
| | - |  | ----------------------------------------------------------------



| |  |  | adverse customer reaction;
| | - |  | --------------------------



| |  |  | negative publicity and damage to our reputation;
| | - |  | ------------------------------------------------



| |  |  | diversion of resources; and
| | - |  | ---------------------------



| |  |  | increased service and maintenance costs.
| | - |  | ----------------------------------------

Defects could also subject us to legal claims. Although our license agreements contain limitation of liability provisions, these provisions may not be sufficient to protect us against these legal claims. The sale and support of our
products, as well as our professional services, may also expose us to product liability claims.

Greater market acceptance of our competitors
products or decisions by potential or actual customers to develop their own service management solutions could result in reduced revenues and reduced gross margins.

The market for mobile workforce management applications and the automation of field service delivery are highly competitive yet fragmented and stratified,
although a number of our traditional competitors have been acquired by larger companies. We compete for the business of global or nationwide organizations that seek to support complex and sophisticated products across a variety of industries. We
compete in the utilities and telecommunications segments of our markets against companies like Service Power Technologies, plc., Vista Equity Partners (via its acquisition of our competitors MDSI and Indus International), ClickSoftware, Ltd.,
Telcordia, and Intergraph Corporation. Our primary competitors in commercial and other general field service markets include enterprise application solution providers such as Astea International Inc. and Metrix Inc., along with traditional ERP and
CRM software application vendors such as Oracle Corporation, and SAP A.G.

Many of our competitors may have significant competitive
advantages over us. These advantages may include greater technical and financial resources, more developed marketing and service organizations, greater expertise and broader customer bases and name recognition than us. Our competitors may also be in
a better position to devote significant resources to the development, promotion and sale of their products, and to respond more quickly to new or emerging technologies and changes in customer requirements. Current and potential competitors have
established or may establish cooperative relationships among themselves or with third parties to increase their ability to successfully market their products. We also expect that competition will increase as a result of consolidations in the
industry. To the extent that we develop new products, we may begin to compete with companies with which we have not previously competed. We cannot assure you that competition will not result in price reductions for our products and services, fewer
customer orders, deferred payment terms, reduced gross margins or loss of market share, any of which could materially adversely affect our business, financial condition and results of operations. A number of potential customers have the ability to
develop software solutions internally thereby eliminating the requirement for suppliers like us. This could result in reduced revenues or lost business for us. In addition to the above, decisions by potential customers to develop, in conjunction
with systems integrators, and use their own internally developed solutions could result in reduced revenues and/or lost business for us.



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We rely on software from third parties. If we cannot continue using that software, we would have to spend
additional capital to redesign our existing software and may not be able to compete in our markets.

We utilize third-party software
products to enhance the functionality of our products. Our business would be disrupted if functional versions of this software were either no longer available to us or no longer offered to us on commercially reasonable terms. In either case, we
would be required to spend additional capital to either redesign our software to function with alternate third-party software or develop these components ourselves. If functional versions of third-party software were either no longer available to us
or no longer offered to us on commercially reasonable terms, we might be forced to limit the features available in our current or future product offerings and the commercial release of our products could be delayed, which could materially adversely
affect our business, financial condition and results of operations.

We may be unable to adequately protect our proprietary rights, which may limit
our ability to compete effectively.

Our success and ability to compete are substantially dependent upon our internally developed
technology. Other than our trademarks, most of our intellectual property consists of proprietary or confidential information that is not subject to patent or similar protection. In general, we have relied on a combination of technical leadership,
trade secret, copyright and trademark law and nondisclosure agreements to protect our proprietary know-how. Unauthorized third parties may attempt to copy or obtain and use the technology protected by those rights. Any infringement of our
intellectual property could have a material adverse effect on our business, financial condition and results of operations. Policing unauthorized use of our products is difficult and costly, particularly in countries where the laws may not protect
our proprietary rights as fully as in the United States.

In connection with some of our licensing agreements, we have placed, and in the
future may place, our software in escrow. The software may, under specified circumstances, be made available to our customers and resellers and this may increase the likelihood of misappropriation or other misuse of our software.

Substantial litigation over intellectual property rights exists in the software industry. We expect that software products may be increasingly subject to
third-party infringement claims as the functionality of products in different industry segments overlaps. We believe that many industry participants have filed or intend to file patent and trademark applications covering aspects of their technology.
We cannot be certain that they will not make a claim of infringement against us based on our products and technology. Any claims, with or without merit, could:



| |  |  | be expensive and time-consuming to defend;
| | - |  | ------------------------------------------



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



| |  |  | divert managements attention and resources; or
| | - |  | -----------------------------------------------



| |  |  | require us to enter into royalty or licensing agreements to obtain the right to use a necessary product or component.
| | - |  | ---------------------------------------------------------------------------------------------------------------------

Royalty or licensing agreements, if required, may not be available on acceptable terms, if at all, and even if available on acceptable terms, shall
increase our expenses and may materially affect our results of operations adversely. A successful claim of product infringement against us and our failure or inability to license the infringed or similar technology could have a material adverse
effect on our business, financial condition and results of operations.

Marketing and distributing our products outside of the United States and
other international operations may require increased expenses and greater exposure to risks that we may not be able to successfully address.

We market and sell our products and services in the United States, Europe and the Middle East, Asia and Australia. We received 21% of our total revenue in 2005, 28% of our total revenue in 2006, and 21% of our total revenue in 2007 from
sales to customers located outside of the United States. In addition to our operations in the United States, we have sales and support facilities and offices in Israel and Australia. These operations require, and the expansion of our existing
operations and entry into additional international markets will require, significant management attention and financial resources. In addition, since our financial results are reported in dollars, decreases in the rate of exchange of non-dollar
currencies in which we make sales relative to the dollar will decrease the dollar-based reported value of those sales. To the extent that decreases in exchange rates are not offset by a reduction in our costs, they may materially adversely affect
our results of operation. Historically, we have not hedged our foreign currency-denominated account receivables and expenses risks. We are also subject to a number of risks customary for international operations, including:



| |  |  | differing technology standards and language requirements;
| | - |  | ---------------------------------------------------------



| |  |  | changing product and service requirements in response to the formation of economic and marketing unions, including the European Economic Union;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | economic or political changes in international markets;
| | - |  | -------------------------------------------------------



| |  |  | greater difficulty in accounts receivable collection and longer collection;
| | - |  | ---------------------------------------------------------------------------



| |  |  | unexpected changes in regulatory requirements;
| | - |  | ----------------------------------------------



| |  |  | the uncertainty of protection for intellectual property rights in some countries; and
| | - |  | -------------------------------------------------------------------------------------



| |  |  | multiple and possibly overlapping tax structures.
| | - |  | -------------------------------------------------

We depend on key personnel, and the loss of any key personnel could affect our ability to compete and our ability to attract additional key personnel may be impaired.

Our future success depends on the continued service of our executive officers and other key personnel. All of our key management and technical personnel
have expertise. The loss of any of these individuals could harm our business significantly. We have employment agreements with our executive officers. Although these agreements generally require notification prior to departure, relationships with
these officers and key employees are at will. The loss of any of our key personnel could harm our ability to execute our business or financial strategy and compete successfully in the marketplace.

Our executive officers, directors and affiliated entities will be able to influence matters requiring shareholder approval and they may disapprove actions that you
voted to approve.

As of July 15, 2008, our executive officers and directors serving as of such date, and entities affiliated
with them, in the aggregate, beneficially owned approximately 27.1% of our outstanding Ordinary Shares, including options and warrants to purchase Ordinary Shares which are exercisable or will become exercisable within 60 days of July 15, 2008
and all Ordinary Shares which may be issued upon conversion of Preferred A Shares .The above % does not take into effect restricted Ordinary shares, that were granted to executive officers and directors, which will be released from restriction
within more than 60 days of July 15, 2008. These shareholders, if acting together, will be able to significantly influence all matters requiring approval by our shareholders, including the election of directors and the approval of mergers or
other business combination transactions.



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Any future acquisitions of companies or technologies may distract our management and disrupt our business.

On February 25, 2002 we completed the acquisition of all of the outstanding shares of iMedeon, Inc. (iMedeon), a provider
of mobile workforce management solutions to the utilities sector and on July 29, 2004, we completed the acquisition of all of the outstanding shares of Utility Partners, Inc. On June 15, 2005, we completed the acquisition of substantially
all of the assets of e-Wise Solutions of Melbourne, Australia. We may, in the future, acquire or make investments in other complementary businesses, technologies, services or products if appropriate opportunities arise and we may engage in
discussions and negotiations with companies about our acquiring or investing in those companies businesses, products, services or technologies. We cannot make assurances that we will be able to identify future suitable acquisition or
investment candidates, or if we do identify suitable candidates, that we will have sufficient resources to complete such acquisitions or investments, will be able to make the acquisitions or investments on commercially acceptable terms or will be
able to complete such acquisitions or investments at all. If we acquire or invest in another company, we could have difficulty assimilating that companys personnel, operations, customers, technology or products and service offerings into our
own. The key personnel of the acquired company may decide not to work for us. These difficulties could disrupt our ongoing business, distract our management and employees, increase our expenses, consume cash resources, and adversely affect our
results of operations. We may incur indebtedness or issue equity securities to pay for any future acquisitions. The issuance of equity securities could be dilutive to our existing shareholders.

Our business may become increasingly susceptible to numerous risks associated with international operations.

Our operations outside the United States have grown in recent years. Our facilities are located in North America, Israel, and Australia. This geographic
dispersion requires significant management resources that may place us at a disadvantage compared to our locally based competitors. In addition, our international operations are generally subject to a number of risks, including:



| |  |  | foreign currency exchange rate fluctuations;
| | - |  | --------------------------------------------



| |  |  | longer sales cycles;
| | - |  | --------------------



| |  |  | multiple, conflicting and changing governmental laws and regulations;
| | - |  | ---------------------------------------------------------------------



| |  |  | greater dependency on partners;
| | - |  | -------------------------------



| |  |  | time zone and cultural differences;
| | - |  | -----------------------------------



| |  |  | protectionist laws and business practices that favor local competition;
| | - |  | -----------------------------------------------------------------------



| |  |  | difficulties in collecting accounts receivables; and
| | - |  | ----------------------------------------------------



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

We expect international revenue to increase as a percentage of total revenue and we believe we must continue to expand our international sales and professional services activities in order to be successful. Our international sales growth
will be limited if we are unable to expand our international sales management and professional services organizations either through a direct presence in local markets or through channel partners. If we fail to manage our geographically dispersed
organization, we may fail to meet or exceed our business plan and our revenues may decline.

Risks Related to Our Location in Israel

It may be difficult to effect service of process and enforce judgments against directors, officers and experts in Israel.

We are organized under the laws of the State of Israel. Several of our executives, directors, certain research and development employees, and some of the
experts named in this annual report are nonresidents of the United States, and a substantial portion of our assets and the assets of these persons are located outside the United States. Therefore, it may be difficult to enforce a judgment obtained
in the United States against us or any of those persons. It may also be difficult to enforce civil liabilities under United States federal securities laws in actions instituted in Israel.

Political, economic and military conditions in Israel could negatively impact our business.

Our principal research and development facilities are located in Israel. We are directly influenced by the political, economic and military conditions
affecting Israel. Since the establishment of the state of Israel in 1948, a number of armed conflicts have taken place between Israel and its Arab neighbors and a state of hostility, which varies in degree and intensity, has caused security and
economic problems in Israel. Any major hostilities involving Israel or the interruption or curtailment of trade between Israel and its present trading partners could adversely affect our operations. We cannot assure you that ongoing or revived
hostilities related to Israel will not have a material adverse effect on us or our business and on our share price. Several Arab countries still restrict business with Israeli companies and these restrictions may have an adverse impact on our
operating results, financial condition or the expansion of our business. We could be adversely affected by restrictive laws or policies directed towards Israel and Israeli businesses. Despite the progress towards peace between Israel and its Arab
neighbors, the future of these peace efforts is uncertain and although Israel has entered into various agreements with Egypt, Jordan and the Palestinian Authority, there has been an increase in unrest and terrorist activity, which began in September
2000 and has continued with varying levels of severity into 2008. The recent election of representatives of the Hamas movement to a majority of seats in the Palestinian Legislative Council may create additional unrest and uncertainty. In addition,
during 2006 an outbreak of open hostilities occurred along Israels northern border with Lebanon, and more recently extensive hostilities along Israels border with the Gaza Strip since June 2007 when the Hamas effectively took control of
the Gaza Strip, which have intensified since February 2008. To date, these matters have not had any material effect on our business and results of operations, but there can be no assurance that they will not do so in the future.

Generally, all male adult citizens and permanent residents of Israel, under the age of 45 in some cases, are, unless exempt, obligated to perform up to
36 days of military reserve duty annually. Additionally, all Israeli residents of this age are subject to being called to active duty at any time under emergency circumstances. Many of our employees are currently obligated to perform annual reserve
duty. Although we have operated effectively under these requirements since we began operations, we cannot assess the full impact of these requirements on our workforce or business if political and military conditions should change, and we cannot
predict the effect on us of any expansion or reduction of these obligations.

We may be adversely affected if the rate of inflation in Israel exceeds
the rate of devaluation of the NIS against the dollar.

Most of our revenues are in dollars or are linked to the U.S. dollar, while
a portion of our expenses, principally salaries and the related expenses for our Israeli operations, are incurred in NIS. We do not utilize hedging to manage currency risk and, therefore, 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 dollar or that the timing of this devaluation lags behind inflation in Israel. This would have the effect of increasing the dollar cost of our operations. During 2007, the NIS
appreciated considerably against the U.S. dollar, which resulted in a significant increase in the U.S. dollar cost of our operations in Israel. Such trend has continued during the first six months of 2008 with further substantial appreciation of the
NIS against the U.S. dollar. NIS linked balance sheet items may create foreign exchange gains or losses, depending upon the relative dollar values of the NIS at the beginning and end of the reporting period, affecting our net income and earnings per
share. We cannot predict any future trends in the rate of inflation in Israel or the rate of devaluation of the NIS against the dollar. If the dollar cost of our operations in Israel increases, our dollar-measured results of operations will be
adversely affected.



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Tax benefits that are available to us from the investment Center of the Israeli Ministry of Industry, Trade and Labor
require us to meet several conditions and may be terminated or reduced in the future, which would increase our future tax expenses.

We
receive tax benefits under Israeli law for capital investments that are designated as approved enterprises. To maintain our eligibility for these tax benefits, we must continue to meet conditions stipulated in applicable law and in our specific
approvals, including making specified investments in fixed assets and employing minimum number of skilled employees. 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. We may submit requests for new programs to be designated as approved
enterprises. These requests might not be approved, particularly in light of difficult economic conditions in Israel. In addition, in March 2005, the law governing these tax benefits was amended to revise the criteria for investments that qualify for
tax benefits as an approved enterprise. We cannot assure you that we will, in the future, be eligible to receive additional tax benefits under this law. The termination or reduction of these tax benefits could seriously harm our financial condition
and results of operations.

Under current Israeli law, we may not be able to enforce covenants not to compete and therefore may be unable to prevent
our competitors from benefiting from the expertise of some of our former employees.

We currently have non-competition agreements
with our employees. These agreements prohibit our employees, if they cease working for us, from directly competing with us or working for our competitors. Recently, Israeli courts have required employers seeking to enforce non-compete undertakings
of a former employee to demonstrate that the competitive activities of the former employee will harm one of a limited number of material interests of the employer which have been recognized by the courts, such as the secrecy of a companys
confidential commercial information or its intellectual property. If we cannot demonstrate that harm would be caused to us, we may be unable to prevent our competitors from benefiting from the expertise of our former employees.

The government grants we have received for research and development expenditures restrict our ability to manufacture products and transfer technologies outside of
Israel and require us to satisfy specified conditions.

From time to time we have received royalty-bearing grants from the Office of
the Chief Scientist of the Ministry of Industry and Trade of the Government of Israel (OCS).OCS grants was last received during 2003. The transfer to a non-Israeli entity of technology developed with OCS funding, including pursuant to a
merger or similar transaction, and the transfer of rights related to the manufacture of more than ten percent of a product developed with OCS funding are subject to approval by an OCS committee and to various conditions, including payment by us to
the OCS of a percentage of the consideration paid to us or our shareholders in the transaction in which the technology is transferred. In connection with a merger or similar transaction, the amount payable would be a fraction of the consideration
equal to the relative amount invested by the OCS in the development of the relevant technology compared to the total investment in our company, net of financial assets that we have at the time of the transaction, but in no event less than the amount
of the grant. In addition, in the event that the committee believes that the consideration to be paid in a transaction requiring payment to the OCS pursuant to the provisions of the law described above does not reflect the true value of the
technology or the company being acquired, it may determine an alternate value to be used as the basis for calculating the requisite payments. These restrictions may impair our ability to enter into agreements for those products or technologies,
without OCS approval. In addition, if we fail to comply with any of the conditions imposed by the OCS, we may be required to refund any grants previously received, together with interest and penalties.

Our United States investors could suffer adverse tax consequences if we are characterized as a passive foreign investment company.

Although we believe that we will not be treated as a passive foreign investment company in 2007, we cannot assure the shareholders that we will not be
treated as a passive foreign investment company in 2008 or in future years. We would be a passive foreign investment company if (i) 75% or more of our gross income in a taxable year, including the pro rata share of the gross income of any
company, US or foreign, in which we are considered to own 25% of the shares by value, is passive income, or (ii) at least 50% of the average value of our assets (or possibly the adjusted bases of our assets in particular circumstances),
including the pro rata share of the assets of any company in which we are considered to own 25% of the shares by value, in a taxable year produce, or are held for the production of, passive income. Passive income includes interest, dividends,
royalties, rents and annuities. If we are or become a passive foreign investment company, many of the shareholders will be subject to adverse tax consequences, including:



| |  |  | taxation at the highest ordinary income tax rates in effect during your holding period on some distributions on our Ordinary Shares and gain from the sale or other
disposition of our Ordinary Shares;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | paying interest on taxes allocable to prior periods; and
| | - |  | --------------------------------------------------------



| |  |  | no increase in the tax basis for our Ordinary Shares to fair market value at the date of your death.
| | - |  | ----------------------------------------------------------------------------------------------------



|Item 4. | Information On Our Company
|------- | --------------------------

History and Development

Both our legal and commercial name is ViryaNet Ltd. We were incorporated and registered in Israel on
March 13, 1988 under the name R.T.S. Relational Technology Systems Ltd. We changed our name to RTS Business Systems Ltd. on September 7, 1997 and to RTS Software Ltd. on February 1, 1998. On April 12, 2000, we changed our name to
ViryaNet Ltd. The principal legislation under which we operate is the Israeli Companies Law, 5759-1999, as amended, which we refer to as the Companies Law.

Our registered office is located at 8 HaMarpe Street, Science Based Industries Campus, P.O. Box 45041, Har Hotzvim, Jerusalem, 91450, Israel, and our telephone number is 972-2-584-1000. We have appointed our United
States subsidiary, ViryaNet, Inc., located at 2 Willow Street, Southborough, Massachusetts 01745-1027 as our agent for service of process.

Over the past 20 years, we have developed, marketed, and supported field service software applications that have provided companies with solutions that improve the quality and efficiency of complex service business processes. During this
period of time, numerous customers around the world have deployed our solutions.

On September 19, 2000, we completed our IPO and our
Ordinary Shares began trading on The Nasdaq National Market. As part of the IPO, we issued 80,000 Ordinary Shares in consideration of net proceeds of approximately $25.6 million.

On October 29, 2001 our Ordinary Shares began trading on the Tel-Aviv Stock Exchange in Israel and we became a dual listed company. On March 4,
2004, we requested to be delisted from the Tel-Aviv Stock Exchange and following such request we have received the confirmation of the Tel-Aviv Stock Exchange that our Ordinary Shares were delisted on June 3, 2004.



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On February 25, 2002, we acquired the outstanding shares of iMedeon, a provider of mobile workforce
management solutions to the utilities sector. iMedeon was a privately held company, headquartered in Alpharetta, Georgia. As a result of the acquisition, iMedeon became a wholly-owned subsidiary of ViryaNet, Inc., which is a wholly-owned subsidiary
of ViryaNet Ltd.

On May 1, 2002, we effected a ten (10) for one (1) reverse share split, issuing one new Ordinary Share, of
NIS 1.0 par value per share, for every ten Ordinary Shares, of NIS 0.1 par value per share.

On September 5, 2002, we were notified by
The Nasdaq National Market that we were not in compliance with Marketplace Rule 4450(a)(2) since we were unable to maintain a minimum market value of $5,000,000 for our publicly held shares, and were informed that we had until December 4, 2002
to regain compliance. Due to the economic and market conditions affecting our valuation, we concluded that we would request a transfer of our securities listing from The Nasdaq National Market to The Nasdaq Capital Market. The transfer was approved
on December 20, 2002 and the trading of our Ordinary Shares on The Nasdaq Capital Market began on December 31, 2002.

On
August 4, 2003, we completed a private placement of our Ordinary Shares with Telvent, GIT S.A. (Telvent), the information technology subsidiary of Abengoa, S.A. of Spain. In exchange for $1.0 million, we issued 107,852 Ordinary
Shares at a price of $9.27 per share. Subsequent to the date of this transaction, Telvent requested that the shares held in the name of Telvent GIT S.A. be assigned to its investment arm, Telvent Investments, S.L.

On November 10, 2003, we completed a private placement of our Ordinary Shares with a large U.S. financial institution and a group of private
investors. In exchange for approximately $1.8 million, we issued 103,465 Ordinary Shares at a price of $17.03 per share. In addition, the investors also received warrants to purchase 18,745 of our Ordinary Shares at an exercise price of $23.50 per
share.

On December 5, 2003, we completed a follow-on private placement of our Ordinary Shares with Vertex Venture Capital Israel
Funds and FBR Infinity Venture Funds, as well as a group of private investors. In exchange for approximately $2.2 million, we issued 110,902 Ordinary Shares at a price of $20.18 per share. In addition, the investors also received warrants to
purchase 16,929 of our Ordinary Shares at an exercise price of $33.05 per share.

On July 28, 2004, we issued to LibertyView Special
Opportunities Fund, L.P. $2.5 million aggregate principal amount of 7.5% Convertible Debt due July 28, 2014. We are obligated to pay interest on this Debt on a quarterly basis commencing October 15, 2004, with interest to be paid either in
cash or registered Ordinary Shares, at our discretion.

On July 29, 2004, we acquired the outstanding shares of Utility Partners, a
provider of mobile workforce management solutions to the utilities sector. Utility Partners was a privately held company, headquartered in Tampa, Florida. As a result of the acquisition, Utility Partners became a wholly-owned subsidiary of ViryaNet,
Inc., which is a wholly-owned subsidiary of ViryaNet Ltd.

In February 2005, we completed a private placement of our Ordinary Shares to
Telvent Investments, S.L., a current shareholder. In exchange for approximately $1.3 million, we issued 116,332 Ordinary Shares at a price of $11.435 per Ordinary Share.

On June 15, 2005, we acquired, through our newly formed Australian subsidiary ViryaNet Pty Ltd, substantially all of the assets of e-Wise Solutions of Australia, a provider of front-office automation solutions to
the utilities sector. e-Wise was a privately held business, headquartered in Melbourne, Australia. ViryaNet Pty Ltd is a wholly-owned subsidiary of ViryaNet, Inc.

On August 8, 2005, we consummated with LibertyView a private placement that involved (i) the issuance of 66,667 of our Ordinary Shares for cash consideration of $700,000, (ii) the issuance of a warrant
to purchase 23,334 Ordinary Shares at an exercise price of $10.50 per Ordinary Share, and (iii) the replacement of the loan under the Debt with a $2.98 million loan under a new debt, which is convertible at a fixed conversion price of $11.025
per Ordinary Shares into 270,295 Ordinary Shares.

On September 28, 2005, we consummated with the September 2005 Investor Group a
private placement that involved (i) the issuance of 47,620 of our Ordinary Shares for cash consideration of $500,000 at an exercise price of $10.50 per Ordinary Share, (ii) the issuance of a warrant to purchase 32,540 Ordinary Shares at an
exercise price of $10.50 per share, (iii) a debt for $500,000 which is convertible at a fixed conversion price of $11.025 per Ordinary Share into 45,352 Ordinary Shares, and (iv) the issuance of 6,508 Ordinary Shares to one of the
investors as a finders fee for this transaction.

On June 2, 2006, we converted $2.0 million of a convertible debt held by
LibertyView to 261,438 Preferred A Shares at an exercise price of $7.65 per Preferred A Share. These Preferred A Shares can be converted to Ordinary Shares by LibertyView in its discretion on a one-to-one basis at any time. The Preferred A Shares
issued to LibertyView have all rights and privileges as our Ordinary Shares including, without limitation, voting rights on an as-converted basis, and will have preference over the Ordinary Shares in any distribution to our shareholders. The
remaining $980,000 balance of LibertyViews convertible debt remained in effect under the existing terms of the debt.

On June 6,
2006, we completed a private placement of our Ordinary Shares with three existing shareholders and one new institutional investor that involved (i) the issuance of 287,540 of our Ordinary Shares for cash consideration of $1,350,000, and
(ii) warrants to purchase 57,508 Ordinary Shares at an exercise price of $5.634 per Ordinary Share.

On September 28, 2006, we
converted the $0.5 million convertible debt held by the September 2005 Investor Group and all accrued interest thereon into 114,301 Ordinary Shares of the Company at a conversion price of $ 4.7025 per Ordinary Share per the terms of the
convertible debt.

On November 30, 2006, LibertyView sold $0.5 million of its Convertible Debt to Jerusalem High-tech Founders, Ltd.
(JHTF), a company controlled by Samuel HaCohen, the Companys Chairman of the Board of Directors, and in which Vladimir Morgenstern, a member of the Companys Board of Directors, has an economic interest. Upon the sale of the
debt, we signed an agreement with JHTF, which was approved by our shareholders and consummated on December 29, 2006, to convert the $500,000 Convertible Debt to Preferred A Shares at $7.65 per Preferred A Share, which may be converted at the
discretion of JHTF on a one-to-one basis to Ordinary Shares at any time. The remaining $480,000 balance of LibertyViews convertible debt remains in effect under the existing terms of the debt.

On January 17, 2007, we effected a five (5) for one (1) reverse share split, issuing one new Ordinary Share, of NIS 5.0 par value per
share, in exchange for every five Ordinary Shares, of NIS 1.0 par value per share and issuing one new Preferred A Share, of NIS 5.0 par value per share, in exchange for every five Preferred A Shares, of NIS 1.0 par value per share.

On April 23, 2007, we dissolved our Japanese subsidiary, ViryaNet Japan K.K., and replaced our direct presence in Japan with a reseller arrangement
with a firm based in Tokyo, Japan, Octpark Ltd., led by the former general manager for ViryaNet Japan. Octpark Ltd. provides sales and support activities for ViryaNet products to our existing customers and new customers in the Japanese market. Prior
to the dissolution, our office lease expired on November 30, 2006 and we terminated the remainder of our full-time employees effective December 31, 2006.



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On June 4, 2007, we voluntarily requested from The NASDAQ Stock Market that our Ordinary Shares be
delisted from The NASDAQ Capital Market on June 11, 2007. We were subsequently advised by Nasdaq that our Ordinary Shares would be delisted from The NASDAQ Capital Market on June 12, 2007 and on December 14, 2007 our Ordinary Shares
began to be quoted and traded on the Over-The-Counter Bulleting Board (OTCBB) under the trading symbol VRYAF.OB.

On
December 19, 2007, we completed a private placement of our Ordinary Shares with a group of new financial investors that included (i) the issuance of 363,636 Ordinary Shares at a price of $1.65 per Ordinary Share for the consideration of
$600,000, (ii) a non-interest bearing convertible note in the amount of $161,000 with a conversion price of $1.65 per Ordinary Share, (iii) a non-interest bearing convertible note in the amount of $439,000 with a conversion price of $1.65
per Ordinary Share, subject to the Companys shareholders approval and (iii) warrants to purchase an aggregate of 600,000 Ordinary Shares at an exercise price of $2.00 per Ordinary Share, subject to the Companys
shareholders approval. The convertible note has no maturity date and can only be converted into Ordinary Shares. The warrants have a callable feature whereby we can force the exercise of up to 50% of the amounts covered under the warrants when
all Ordinary Shares issued in connection with this new investment are registered with the SEC.

On January 31, 2008 the Companys
shareholders approved the issuance of the $439,000 convertible note and the warrants mentioned above.

On September 11, 2008, due to
our delinquency with respect to the filing of our annual report on Form 20-F for the period ended December 31, 2007, our Ordinary shares ceased to be eligible for quotation on the OTC Bulletin Board (OTCBB) and have been removed
from OTCBB. Following the removal from OTCBB, our Ordinary shares became immediately eligible for quotation and trading on the Pink Sheets. After the filing of this Form 20-F we will review our alternatives for the reinstatement of our quotation on
the OTC Bulletin Board.

Business Overview

ViryaNet is a provider of packaged software applications that automate business processes for mobile workforce management and field service delivery. Optimizing both simple and complex field service work,
ViryaNets solutions schedule and dispatch resources, enable mobile field communication, and provide visibility and operational guidance. Our mission is to provide companies with solutions that improve the quality and efficiency of their
service business processes. We also provide professional services required to implement and support our software solutions. We have approximately 60 customers worldwide with operations and support offices in the United States, Israel, and Australia.

We target companies in the utility, telecommunications, retail, insurance and general service industries that have distributed mobile
workforces, strong commitments to customer satisfaction, extensive service agreements, and a need to improve their service operations. We believe that these industries provide substantial growth opportunities for our products and services.

Our historical growth has occurred organically as well as through acquisitions. In February 2002, we acquired Alpharetta, Georgia based
iMedeon, Inc. In July 2004, we acquired another mobile workforce management company, Tampa, Florida based Utility Partners, and in June 2005, we acquired substantially all of the assets of e-Wise Solutions of Australia, a provider of front-office
automation solutions to the utilities sector. These acquisitions have provided us with domain expertise; an installed base of customers in the utilities market, our primary market focus; and significant partnerships, and have enabled us to
incorporate additional features, functions and technology into our advanced product platform.

Business Strategy

Our goal is to become the leader in the mobile workforce management software market. We intend to achieve this goal by increasing our sales and marketing
efforts in North America, growing our business in target sectors through our partner network as well as through our direct sales force; increasing our revenues from Europe and Asia/Pacific by expanding our partner network, adding resources in
support of international activities, establishing a local presence in certain targeted geographic markets where a subsidiary structure is warranted; and intensifying our focus on account management and customer support to enable follow-on sales into
our installed base.

Markets

We
deliver state-of-the-art solutions specific to the needs of key markets, including utilities, telecommunications and cable/broadband companies, retail/grocery companies, insurance companies, and general service providers. We reach prospects within
each of these markets through our direct sales force, supported by marketing campaigns, as well as through our partner network, including, among others, GE Energy, Mitchell International, Telvent, and Vodafone, which acquired Aspective in 2007.

Utilities. The utilities market targeted by us consists of electric, gas and water companies. We see substantial opportunities within this
market, as companies have need to (i) add new technology to improve their service offering, and (ii) replace their old technology in favor of an Internet and wireless-based solution model, and (iii) continue with the initial build-out
of their systems infrastructure, especially in developing geographies.

Telecommunications and Cable/Broadband. We target companies within
these segments of the telecommunications sector: cable and satellite, data services, fixed line services, and wireless communications services providers. Over the past 12 months, we have seen a resurgence in the level of interest on the part of
prospects in this industry for solutions such as ours.

Insurance. We sell into the insurance market exclusively through our partner,
Mitchell International.

Retail. Within the retail sector, we target grocery companies, drug stores and pharmacies, retail marketing
companies, and consumer packaged goods companies.

General Field Service. This includes heating, ventilation, and air conditioning;
property maintenance; office and home appliance/equipment maintenance; and security companies  many of which require mobile workforce management solutions. We evaluate these companies on a case-by-case business in the context of their size,
business processes, as well as our domain understanding and products fit.

Our revenues are derived mainly from the sale
of software licenses and from maintenance and services that we provide in support of our software. The following table describes, for the periods indicated, the percentage of revenues represented by each of the items on our consolidated statements
of operations:



|                         |  |                         |   |  |      |   |  |      |  
|------------------------ |  | ----------------------- | - |  | ---- | - |  | ---- | -
|                         |  | Year Ended December 31, |  
|                         |  | 2005                    |   |  | 2006 |   |  | 2007 |  
|Revenues:                |  |                         |   |  |      |   |  |      |  
|Software licenses        |  | 12.1                    |   |  | 11.0 |   |  | 15.9 |  
|Maintenance and services |  | 87.9                    |   |  | 89.0 |   |  | 84.1 |  
|                         |  |                         |   |  |      |   |  |      |  
|Total revenues           |  | 100                     | % |  | 100  | % |  | 100  | %



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The following table summarizes the revenues from our products and services by country, stated as a
percentage of total revenues for the periods indicated:



|              |  |                         |   |  |       |   |  |       |  
|------------- |  | ----------------------- | - |  | ----- | - |  | ----- | -
|              |  | Year Ended December 31, |  
|Country       |  | 2005                    |   |  | 2006  |   |  | 2007  |  
|United States |  | 79.3                    |   |  | 71.6  |   |  | 78.9  |  
|Europe        |  | 7.4                     |   |  | 7.4   |   |  | 9.0   |  
|Asia Pacific  |  | 13.3                    |   |  | 21.0  |   |  | 12.1  |  
|              |  |                         |   |  |       |   |  |       |  
|Total         |  | 100.0                   | % |  | 100.0 | % |  | 100.0 | %

The majority of our sales personnel operates through our United States subsidiary and cover North America, Europe
and portions of Asia Pacific, and the rest operate through our subsidiary in Australia. Our sales and marketing staff consists of professionals in a variety of fields, including marketing and media relations, direct sales, technical sales
consultants, product management, and business development. As of December 31, 2007, we employed 13 sales, marketing and business development personnel.

We intend to expand our marketing and implementation capacity through the use of third parties, including systems integrators, vendors of complementary products and providers of service applications. By employing
third parties in the marketing and implementation process, we expect to enhance sales by taking advantage of the market presence of these third parties.

Our North American strategy utilizes a direct sales model, supplemented by key partners like GE Energy and Telvent. Our international strategy uses a combination of direct and indirect sales channels in order to sell
effectively into local markets and perform certain implementation activities on our behalf. We expect to benefit from marketing programs and leads generated by these partners, as well as cooperation from the sales forces of these partners in sales
opportunities. In certain targeted geographic markets where growth opportunities in our key vertical markets support a local presence, such as Australia, we may determine that the investment in a subsidiary structure is warranted. Otherwise, we will
continue to explore and establish indirect sales channels through relationships with agents, local resellers who offer complementary products and solutions, global systems integrators, and application service providers.

In Europe, we continue to utilize our global partners GE Energy and Telvent along with our partner Vodafone (which acquired Aspective in 2007) which has
developed a specialized practice dedicated to the implementation of ViryaNets solutions and providing post-contract maintenance and support. All of our partners, and their customers are supported by our business development, customer care, and
professional services organizations in the United States, Israel, and Australia.

Application service providers are used to provide our
product to customers who wish to avoid the initial cost of our product combined with the required hardware platforms and infrastructure investments. Through an application service provider, customers will be billed a monthly rental or subscription
fee. We have three partners that have hosting capability, offering our products in a software as a service (SaaS) model: Vodafone, Mitchell International, and Alliance Data Systems (ADS).

ViryaNet Service Hub and Applications

Our principal
product, the ViryaNet Service Hub, supports a wide range of work order needs: from short-duration tasks to complex, multi-day, multi-resource projects. ViryaNet Service Hub manages the entire lifecycle of a work order, including, scheduling and
dispatching, mobile technology, field-level reporting, tracking materials, managing assets, and ensuring support for entitlements and compliance with service level agreements (SLAs). We typically issue one major version release of ViryaNet Service
Hub every one to two years.

We currently package our applications for specific industries by seeking to capture best business practices
and embedding those processes into our application, incorporating processes, workflows, reports, and screens appropriate for companies in our target industries. These best practices, coupled with powerful functionality capabilities, allow us to
package ViryaNet Service Hub and applications into industry bundles, including:



| |  |  | ViryaNet Service Hub for Utilities
| | - |  | ----------------------------------



| |  |  | ViryaNet WorkUP for Utilities
| | - |  | ------------------------------



| |  |  | ViryaNet Service Hub for Telecommunications
| | - |  | -------------------------------------------



| |  |  | ViryaNet Service Hub for Retail
| | - |  | -------------------------------



| |  |  | ViryaNet Service Hub for General Service
| | - |  | ----------------------------------------

ViryaNet Service Hub is built using open standards (Java, XML), common to Internet, wireless, and workflow technologies, allowing customers to adapt and easily integrate ViryaNet Service Hub to their continuously
changing conditions. ViryaNet Service Hub includes an information service portal that provides community access and collaboration;

business intelligence
for real-time reporting, analysis, and responsive action; workflow-driven business processes; a powerful integration server and application program interface (API) set that interfaces to other applications, including enterprise resource planning
(ERP) applications, customer relationship management (CRM) applications, data warehouses and other commonly used service applications; and a mobile gateway that allows mobile users to access and communicate service information using a wide variety
of devices over popular wire-line and wireless networks.

With ViryaNet Service Hub, a service organization can quickly transition its
complex business processes into a manageable, scalable Internet operation, with goals of increasing efficiency, quality of service, customer satisfaction, customer retention, and profitability. Using ViryaNet Service Hub, our customers can manage
the continuum of their service operations, from ensuring that the right person is in the right place at the right time with the right parts and information about the customer, to automating the repair processes utilizing the Internet and at the
least cost.

ViryaNet Service Hub Internet Platform Components

The infrastructure ofViryaNet Service Hub includes these important platform components:

ViryaNet Service Portal

Offers a singular, personalized gateway that allows internal users as well as customers, field employees and external partners, suppliers, and
vendors to interface with Service Hub through the Web. The ViryaNet Service Portal allows users to access service information in real-time, share documents, collaborate with other users and obtain service.

Mobile Computing Platform (MCP)

Provides
mobile users with access to the data and applications they require, allowing them to stay productive, regardless of location. ViryaNet MCP enables mobile users to work in both on-line and off-line mode utilizing both thin clients and fat clients.



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ViryaNet Service Intelligence & Data Mart

Aggregates a pool of key performance indicators (KPIs) that track data based on criteria, such as: financial trends, service performance, service rates, revenue, and
cost-per-product.

ViryaNet Service Workflow Engine/ Editor

Defines and applies rules to automate movement of documents, work orders and information, between users. The ViryaNet Service Workflow Engine/Editor also includes a tool for monitoring active processes and auditing
completed processes. The Service Workflow Engine provides a working environment that guarantees maximum flexibility.

ViryaNet
Integration Server

Enables organizations to integrate with its other systems, databases, applications, including external web applications.

ViryaNet Service Hub Application Components

ViryaNet Service Hub is a mobile workforce management solution, providing beginning-to-end management of work orders and the real-time capture of field workforce activity, tasks and events with wireless devices. Application
components include the following:

ViryaNet Schedule

Optimizes the assignment of work across the clients available workforce. ViryaNet Schedule automatically assigns field resources by using intelligent scheduling algorithm that verifies availability, and then
applies selection criteria (skills, proximity, available parts, and more) weighted in importance by the client. ViryaNet Schedule comes with an appointment booking function that identifies a timeslot for completion of the order that is agreeable to
the customer, meets service level agreements, and matches available resources.

ViryaNet Dispatch

Provides multiple, user configurable views, giving the dispatcher real-time visibility to the situation in the field and tools to automatically or manually balance the
workload. ViryaNet Dispatch includes functions and views that enable the dispatcher to manage exceptions and monitor the business process while allowing normal operations to proceed automatically and with no human intervention.

ViryaNet Field

Gathers the right information
so that the client can embrace change, evolve processes, and achieve a level of excellence. ViryaNet Field enables technicians in the field to update status and detailed work information associated with work orders, working in online or offline
mode. On their mobile devices, technicians receive service orders (job details, maps, driving directions, and attachments), acknowledge or reject orders, report activities such as en-route, arrived on site, left site, completed, on break; and report
work-related activities, such as time, labor, parts usage, travel and expenses.

ViryaNet Visibility

ViryaNet Visibility enables the client to quickly gather the right information so that you can embrace change, evolve processes, and achieve service excellence. ViryaNet
Visibility includes two tools: Executive Dashboard and Operational Dashboard. The ViryaNet Executive Dashboard provides immediate, on-demand access to a wealth of historical and near real-time business information. The ViryaNet Operational Dashboard
is a business activity monitoring application that provides a real-time, as its happening view of relevant business information.

ViryaNet Parts

Tracks consumption and usage of the various tools, parts, and equipment used during the work process. ViryaNet Parts
automatically captures information from the field workers, and summarizes appropriate data for various interfaced systems.

ViryaNet
Contract

Manages the total contract lifecycle, from the initial quote to the production of invoice data for services purchased. ViryaNet Contract
provides comprehensive and flexible management of service portfolios and customer contracts. It enables you to outline your relationship with customers and to establish customers expectations of the services that they will receive, including
the response time, method of delivery, and cost of delivery.

ViryaNets Customers

Over 700 person-years of technical and business experience have been invested in the ViryaNet products. ViryaNet Service Hub and the ViryaNet service
applications have been licensed to and implemented at numerous customers. Descriptions of product usage and resulting benefits of improved service delivery and enhanced customer satisfaction from some of our customers include:

Black Hills Corporationthis leading utility, serving electric and natural gas customers in seven US states, has acquired Aquila, a
WorkUP customer since 1996, in 2008. ViryaNet WorkUP allows Black Hills to manage its entire field workforce.

Citizens
(Frontier) Communicationsthe largest independent local exchange carrier in the United States. Citizens uses the ViryaNet Service Hub to automate the dispatching of service orders, trouble tickets, and work requests to its 2,500
technicians. Citizens uses ViryaNet Service Hub to manage the critical issues facing customer service organizations, such as deploying the right technician, diminishing travel times, satisfying customer requests, reacting responsively to increased
volumes, assimilating acquisitions, and managing costs. Citizens technicians carry hand-held CE devices or laptops that route them through their daily responsibilities via ViryaNet Service Hubs mobile gateway. Dispatchers monitor and
assist these technicians through ViryaNet Service Hub, while senior management and supervisors receive immediate visibility into the operations performance.

ConEdthis leading utility, and one of the largest investor-owned energy companies in the United States, has utilized WorkUP for its natural gas emergency operations since early 2002 and plans a
further roll-out this year within its Orange & Rockland subsidiary.



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Las Vegas Valley Water Districta not-for-profit agency that provides water to The Las Vegas
Valley, and one of the fastest growing water districts in the Southwest United States, uses ViryaNet Service Hub for Utilities to optimize the scheduling and management of approximately 200 field service technicians across a vast service territory
and within multiple divisions, including meter services, customer service, distribution, fleet services, and facilities maintenance.

Leslies PoolMartthe worlds largest swimming pool equipment and supplies retail chain with headquarters in Phoenix, AZ and offices across the United States, uses ViryaNet Service Hub to manage the installation,
replacement, and onsite maintenance (and preventive maintenance) of pumps, filters, heaters and other devices and equipment for public and private swimming pools. ViryaNet Service Hub and applications optimize the scheduling, dispatch, appointment
booking, and field reporting of Leslies PoolMarts seasonal field resources and support staff.

LoJackthis
recognized world leader in stolen vehicle tracking and recovery, licensed ViryaNet Service Hub to streamline the installation of its recovery systems, and support its rapidly expanding sales and installation channel strategy. ViryaNet Service Hub
and applications optimize LoJacks 300 field technicians and 100 support staff who manage the functions of appointment booking, dispatch, and scheduling.

Louisville Water Companya publicly owned and privately operated for-profit utility serving more than 800,000 people in and around Greater Louisville, Kentucky, selected ViryaNet Service Hub for Utilities
suite of applications to improve the efficiency of its technicians and field service processes who perform activities such as meter exchanges, emergency responses, services connects and disconnects, and preventive maintenance on assets.

Publix Super Marketsthe largest employee-owned supermarket chain and one of the 10 largest volume supermarket chains in the United
States, uses ViryaNet Service Hub to automate its maintenance and facilities operations, including the activities associated with workforce management and asset and repair management. Publix uses ViryaNet Service Hub (Mobile Workforce Management,
Service Scheduler, Service Supply Chain, and eRepair modules) to manage and automate a variety of short-duration tasks, such as preventive maintenance activities on equipment, to more complicated projects. In addition, ViryaNet Service Hub enables
Publix to optimize the use of its internal workforce and to better manage its large subcontractor base.

The Building
Commissionlocated in Melbourne, this statutory authority that oversees the building control system in Victoria and regulates building practices, uses the ViryaNet product for its Compliance and Conciliation and its Technical Services Group
to better utilize its existing workforce, cut response times to customers, and lower operations costs through improved communications, better customer service, and optimize workforce productivity.

City West Water (CWW)  one of three retail water businesses located in metropolitan Melbourne and owned by the Victorian Government, CWW
provides drinking water, sewerage, trade waste, and recycled water services to approximately 276,000 residential and 31,300 non-residential customers in the Melbourne area. CWW uses ViryaNet mobile workforce management automating approximately
100 CWW technicians who respond to reactive, scheduled, and SCADA jobs over a vast geographical area. The ViryaNet product was integrated with asset management, GIS, and SCADA systems. Using the ViryaNet product CWW has improved the operational
performance of its crews, expedited work orders, and has provided real-time updates of job progress in the office and field, thus, improving organizational efficiency, customer satisfaction, and job morale.

Sheetzthe fastest-growing convenience store chain in the United States with 344 locations across six states and, in 2007, ranked as one of
the best companies to work for in Pennsylvania, uses ViryaNet Service Hub for comprehensive field service management of its retail operations. Sheetz deployed ViryaNet Service Hub for Retail to manage customer interactions, schedules appropriate
field resources, dispatches work orders via wireless technologies, return updated data from the field to the external systems, and give technicians insight into inventory information. Sheetz will use Service Hub as the foundation for improving the
availability of products and services to customers and increase field productivity, reduce maintenance costs, and enhance the overall customer experience.

Singapore Power Servicesthis wholly-owned subsidiary of Singapore Power, an Asian utility and energy group based in Singapore, uses ViryaNet Service Hub for Utilities in conjunction with GE to automate
its field workforce activities.

Spencer Technologiesthis provider of cabling, systems integration, installation and
maintenance services to the most advanced retail environments, selected ViryaNet Service Hub and Workforce Management, eStock, and eContract applications to manage its installation and service business. ViryaNet Service Hub schedules and dispatches
Spencers field engineers, capture logistics and labor activity at its source, report and measure field activity using key performance indicators, and integrate with several existing Spencer systems to improve billing activities and customer
satisfaction.

Symbolthis provider of wireless and Internet-based mobile data management systems offers a combination of
priority phone and on-site hardware repair services to the retail, transportation, healthcare, and manufacturing markets. Symbol uses ViryaNet Service Hub to migrate its traditional service processes to the Internet, allowing users to access
information from various locations throughout the organization, such as call centers, financial systems and data warehouses, and make that information available to any member within the service community who requires it.

T-Mobile International AG & Co. K.G.the mobile communications subsidiary of Deutsche Telekom AG, T-Mobile is a major international
telecommunications company based in Europe. T-Mobile utilizes ViryaNet Service Hub for Telecommunications to improve the effectiveness of its field engineers using scheduling and dispatching, capture logistics and labor activity, monitor, report and
measure field activity, and unite the many constituents of the companys service community through web browsers, cellphones, personal digital assistants, and other wireless devices.

UGIthis leading provider of natural gas to distribution residential and commercial customers in Pennsylvania is ranked highest in Customer
Satisfaction by J.D. Power and Associates for two years in a row, and has been a production WorkUP customer since 1996. UGI fully embraces WorkUPs latest map-based dispatch functionality with embedded GPS/AVL capabilities for its
service technicians.

XO Communicationsa leading broadband communications service provider for small/medium business, large
enterprises and carriers in North America, XO Communications uses the ViryaNet Service Hub for Telecommunications suite of applications comprised of Workforce Management, Advanced Scheduling Optimization, Mapping, Contract Entitlement, Field Parts
Logistics, and automated work flow processing to automate its technicians and field service business processes.

ViryaNet Partnerships

The unique strength of the ViryaNet Service Hub platform, combined with our broad and modular service applications, has allowed us to form strategic
alliances with world-class systems integrators (SIs) and value-added resellers (VARs), including:



| |  |  | Amdocsa high technology company that offers integrated customer management solutions, enabling the worlds leading service providers to build
stronger, more profitable customer relationships. ViryaNet is a member of the Amdocs OSS ecosystem, selected as its primary mobile workforce management provider.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Vodafonea European eBusiness solution provider, specializing in front-office applications for sales, marketing and customer service that positions
ViryaNet Service Hub and mobile workforce management applications in the UK, with vast reach into continental Europe. Vodafone has acquired Aspective , our partner in the UK, in 2007.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | GE Energya business unit of GE Power Systems and leading global supplier of strategic network solutions to the utilities industry. GE has integrated
ViryaNet Service Hub and mobile workforce management application into its existing portfolio, and positions the ViryaNet offering to the utilities and telecommunications industry.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Alliance Data Systems (ADS)a provider of business process outsourcing services for companies across a number of vertical markets,
including utilities. ADS offers, through its technologically advanced and highly secure data centers, the ViryaNet products to its customers who contract with ADS to manage their applications and/or run their business processes in an
outsourced capacity
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Mitchell Internationala high technology provider operates primarily within the United States, incorporates ViryaNet Service Hub and application
technology within its product offering intended exclusively for use in the insurance vertical market.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Telventthe information technology subsidiary for Abengoa, S.A. of Spain and an affiliate of ViryaNets shareholder, Telvent markets, sells, and
services ViryaNet solutions in the utilities, oil and gas, and telecommunications markets in Spain, Portugal and Latin America.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Competition

The market for mobile workforce management applications and the automation of field service delivery are highly
competitive yet fragmented and stratified, although a number of our traditional competitors have been acquired by larger companies. We compete for the business of global or nationwide organizations that seek to support complex and sophisticated
products across a variety of industries. We compete in the utilities and telecommunications segments of our markets against companies like Service Power Technologies, plc., Vista Equity Partners (via its acquisition of our competitors MDSI and Indus
International), ClickSoftware Ltd., Telcordia, and Intergraph Corporation. Our primary competitors in commercial and other general field service markets include enterprise application solution providers such as Astea International Inc. and Metrix
Inc., along with traditional ERP and CRM software application vendors such as Oracle Corporation, and SAP A.G.

Many of our competitors may
have significant competitive advantages over us. These advantages may include greater technical and financial resources, more developed marketing and service organizations, greater expertise and broader customer bases and name recognition than us.
Our competitors may also be in a better position to devote significant resources to the development, promotion and sale of their products, and to respond more quickly to new or emerging technologies and changes in customer requirements. Current and
potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase their ability to successfully market their products. We also expect that competition will increase as a result of
consolidations in the industry. To the extent that we develop new products, we may begin to compete with companies with which we have not previously competed. We cannot assure you that competition will not result in price reductions for our products
and services, fewer customer orders, deferred payment terms, reduced gross margins or loss of market share, any of which could materially adversely affect our business, financial condition and results of operations. A number of potential customers
have the ability to develop software solutions internally thereby eliminating the requirement for suppliers like us. This could result in reduced revenues or lost business for us. In addition to the above, decisions by potential customers to
develop, in conjunction with systems integrators, and use their own internally developed solutions could result in reduced revenues and/or lost business for us.

Intellectual Property Rights

We rely primarily on a combination of trademarks, trade secret laws, confidentiality
procedures and licensing arrangements to protect our intellectual property rights, as well as limiting access to the distribution of proprietary information. We cannot assure you that the steps taken to protect our intellectual property rights will
be adequate to prevent misappropriation of our technology or to preclude competitors from independently developing such technology. Furthermore, we cannot assure you that, in the future, third parties will not assert infringement claims against us
or with respect to our products.

As a general matter, the software industry is characterized by substantial litigation regarding patent
and other intellectual property rights. Third parties may claim that we are infringing their intellectual property rights. We have certain indemnification obligations to customers with respect to the infringement of third party intellectual property
rights by our products. There can be no assurance that infringement claims by third parties or claims for indemnification by customers or end users of our products resulting from infringement claims will not be asserted in the future or that such
assertions, if proven to be true, will not materially adversely affect our business, financial condition or operating results. In the event of any adverse ruling in any such matter, we could be required to pay substantial damages, which could
include treble damages, cease the manufacturing, use and sale of infringing products, discontinue the use of certain processes or obtain a license under the intellectual property rights of the third-party claiming infringement. There can be no
assurance that a license would be available on reasonable terms or at all. Any limitations on our ability to market our products, any delays and costs associated with redesigning our products or payments of license fees to third parties or any
failure by us to develop or license a substitute technology on commercially reasonable terms could have a material adverse effect on our business, financial condition and operating results.

There can be no assurance that others will not develop technologies that are similar or superior to our technology, or design around any licensing
arrangements issued to us. Despite our efforts to protect our proprietary rights, unauthorized parties may copy aspects of our products or obtain and use information that we regard as proprietary. Policing any of such unauthorized uses of our
products is difficult, and although we are unable to determine the extent to which piracy of our software products exists, software piracy can be expected to be a persistent problem. In addition, the laws of some foreign countries do not protect
proprietary rights as fully as do the laws of the United States or Israel. There can be no assurance that our efforts to protect our proprietary rights will be adequate or that our competitors will not independently develop similar technology.

Organizational Structure

We are organized under the laws of the State of Israel. We are the parent company of our wholly owned subsidiaries which are specified in the table below.



|                           |  |                         
|-------------------------- |  | ------------------------
|Name of Subsidiary         |  | Country of Incorporation
|                           | 
|ViryaNet, Inc.             |  | Delaware, USA           
|                           | 
|Utility Partners, Inc. (*) |  | Delaware, USA           
|                           | 
|iMedeon, Inc. (*)          |  | Georgia, USA            
|                           | 
|ViryaNet Pty Ltd. (*)      |  | Australia               
|                           | 
|ViryaNet Europe Ltd.       |  | United Kingdom          



|(*) | Wholly-owned subsidiary of ViryaNet, Inc.
|--- | -----------------------------------------

Note: On April 23, 2007,
we formally dissolved our Japanese subsidiary, ViryaNet Japan KK.



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Property, Plants and Equipment

We do not own any real property. We lease approximately 7,900 square feet of space in Jerusalem, Israel, used primarily for research and development, with
an annual rent of approximately $123,000. The lease agreement for these premises expires on October 31, 2008. Currently, we intend to seek to renew this lease agreement on similar terms or to seek similar office space at approximately the same
annual cost, if available.

ViryaNet, Inc., our subsidiary located in Massachusetts, leases 10,007 square feet of office space in
Southborough, Massachusetts, that is utilized primarily for administrative, marketing, sales, service and technical support purposes, with an annual rent of approximately $185,000. The lease agreement for these premises expires on June 30,
2011.

Utility Partners, the subsidiary of ViryaNet, Inc. located in Tampa, Florida, leased approximately 4,300 square feet of office space
used primarily for engineering, sales, services and technical support purposes. The premises were leased under a lease agreement that expired on October 16, 2007, with a total annual rent of approximately $127,000, including certain
communication costs. We agreed to extend the term of this lease agreement on a quarterly basis at the same monthly cost until we found lower cost space in a suitable location. On July 17, 2008, we have moved to another location in the Tampa
area under a renewable six months lease term with an annual rent of approximately $20,000.

ViryaNet Pty Ltd., our subsidiary in Australia,
leases approximately 1,700 square feet of office space in Melbourne, Australia on monthly basis with a total annual rent of approximately $23,000.



|Item 5. | Operating and Financial Review and Prospects
|------- | --------------------------------------------

YOU SHOULD READ THE FOLLOWING DISCUSSION AND ANALYSIS IN CONJUNCTION WITH ITEM 3 SELECTED CONSOLIDATED FINANCIAL DATA AND OUR CONSOLIDATED FINANCIAL STATEMENTS AND NOTES THERETO INCLUDED ELSEWHERE IN THIS ANNUAL REPORT.
IN ADDITION TO HISTORICAL INFORMATION, THE FOLLOWING DISCUSSION CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS THAT INVOLVE KNOWN AND UNKNOWN RISKS AND UNCERTAINTIES, SUCH STATEMENTS OF OUR PLANS, OBJECTIVES, EXPECTATIONS AND INTENTIONS. SEE
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS.

Overview

We are a provider of integrated mobile and Web-based software applications for workforce management and the automation of field service delivery. In
addition, we provide software applications for spare parts logistics, contract management, and depot repair operations. Our mission is to provide companies with solutions that improve the quality and efficiency of their complex service business
processes. With ViryaNet Service Hub, our principal product, a service organization can quickly transition its complex field service business processes into a manageable, scalable Internet operation, with goals of increasing efficiency, quality of
service, customer satisfaction, customer retention, and profitability. Using ViryaNet Service Hub, our customers can manage the continuum of their service operations, from ensuring that the right person is in the right place at the right time with
the right parts and information about the customer, to automating the repair processes utilizing the Web and at the least cost.

Revenues

We derive revenues from licenses of our software products and from the provision of related services. Our operating history shows that
a significant percentage of our quarterly software revenue results from orders placed toward the end of a quarter. Software license revenues are comprised of perpetual software license fees primarily derived from contracts with our direct sales
clients and indirect partner channels. We recognize revenues in accordance with the AICPA Statement of Position 97-2, Software Revenue Recognition, or SOP 97-2, as amended, and AICPA Statement of Position 81-1, Accounting for
Performance of ConstructionType and Certain ProductionType Contracts and also adopted Staff Accounting Bulletin (SAB) No. 104 Revenue Recognition (See Critical Accounting Policies and notes
to our consolidated financial statements).

Services revenues are comprised of revenues from the performance of implementation, consulting,
integration, post-contract maintenance support and training services. Implementation, consulting, integration and training services are billed at an agreed upon rate plus incurred expenses. Customers that license our products generally purchase
these services from us or from our resellers and systems integrators. Post-contract maintenance support provides technical support and the right to unspecified software upgrades when and if available. Post-contract maintenance support revenues are
charged to customers as a percentage of license fees depending upon the level of support coverage desired by the customer.

We sell our
products through our direct sales force and through relationships with system integrators, application service providers and resellers. Our sales cycle from our initial contact with a potential customer to the signing of a license and related
agreements has historically been lengthy and variable. We generally must educate our potential customers about the use and benefit of our products and services, which can require the investment of significant time and resources, causing us to incur
most of our product development and selling and marketing expenses in advance of a potential sale. In addition, a number of companies decide which products to buy through a request for proposal process. In those situations, we also run the risk of
investing significant resources in a proposal that results in a competitor obtaining the desired contract from the customer or in a decision by a customer not to proceed.

The majority of our revenues are derived from customers in the United States, with the balance generated by customers in Europe, and the Asia Pacific regions. The percentage of revenue derived from the Asia Pacific
region decreased from 21% of total revenue in 2006 to 12% of total revenue in 2007. This decline is attributed primarily to the dissolution of our Japanese subsidiary in April 2007 and the completion in 2007 of several projects in Asia-Pacific
region which were initiated prior to 2007. The percentage of revenue derived from Europe was 7% in 2006 and increased to 9% in 2007. The increase in the percentage of revenue derived from Europe is attributable to a substantial license transaction
with a customer in the utilities market based in Germany. Further growth in the percentage of revenue derived from Europe will depend upon the success of our partners, principally GE Energy and Vodafone to successfully close license sales with new
customers.

We price our products based on market conditions in each jurisdiction where we operate. Historically, a significant portion of
our revenues has been derived from a small number of relatively large companies and we expect this trend to continue. See Risk FactorsHistorically, our revenues have been concentrated in a few large orders and a small number of
customers. Our business could be adversely affected if we lose a key customer.

Cost of Revenues

The cost of revenues consists of the cost of software license revenues and cost of maintenance and services. The cost of software license revenues
consists of costs of third-party software that is either embedded in our software or licensed for resale from third-party software providers to enhance the functionality of our software, amortization of acquired technology, and to a lesser extent
royalty payments to the OCS. The cost of acquired technology is established as part of the purchase price allocation related to the acquisitions of Utility Partners, Inc. and e-Wise Solutions and is amortized using a method of amortization that
reflects the pattern in which the economic benefits of the intangible assets are consumed or otherwise used up in accordance with SFAS No. 142, . Cost of maintenance and services consists of salaries and related expenses of our professional
services organization employees, third-party consultants and contractors, amortization of stock-based compensation and other administrative expenses incurred in support of these personnel. We expect the annual increase in the cost of services to
approximate the growth of professional services revenue on an annual basis.



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Operating Expenses

Operating expenses are categorized into research and development expenses, sales and marketing expenses, and general and administrative expenses.

Research and development expenses include costs relating to the development of our products. These costs consist primarily of salaries and benefits for
research and development employees, facilities and other administrative expenses, the cost of consulting development resources that supplement our internal development team and amortization of stock-based compensation. These expenses are presented
net of any governmental grants. Due to the relatively short time between the date our products achieve technological feasibility and the date they generally become available to customers, costs subject to capitalization under SFAS No. 86 have
been immaterial and have been expensed as incurred.

Sales and marketing expenses consist of salaries and commissions for sales and
marketing employees and consultants, amortization of acquired customer relationship, office expenses, travel, printing and distribution, market research, advertising and promotional expenses, other administrative expenses and amortization of
stock-based compensation. The cost of customer relationship is established as part of the purchase price allocation related to the acquisitions of Utility Partners, Inc. and e-Wise Solutions, and amortized using a method of amortization that
reflects the pattern in which the economic benefits of the intangible assets are consumed or otherwise used up in accordance with SFAS No. 142.

General and administrative expenses consist of salaries for administrative, executive and finance personnel, information system costs, insurance, accounting, legal, professional fees, other administrative expenses and
amortization of stock-based compensation.

Amortization of stock-based compensation includes the amortization of employee stock-based
compensation and expenses for stock -based awards granted to employees, directors and consultants in exchange for services. Stock-based compensation expense is amortized over the vesting schedule of the stock options or restricted shares using the
straight-line approach, or, over the term of the services provided. These expenses are reported in the statement of operations under the applicable operating expense categories (i.e., cost of services, sales and marketing, research and development,
and general and administrative) and no longer reported as a separate line item.

Our Reporting Currency

Our reporting currency is the United States dollar. Transactions and balances of subsidiaries whose functional currency is not the dollar have been
translated to dollars under the principles described in Financial Accounting Standards Board Statement (FASB) No. 52. Under this FASB Statement, assets and liabilities have been translated at period-end exchange rates and results of
operations have been translated at average exchange rates. The exchange gains and losses arising from these translations are recorded as a separate component of accumulated other comprehensive losses in the shareholders equity section of our
balance sheet.

Adoption of New Accounting Standard

On January 1, 2007, we adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109 , or FIN 48. See discussion below
under Critical Accounting Policies and Note 14 to our financial statements, Taxes on Income.

Our Location in Israel

We are incorporated under the laws of the State of Israel, and our principal executive offices and principal research and development
facilities are located in Israel. See Item 3D Risk Factors  Risks Related to Our Location in Israel for a description of governmental, economic, fiscal, monetary or political polices or factors that have materially affected or
could materially affect our operations.

Impact of Currency Fluctuation and of Inflation

A significant portion of the cost of our Israeli operations, mainly personnel costs, is incurred in NIS. Therefore, our NIS related costs, as expressed in
U.S. dollars, are influenced by the exchange rate between the U.S. dollar and the NIS. During 2007, the NIS appreciated against the U.S. dollar, which resulted in a significant increase in the U.S. dollar cost of our operations in Israel. Such trend
continued during the first six months of 2008 with the NIS further appreciated against the U.S. dollar. Also, NIS linked balance sheet items may create foreign exchange gains or losses, depending upon the relative dollar values of the NIS at the
beginning and end of the reporting period, affecting our net income and earnings per share. Although we may use hedging techniques we cannot eliminate the effects of currency fluctuations. Thus, exchange rate fluctuations resulting in a devaluation
of the U.S. dollar compared to the NIS could have a material adverse impact on our operating results and share price. The caption Financial and other income (expenses), net in our consolidated financial statements includes the impact of
these factors as well as traditional interest income or expense.

Seasonality

Our operating results are generally not characterized by a seasonal pattern.

Recently Issued Accounting Standards

In September 2006, the FASB issued SFAS No. 157, 
Fair Value Measurements , or SFAS 157, which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS 157 applies to other accounting pronouncements that require or permit
fair value measurements and, accordingly, does not require any new fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007 for financial assets and liabilities, as well as for any other assets and
liabilities that are carried at fair value on a recurring basis, and should be applied prospectively. The adoption of the provisions of SFAS 157 related to financial assets and liabilities and other assets and liabilities that are carried at fair
value on a recurring basis is not anticipated to materially impact our consolidated financial position and results of operations. Subsequently, the FASB provided for a one-year deferral of the provisions of SFAS 157 for non-financial assets and
liabilities that are recognized or disclosed at fair value in the consolidated financial statements on a non-recurring basis. We are currently evaluating the impact of adopting the provisions of SFAS 157 for non-financial assets and liabilities that
are recognized or disclosed on a non-recurring basis.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for
Financial Assets and Financial Liabilities,  or SFAS No. 159. SFAS No. 159 permits companies to choose to measure certain financial instruments and certain other items at fair value. The standard requires that unrealized gains and
losses on items for which the fair value option has been elected be reported in earnings. The provisions of SFAS No. 159 are effective for financial statement issued for fiscal years beginning on January 1, 2008. We have determined
that the adoption of SFAS 159 will not have an impact on our consolidated financial statements.



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In December 2007, the FASB issued SFAS No. 141R (revised 2007), Business Combinations,
or SFAS 141R. SFAS 141R establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any non controlling interest in the acquiree
and the goodwill acquired. SFAS 141R also establishes disclosure requirements to enable the evaluation of the nature and financial effects of the business combination. SFAS 141R is effective for fiscal years beginning after
December 15, 2008. Earlier adoption is prohibited. SFAS 141R will have an impact on accounting for future business combinations once adopted and not on prior acquisitions. As such the nature and magnitude of the specific effects will dependent
upon the nature, terms and size of the acquisitions we consummate after the effective date.

In December 2007, the FASB issued SFAS
No. 160,  Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51 , or SFAS No. 160. SFAS No. 160 establishes accounting and reporting standards that require that the ownership
interests in subsidiaries held by parties other than the parent be clearly identified, labeled, and presented in the consolidated statement of financial position within equity, but separate from the parents equity; the amount of consolidated
net income attributable to the parent and to the noncontrolling interest be clearly identified and presented on the face of the consolidated statement of income; and changes in a parents ownership interest while the parent retains its
controlling financial interest in its subsidiary be accounted for consistently. SFAS No. 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. The adoption of the
provisions of SFAS No. 160 is not anticipated to materially impact our consolidated financial position and results of operations.

On
December 21, 2007 the staff of the Securities and Exchange Commission issued SAB No. 110, which, effective January 1, 2008, amends and replaces SAB 107, Share-Based Payment. SAB 110 expresses the views of the Staff regarding the use
of a simplified method in developing an estimate of expected term of plain vanilla share options in accordance with SFAS No. 123(R), Share-Based Payment. Under the simplified method, the expected term is
calculated as the midpoint between the vesting date and the end of the contractual term of the option. The use of the simplified method, which was first described in SAB 107, was scheduled to expire on December 31, 2007. SAB 110
extends the use of the simplified method for plain vanilla awards in certain situations. The Staff does not expect the simplified method to be used when sufficient information regarding exercise behavior, such as
historical exercise data or exercise information from external sources, becomes available. As a result, we do not expect that the adoption of SAB No. 110 will have a significant impact on our consolidated financial statement.

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. We evaluate these estimates 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

Revenue results are difficult to predict, and any shortfall in revenues or delay
in recognizing revenues could cause our operating results to vary significantly from quarter to quarter and could result in future operating losses. In addition, the timing of our revenue recognition influences the timing of certain expenses, such
as commissions and royalties, which could cause our expenses to fluctuate from period to period. We follow very specific and detailed guidelines in measuring revenues. However, certain judgments affect the application of our revenue policy.

The Company generates revenues from licensing the rights to use its software products directly to end-users. The Company also enters into
license arrangements with indirect channels such as resellers and systems integrators resellers whereby revenues are recognized upon sale through to the end user by the reseller.

The Company also generates revenues from rendering professional services, including consulting, customization, implementation, training and post-contract
maintenance and support.

Revenues from software product license agreements that do not involve significant customization and modification
of the software product are recognized, under Statement of Position No. 97-2, Software Revenue Recognition (SOP No. 97-2), as amended by Statement of Position 98-9, Modifications of SOP 97-2, Software Revenue
Recognition with Respect to Certain Transactions. SOP No. 98-9 generally requires revenues earned from software arrangements involving multiple elements that typically consist of license, professional services, and post-contract
maintenance and support, be recognized under the residual method and allocated to each element. Under the residual method, revenue is recognized for the delivered elements when (1) there is vendor-specific objective evidence (VSOE)
of the fair values of all the undelivered elements, (2) VSOE of fair value does not exist for one or more of the delivered elements in the arrangement, and (3) all revenue recognition criteria of the amended SOP 97-2 are satisfied. Under
the residual method, any discount in the arrangement is allocated to the delivered element. Our VSOE used to allocate the sales price to professional services and maintenance is based on the price charged when the undelivered elements are sold
separately. In the event that VSOE of fair value does not exist for all undelivered elements to support the allocation of the total fee among all delivered and undelivered elements of the arrangement, revenue would be deferred until such evidence
exists for the undelivered elements, or until all elements are delivered, whichever occurs earlier.

Revenue from software license fees is
recognized when persuasive evidence of an arrangement exists, delivery of the product has occurred, the fee is fixed and determinable and collectability is probable. We do not grant a right of return to our customers. If the fee due from the
customer is not fixed or determinable, revenue is recognized as payments become due from the customer, assuming all other revenue recognition criteria have been met.

In judging the probability of collection of software license fees, we continuously monitor collection and payments from our customers and maintain a provision for estimated credit losses based upon our historical
experience and any specific customer collection issues that we have identified. In connection with customers with whom we have no previous experience, we may utilize independent resources to evaluate the creditworthiness of those customers. From
time to time, we may perform credit evaluations of our customers. If the financial situation of any of our customers were to deteriorate, resulting in an impairment of their ability to pay amounts owed to us, additional allowances may be required.

Arrangement that include services are evaluated to determine if those services are considered essential to the functionality of the other
elements of the arrangement, Services that are considered essential consist primarily of significant production, customization or modification of the software product. When such services are provided revenues under the arrangement are recognized
using contract accounting in accordance with Statement of Position No. 81-1 Accounting for Performance of ConstructionType and Certain ProductionType Contracts (SOP No. 81-1), using the
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 contract, provided that the revenues are fixed or can be reasonably estimated, collection
is probable, costs related to performing the work are determinable or can be reasonably determined, and there is no substantial uncertainty regarding our ability to complete the contract and to meet the contractual terms. When services are not
considered essential, the revenues from the services are recognized as the services are performed.



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In recognizing revenues based on the percentage-of-completion method, we estimate time to completion with
revisions to estimates made in the period in which the basis of such revisions becomes known. If we do not accurately estimate the resources required or scope of work to be performed, manage our projects properly within the planned periods of time
or satisfy our obligations under the contracts, then future services margins may be significantly and negatively affected or a provision for estimated contract losses on existing contracts may need to be recognized in the period in which the loss
becomes probable and can be reasonably estimated.

Service revenues from professional services include implementation and consulting,
post-contract maintenance support and training. Implementation and consulting services revenues are generally recognized on a time and material basis or as these services are performed. Post-contract maintenance support agreements provide technical
support and the right to unspecified software updates, when available. Revenues from post-contract maintenance support services are recognized ratably over the contractual support term, generally one year. Amounts collected from customers in excess
of revenues recognized are recorded as deferred revenue.

Allowance for Doubtful Accounts

We evaluate the collectibility of accounts receivable based on a combination of factors related to our customers. In circumstances where we are aware of a
specific customers inability to meet its financial obligations to us (e.g. bankruptcy filings, substantial down-grading of credit ratings), we record a specific reserve for bad debts against amounts due to reduce the net recognized receivable
to the amount we reasonably believe will be collected. For all other customers, we recognize reserves for bad debts based on the length of time the receivables are past due and on our historical experience in collecting such receivables.

Goodwill and Other Intangible Assets

Under
Statement of Financial Accounting Standard No. 142, Goodwill and Other Intangible Assets (SFAS No. 142) goodwill is not amortized but is subject to an annual impairment test. 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 recorded goodwill of approximately $2.8 million related to our acquisition of iMedeon on February 25, 2002, $3.7 million related to our acquisition of Utility Partners, Inc. on July 29, 2004, and $0.6 million
related to our acquisition of substantially all of the assets of e-Wise Solutions on June 15, 2005. We have performed impairment tests and determined that our goodwill of approximately $7.2 million is not subject to an impairment charge as of
year-end 2007.

In addition, we test for impairment periodically whenever events or circumstances occur subsequent to our annual impairment
tests that indicate that the asset may be impaired. Indicators we consider important which could trigger an impairment include, but are not limited to, significant underperformance relative to historical or projected future operating results,
significant changes in the manner of use of the acquired assets or the strategy for our overall business, significant negative industry or economic trends, or a significant decline in our stock price for a sustained period.

Long-lived Assets other than Goodwill

We are
required to assess the impairment of long-lived assets, other than goodwill, tangible and intangible under SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, (SFAS No. 144) on a periodic basis, when
events or changes in circumstances indicate that the carrying value may not be recoverable. Where events and circumstances are present which indicate that the carrying value may not be recoverable, we recognize an impairment loss. Such impairment
loss is measured by comparing the recoverable amount of the asset with its carrying value. The determination of the value of such intangible assets requires management to make assumptions regarding estimated future cash flows and other factors to
determine the fair value of the respective assets. If these estimates or the related assumptions change in the future, we could be required to record impairment charges. We have performed impairment tests and determined that the unamortized portion
of our long-lived assets other than goodwill of approximately $1.3 million is not subject to an impairment charge as of year-end 2007.

Contingencies

From time to time, we are defendant or plaintiff in various legal actions, which arise in the normal course of business. We are
required to assess the likelihood of any adverse judgments or outcomes to these matters as well as potential ranges of probable losses. A determination of the amount of reserves required for these contingencies, if any, which would be charged to
earnings, is made after careful and considered analysis of each individual action together with our legal advisors. The required reserves may change in the future due to new developments in each matter or changes in circumstances, such as a change
in settlement strategy. A change in the required reserves would affect our earnings in the period the change is made.

Equity-based Compensation Expense

We account for equity-based compensation in accordance with SFAS No. 123(R), Share-Based Payment. Under the fair value
recognition provisions of this statement, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as an expense over the requisite service periods. Determining the fair value of stock-based
awards at the grant date requires the exercise of judgment, including the amount of stock-based awards that are expected to be forfeited. If actual results differ from these estimates, equity-based compensation expense and our results of operations
could be impacted.

Prior to the adoption of SFAS No. 123(R), we accounted for equity-based awards to employees and directors using
the intrinsic value method in accordance with APB No. 25 as allowed under SFAS No. 123, Accounting for Stock-Based Compensation, or SFAS No. 123. Pursuant to these accounting standards, we recorded deferred compensation
for stock options granted to employees at the date of grant equal to the excess of the market value of the underlying shares at that date over the exercise price of the options. Furthermore, when terms of options granted were modified, we accounted
for the modifications as an exchange of the original award, resulting in additional compensation expenses based on the differences between the fair value of the new award and the original award immediately before modification and in accordance with
SFAS No 123.

We adopted SFAS No. 123(R) using the modified prospective transition method, which requires the application of the
accounting standard as of January 1, 2006, the first day of the Companys fiscal year 2006. Under that transition method, compensation cost recognized in the year ended December 31, 2006, included: (a) compensation cost for all
share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, and (b) compensation cost for all share-based
payments granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123(R). As required by the modified prospective method, results for prior periods have not been
restated.

We did not grant any stock options during 2006 and 2007. During 2005, 2006 and 2007 we granted restricted shares to employees,
directors and consultants. All restricted shares were granted for no consideration. In accordance with SFAS 123(R), restricted shares are measured at their fair value as if they were vested and issued on the grant date; therefore, their fair value
was equal to the share price at the date of grant.



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Accounting for Income Tax

On January 1, 2007, we adopted the Financial Accounting Standards Board, or FASB, Interpretation No. 48, Accounting for Uncertainty in Income Taxes , an Interpretation of FASB Statement No. 109,
 or FIN 48, which contains a two-step approach to recognizing and measuring uncertain tax positions accounted for in accordance with SFAS No. 109,  Accounting for Income Taxes . The first step is to evaluate the tax position
taken or expected to be taken in a tax return by determining if the weight of available evidence indicates that it is more likely than not that, on an evaluation of the technical merits, the tax position will be sustained on audit, including
resolution of any related appeals or litigation processes. The second step is to measure the tax benefit as the largest amount that is more than 50% likely to be realized upon ultimate settlement. Prior to January 1, 2007, we estimated our
uncertain income tax obligations in accordance with SFAS No. 109 and SFAS No. 5 Accounting for Contingencies , or SFAS No. 5. As a result of the adoption of the FIN 48 and our evaluation of our tax position taken or
expected to be taken with respect to uncertain tax obligations, we have recorded a liability for unrecognized tax benefits, of approximately $55,000 which was accounted for as an increase to the January 1, 2007 balance of the accumulated
deficit and an amount of $13,000 related to interest and penalties on tax positions for the year ended December 31, 2007 which was recorded in financial expenses.

Accounting for tax positions requires judgments, including estimating reserves for potential uncertainties. We also assess our ability to utilize tax attributes, including those in the form of carry forwards, for
which the benefits have not been reflected in the financial statements. We do not record valuation allowances for deferred tax assets that we believe are more likely than not to be realized in future periods. While we believe the resulting tax
balances as of December 31, 2007 and 2006 are appropriately accounted for in accordance with FIN 48, SFAS No. 5 and SFAS No. 109 as applicable, the ultimate outcome of such matters could result in favorable or unfavorable adjustments
to our consolidated financial statements and such adjustments could be material. See note 14 to consolidated financial statements for further information regarding income taxes. We are in the process of filing local and foreign tax returns that are
subject to audit by the respective tax authorities. Our tax returns are subject to ongoing audits by the tax authorities, which often result in proposed assessments. Our estimate of the potential outcome for any uncertain tax issue is highly
judgmental. We believe that we adequately provided for any reasonably foreseeable outcomes related to tax audits and settlement. However, our future results may include favorable or unfavorable adjustments to our estimated tax liabilities in the
period the assessments are made or resolved, audits are closed or when statutes of limitation on potential assessments expire.

The Company and its
subsidiaries file federal and state income tax returns in the U.S., Israel, Australia and the UK. ViryaNet Ltd. may be subject to examination by the Israel tax authorities for fiscal years 2003 through 2007. ViryaNet Inc.'s (the U.S. subsidiary) tax
returns through 2006 were audited by the U.S. Internal Revenue Service (IRS) which resulted with no incremental tax liability. ViryaNet Inc. may be subject to examination by the IRS for fiscal year 2007. ViryaNet PTY (the Australian
subsidiary) may be subject to examination by the Australian tax authorities for fiscal years 2005 through 2007.

Operating
Results

The following table describes, for the periods indicated, the percentage of revenues represented by each of the items on our
consolidated statements of operations:



|                                      |  |                         |   |  |       |   |  |       |  
|------------------------------------- |  | ----------------------- | - |  | ----- | - |  | ----- | -
|                                      |  | Year Ended December 31, |  
|                                      |  | 2005                    |   |  | 2006  |   |  | 2007  |  
|Revenues:                             |  |                         |   |  |       |   |  |       |  
|Software license                      |  | 12.1                    | % |  | 11.0  | % |  | 15.9  | %
|Maintenance and services              |  | 87.9                    |   |  | 89.0  |   |  | 84.1  |  
|                                      |  |                         |   |  |       |   |  |       |  
|Total revenues:                       |  | 100.0                   |   |  | 100.0 |   |  | 100.0 |  
|Cost of revenues:                     |  |                         |   |  |       |   |  |       |  
|Software licenses                     |  | 2.5                     |   |  | 2.6   |   |  | 3.2   |  
|Maintenance and services              |  | 55.3                    |   |  | 49.3  |   |  | 50.5  |  
|                                      |  |                         |   |  |       |   |  |       |  
|Total costs of revenues               |  | 57.8                    |   |  | 51.9  |   |  | 53.7  |  
|Gross profit                          |  | 42.2                    |   |  | 48.1  |   |  | 46.3  |  
|                                      |  |                         |   |  |       |   |  |       |  
|Operating expenses:                   |  |                         |   |  |       |   |  |       |  
|Research and development              |  | 17.6                    |   |  | 15.3  |   |  | 20.5  |  
|Sales and marketing                   |  | 36.7                    |   |  | 26.6  |   |  | 30.7  |  
|General and administrative            |  | 21.1                    |   |  | 19.7  |   |  | 22.3  |  
|                                      |  |                         |   |  |       |   |  |       |  
|Total operating expenses              |  | 75.5                    |   |  | 61.7  |   |  | 73.5  |  
|Operating loss                        |  | (33.3                   | ) |  | (13.5 | ) |  | (27.2 | )
|Financial expenses, net               |  | (9.3                    | ) |  | 0     |   |  | (4.8  | )
|Loss from liquidation of a subsidiary |  | 0                       |   |  | 0     |   |  | (2.1  | )
|Net loss                              |  | (42.6                   | ) |  | (13.8 | ) |  | (34.1 | )

Geographic Distribution

The following table summarizes the revenues from our products and services by country/region, stated as a percentage of total revenues for the periods indicated.



|               |  |                         |   |  |       |   |  |       |  
|-------------- |  | ----------------------- | - |  | ----- | - |  | ----- | -
|               |  | Year Ended December 31, |  
|Country/Region |  | 2005                    |   |  | 2006  |   |  | 2007  |  
|United States  |  | 79.3                    |   |  | 71.6  |   |  | 78.9  |  
|Europe         |  | 7.4                     |   |  | 7.4   |   |  | 9.0   |  
|Asia Pacific   |  | 13.3                    |   |  | 21.0  |   |  | 12.1  |  
|               |  |                         |   |  |       |   |  |       |  
|Total          |  | 100.0                   | % |  | 100.0 | % |  | 100.0 | %

Comparison of Fiscal Years Ended December 31, 2006 and 2007

Revenues

Our total revenues decreased by $2.7
million or 19.5% from $13.9 million in 2006 to $11.2 million in 2007. Revenues from maintenance and services revenues declined by approximately $3.0 million from $12.3 million to $9.4 million, off set by an increase in revenues from software
licenses of $0.3 million from $1.5 million to $1.8 million. From a geographic perspective, our revenues in North America declined by $1.1 million, from $9.9 million to $8.8 million and our revenues from Asia Pacific, including Japan, declined by
$1.6 million from $2.9 million to $1.3 million, while revenues in Europe were flat at approximately $1.0 million. From a channels perspective, the contribution of revenue from direct sales and indirect sales was the same in 2007 as 2006 at 71% and
29%, respectively, however, the volume of direct sales declined by $1.9 million and the volume of indirect sales fell by $0.8 million.



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In 2007, we were successful at increasing our revenues from software licenses compared with 2006 and
acquired several new customers which contributed to this growth. However, we completed several large services arrangements that were initiated prior to 2007 and contributed substantially less revenue during 2007, and, we were not successful in
closing services revenue opportunities suitable to replace these projects, particularly in the Asia Pacific region.

In 2008, we believe
that we can grow our total revenue with expectations for a continued increase in new license sales with new customers, and an increase in the sale of licenses and professional services into our installed base of existing customers. We expect to
receive more contributions to revenue in 2008 from our investments in sales and marketing efforts in support of our existing channel partners in Europe, and the introduction of new software product offerings to markets which extend our ability to
assist customers with the operations of their business.

Software Licenses

Software license revenues increased by 16.4%, from $1.5 million in 2006 to $1.8 million in 2007. This increase of $0.3 million is attributable to higher
revenue derived from the sale of our software to new customers in the retail market.

As a percentage of total revenue, software licenses
increased from 11.0% of revenue in 2006 to 15.9% of revenue in 2007. The increase in the percentage of revenue provided by software licenses is attributable to the 16% increase in the volume of our software licenses, as mentioned above, and the 24%
decline in maintenance and services revenues from new and existing customers which fell from $12.3 million in 2006 to $9.4 million in 2007. There were no rate changes in our license fees that had a material impact on our revenues.

Maintenance and Services

Our maintenance and
services revenues decreased by 24%, from $12.3 million in 2006 to $9.4 million in 2007. During 2007, our maintenance and services revenues declined by $3.0 million worldwide as several services projects which began prior to 2007 were successfully
completed but contributed substantially less revenue during 2007, and we were not successful replacing these projects with new implementation efforts in a timely manner to avoid the reduction in annual maintenance and services revenue. In North
America, our maintenance and services revenues declined by approximately $1.2 million. In Asia Pacific, our maintenance and services revenues declined by approximately $1.6.

As a percentage of total revenue, maintenance and services revenue decreased from 89.0% of revenue in 2006 to 84.1% of revenue in 2007 as a result of the
16% growth in sales of software licenses and 24% decline in maintenance and services revenues. There were no rate changes in our maintenance and services fees that had a material impact on our revenues.

Cost of Revenues

Total cost of revenues
decreased by 17% from $7.2 million in 2006 to $6.0 million in 2007, as further explained below.

Cost of Software Licenses

The cost of software licenses was $0.4 million in 2006 and in 2007, while the cost of software licenses as a percent of software license revenue decreased
from 23.4% in 2006 to 20.2% in 2007. The decrease in the cost of software licenses as a percent of software license revenue is attributable to the expiration of amortization costs related to acquired technology assets from the acquisition of Utility
Partners in July 2004.

Cost of Maintenance and Services

The cost of maintenance and services decreased by 18%, from $6.8 million in 2006 to $5.6 million in 2007. The decrease in the cost of maintenance and services of $1.2 million is attributable to (i) a decrease of
$1.1 million in compensation costs related to the reduction of 10 maintenance and service personnel on a full-year weighted average basis, and (ii) a reduction of $0.1 million related to the discontinuation of maintenance services provided by a
third party to one of our end-users. Maintenance and services costs as a percentage of maintenance and services revenues increased from 55% in 2006 to 60% in 2007. The increase in the cost of maintenance and services as a percentage of maintenance
and services revenues resulted primarily from the 24% decrease in maintenance and services revenues and our inability to lower costs proportionally with the substantial decline in revenues.

Operating Expenses

Research and Development

Our net research and development expenses increased by 8% from $2.1 million in 2006 to $2.3 million in 2007, and increased as a percent of
revenue from 15.3% of revenue in 2006 to 20.5% in 2007. The increase in the amount of research and development expenses in 2007 of approximately $0.2 million was primarily attributable to the exchange rate impact of the U.S. dollar against the NIS
as the majority of our research and development activity occurs at our development facility in Israel.

We expect that we will continue to devote a substantial portion of our revenues to research and development to enhance our existing products, merge certain features and functionality of WorkUPand FOCUS with ViryaNet Service Hub, enhancements to improve the quality and configurability of our software, and develop new features and functionality
that will benefit all of our customers. In 2008, we expect the amount of expenses for research and development to increase slightly in comparison to the amount of those expenses in 2007, and we expect that research and development as a percentage of
revenue should remain flat or slightly decline if revenue growth occurs as expected. See Cautionary Statement Regarding Forward-Looking Statements.

Sales and Marketing

Our sales and marketing expenses were $3.4 million, or 30.7% of revenue in 2007 compared to $3.7
million or 26.6% of revenue in 2006, a year over year decrease of $0.3 million or 7.1%. This decrease was primarily attributable to a reduction in base and variable compensation costs of approximately $0.3 million related to a decrease of 3 sales
personnel on a full-year weighted average basis. We expect sales and marketing expenses to increase in 2008 compared to 2007 and we expect that sales and marketing as a percentage of revenue should remain flat or decline slightly to the extent that
revenue growth occurs as expected. See Cautionary Statement Regarding Forward-Looking Statements.

General and Administrative

Our general and administrative expenses were $2.5 million, or 22.3% of revenue in 2007 compared to $2.7 million, or 19.7% of revenue in
2006, a year over year decrease of $0.2 million or 9.1%. This decrease was attributable to a reduction in compensation costs of $0.2 million related to a decrease of 2 administrative personnel on a full-year weighted average basis. We expect general
and administrative expenses to remain flat or slightly increase in 2008 compared to 2007 and we expect that these expenses as a percentage of revenue should decline to the extent that revenue growth occurs as expected. See Cautionary Statement
Regarding Forward-Looking Statements.



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Financial Income and Expenses, net

Financial income and expenses, net, changed from $44,000 of expenses in 2006 to approximately $0.5 million of expenses in 2007. The year to year change in
the amount of financial income and expense, net, of approximately $0.5 million was attributable to (i) a one-time non-cash benefit of approximately $1.0 million in 2006 related to the conversion of $2.5 million of the convertible debts held by
LibertyView and JHTF, offset by (ii) lower interest expenses in 2007 of approximately $0.3 million, resulting from repayment of long-term bank loan in 2007 and conversion of convertible debts mentioned above and (iii) financial expenses of
approximately $0.2 million in 2006, related to certain fundraising activities. We expect that financial expenses, net, to increase in 2008 resulting from foreign currency translation adjustment caused by the weakening of the US dollar relative to
the NIS. See Cautionary Statement Regarding Forward-Looking Statements.

Loss from Liquidation of a Subsidiary

Our loss from the liquidation of our Japanese subsidiary in April 2007 was $0.2 million in 2007. The amount of the loss recorded is related to the
accumulation of currency translation adjustments since the inception of the subsidiary that is removed from the separate component of equity upon the dissolution of our Companys Japanese subsidiary.

Comparison of Fiscal Years Ended December 31, 2005 and 2006

Revenues

Our total revenues decreased by 2% from $14.2 million in 2005 to $13.9 million in 2006. While overall
revenues declined by approximately $0.3 million, our revenues in North America and Japan declined by $1.3 million and $0.3 million, respectively, in 2006 compared to 2005, offset by an increase in revenue contributed by Asia Pacific, excluding
Japan, of $1.3 million as we received the full-year benefit of revenue contributed by our new Australia subsidiary established in June 2005 and the successful expansion of our focus into the Asia Pacific market. In North America, most of the
reduction occurred in maintenance and services revenues as several projects that began in 2005 were successfully completed in the first half of 2006. In Japan, the revenue decline indicated a weakening demand for our products and services and we
concluded this market could be more profitably supported utilizing a local reseller. Consequently, in 2007 we dissolved our Japanese subsidiary and replaced our direct presence in Japan with a reseller based in Tokyo, Japan that provide sales and
support activities for our products.

Software Licenses

Software license revenues decreased by 12%, from $1.7 million in 2005 to $1.5 million in 2006. This decrease of $0.2 million is primarily attributable to lower revenue derived from the sale of our software in the
North America market as we experienced delays later in the year in closing certain new deals before the end of the year. In 2006, we became more dependent on our channel partners to sell our software as the percentage of software licenses sold
through partners increased to 54% compared to 9% in 2005. With the increased reliance on partners, we became less able to control the timing of the closing for transactions involving partners.

As a percentage of total revenue, software licenses decreased from 12.1% of revenue in 2005 to 11.0% of revenue in 2006. The reduction in the percentage
of revenue provided by software licenses is attributable to the decline in software license revenue due to the reduction in the sales of licenses in our North America market, as mentioned above. Maintenance and services revenues from new and
existing customers from 2005 to 2006 declined slightly but had no material impact on the decline in software license revenue as a percentage of total revenue. There were no rate changes in our license fees that had a material impact on our revenues.

Maintenance and Services

Our
maintenance and services revenues decreased slightly by 1%, from $12.5 million in 2005 to $12.3 million in 2006. The decrease of $0.1 million reflects a shift in the contribution of professional services revenue from North America and our Japanese
subsidiary in 2006 compared to 2005. During 2006, North America revenues declined by approximately $1.0 million as several projects which began in 2005 were successfully completed in the first half of 2006 and we were not able to replace these
projects with new implementation efforts in a timely manner to avoid the reduction in annual maintenance and services revenue. In Japan, our services revenues declined by approximately $0.2 million. We were not as successful in 2006 in selling new
services to our installed base of customers that could adequately justify the continuation of a subsidiary operation in Japan. We concluded that this market could be more profitably supported utilizing a local reseller familiar with our products and
services capabilities, our installed base of customers, and the Japanese market demand for mobile workforce management solutions. In Asia Pacific, our services revenues increased by $1.1 million, primarily as a result of the full-year contribution
of our new subsidiary in Australia which was established in June 2005. There were no rate changes in our maintenance and services fees that had a material impact on our revenues.

Cost of Revenues

Total cost of revenues decreased by 12% from $8.2 million in 2005 to $7.2
million in 2006, as further explained below.

Cost of Software Licenses

The cost of software licenses was $0.4 million in 2005 and in 2006, while the cost of software licenses as a percent of software license revenue increased
from 20.8% in 2005 to 23.4% in 2006. The increase in the cost of software licenses as a percent of software license revenue is attributable to the full-year effect of expenses related to the amortization costs of acquired technology arising from the
acquisition of e-Wise Solutions in June 2005, and the effect of the lower volume of software licenses sold in 2006 compared with 2005.

Cost of
Maintenance and Services

The cost of maintenance and services decreased by 13%, from $7.9 million in 2005 to $6.8 million in 2006.
The decrease in the cost of maintenance and services of $1.0 million is primarily attributable to a reduction in compensation costs related to the reduction of 14 maintenance and service personnel on a weighted average basis, offset by an increase
of $0.1 million related to the cost of resources utilized from the development organization in the delivery of maintenance and services to customers. Maintenance and services costs as a percentage of maintenance and services revenues decreased from
63% in 2005 to 55% in 2006. The decrease in maintenance and services costs as a percentage of maintenance and services revenues resulted primarily from the decrease in personnel noted above along with an increase in the efficiency and utilization of
our services personnel needed to deliver maintenance and services revenue.

Operating Expenses

Research and Development, Net

Our net research
and development expenses decreased by 15% from $2.5 million in 2005 to $2.1 million in 2006, and declined as a percent of revenue from 17.6% of revenue in 2005 to 15.3% in 2006. We did not receive any government grants from the OCS during 2005 and
2006. The decrease in the amount of research and development expenses in 2006 of approximately $0.4 million is attributable to (i) a reduction in compensation costs of approximately $0.3 million related to a reduction of 3 development personnel
on a weighted average basis, and (ii) an allocation of development resources to professional services of approximately $0.1 million.



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Sales and Marketing

Our sales and marketing expenses were $3.7 million, or 26.6% of revenue in 2006 compared to $5.2 million or 36.7% of revenue in 2005, a year over year decrease of $1.5 million or 29.2%. This decrease was attributable
to (i) a reduction in base and variable compensation costs of approximately $1.4 million related to a decrease of 9 sales personnel on a weighted average basis, and (ii) a decrease of approximately $0.1 million in travel expenses.

General and Administrative

Our
general and administrative expenses were $2.7 million, or 19.7% of revenue in 2006 compared to $3.0 million, or 21.1% of revenue in 2005, a year over year decrease of $0.3 million or 9.0%. This decrease was attributable to (i) a reduction in
compensation costs of approximately $0.2 million related to a decrease of 2 administrative personnel on a weighted average basis, and (ii) a decrease of approximately $0.1 million related to professional fees.

Financial Income and Expenses, net

Financial
income and expenses, net, changed from approximately $1.3 million of expenses in 2005 to approximately $0.04 million of expenses in 2006. The year to year change in the amount of financial income and expense, net, of approximately $1.3 million is
primarily attributable to (i) a one-time non-cash charge of approximately $0.8 million in 2005 related to the accounting for a modification to the terms of the LibertyView convertible debt, (ii) a one-time non-cash benefit of approximately
$1.0 million in 2006 related to the conversion of $2.5 million of the convertible debts held by LibertyView and JHTF, offset by (iii) unfavorable foreign currency translation adjustment of approximately $0.3 million caused by the weakening of
the US dollar relative to the NIS and (iv) 
financial expenses of approximately $0.2 million related to certain fundraising activities.

Liquidity and Capital Resources

How We Have Financed Our Business

On September 19, 2000, we completed our IPO. In this offering, we raised gross proceeds of $32.0 million and issued 80,000 Ordinary Shares at an effective price of $400.00 per Ordinary Share (adjusted for our one-for-ten reverse share
split in May 2002, and our one-for-five reverse share split in January 2007). Since the time of our IPO, we have financed our operations primarily through additional sales of our Ordinary Shares through private placements or incurrence of
convertible debt, bank related financings and sale of receivables. Historically, cash flow from operations has not been sufficient to fund operations without the use of these additional financing measures.

Sources of Cash

Equity or Convertible Debt
Financings

During 2003, we raised approximately $5.0 million in cash, excluding transaction related expenses, from the sale of our
Ordinary Shares from private equity financings. These transactions consisted of the following:



| |  |  | On August 4, 2003, we completed a private placement of our Ordinary Shares with Telvent, the information technology subsidiary of Abengoa, S.A. of Spain. In
exchange for gross proceeds of $1.0 million, we issued 107,852 Ordinary Shares at a price of $9.27 per share.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | On November 10, 2003, we completed a private placement of our Ordinary Shares with a large U.S. financial institution and a group of private investors. In
exchange for gross proceeds of approximately $1.8 million, we issued 103,465 Ordinary Shares at a price of $17.03 per share. In addition, the investors also received warrants to purchase 18,745 Ordinary Shares at an exercise price of $23.50 per
share exercisable until the earlier of November 10, 2006, or, an M&A transaction as defined in such warrants. These warrants expired and were not exercised.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | On December 5, 2003, we completed a follow-on private placement of our Ordinary Shares with Vertex Venture Capital Israel Funds and FBR Infinity Venture Funds,
as well as a group of private investors. In exchange for gross proceeds of approximately $2.2 million, we issued 110,902 Ordinary Shares at a price of $20.18 per share. In addition, the investors also received warrants to purchase 16,929 Ordinary
Shares at an exercise price of $33.05 per share exercisable until the earlier of December 5, 2006, or, an M&A transaction as defined in such warrants. These warrants expired and were not exercised.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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During 2004, we raised approximately $2.5 million of cash, excluding transaction related expenses, in a
convertible debt financing transaction. The transaction consisted of the following:



| |  |  | On July 28, 2004, we issued to LibertyView a 7.5% Convertible Debt in the aggregate principal amount of $2.5 million due July 28, 2014. We are obligated
to pay interest on the Debt on a quarterly basis commencing October 15, 2004, either in cash or our Ordinary Shares, at our discretion. The Debt is convertible, at the option of LibertyView, at any time before its maturity date into our
Ordinary Shares at a fixed conversion price of $21.50 per Ordinary Share. LibertyView also has an option to require us to purchase the Debt in an amount equal to 100% of the principal amount plus accrued and unpaid interest, on July 15,
2008, July 15, 2009, and July 15, 2011. If LibertyView elects to require us to purchase the Debt, we can elect to pay the repurchase price in cash, Ordinary Shares, or a combination thereof. The Debt is also subject to repurchase for
cash, at LibertyViews option and at a repurchase price equal to 100% of the principal amount plus accrued and unpaid interest, on the occurrence of certain events, including the following: (i) an acquisition of our company for cash only,
(ii) an acquisition of our company by another company whose market value is less than $25.0 million, (iii) if our Ordinary Shares are neither listed for trading on a U.S. national securities exchange nor approved for trading on The Nasdaq
Stock Market or any similar system of automated dissemination of quotations of securities prices, and (iv) if we become subject to bankruptcy or similar proceedings (regarding changes in the terms of the Debt, see also the August 8, 2005,
transaction with LibertyView below). In connection with the Debt, we agreed to file an F-3 Registration Statement covering the Ordinary Shares which may be issued upon conversion of the Debt within the earlier of (i) 60 days from the date of
the Debt, and (ii) 5 business days after the registration statement that was filed with the SEC prior to the date the Debt is declared effective by the SEC. In that respect, we have also agreed that in the event the F-3 is not filed on time or
not declared effective by the SEC within 90 days after it is filed, we will pay LibertyView cash compensation equal to 1% of the loan under the Debt for each month of delay (on a pro rated basis). On May 27, 2005, we entered into a letter
agreement with LibertyView under which we agreed to issue to LibertyView 10,000 of our Ordinary Shares and pay a cash amount of $40,000 as the sole and complete remedy for our inability to meet such registration deadlines. On June 29, 2005, we
entered into an additional letter agreement with LibertyView under which LibertyView agreed, for the period ending on January 1, 2006, to waive its right to require us to repurchase the debt if our Ordinary Shares are neither listed for trading
on a U.S. national securities exchange nor approved for trading on The Nasdaq Stock Market or any similar system of automated dissemination of quotations of securities prices. In connection with such waiver, we issued 2,000 of our Ordinary Shares to
LibertyView.
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During 2005, we raised approximately $3.5 million of cash, excluding transaction related expenses, in a
combination of convertible debt financing and private placement transactions for our Ordinary Shares. The transactions consisted of the following:



| |  |  | In February 2005, we completed a private placement of our Ordinary Shares to Telvent Investments, S.L., a current shareholder. In exchange for approximately $1.3
million, we issued 116,332 Ordinary Shares at a price of $11.435 per Ordinary Share.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | On August 8, 2005, we completed with LibertyView a private placement of our Ordinary Shares that involved (i) the issuance of 66,667 of our Ordinary
Shares for cash consideration of $700,000 at a price of $10.50 per Ordinary Share, (ii) the issuance of a warrant to purchase 23,333 Ordinary Shares at an exercise price of $10.50 per share, and (iii) cash of $480,000 in consideration for
an increase in the value of the Debt from $2.5 million to $2.98 million and a replacement of the loan under the Debt with a new debt, which is convertible at a fixed conversion price of $11.025 per Ordinary Shares into 270,295 Ordinary Shares.
Liberty View also has an option to require us to purchase the Debt in an amount equal to 100% of the principal amount plus accrued and unpaid interest, on July 15, 2008, July 15, 2009, and July 15, 2011.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | On September 28, 2005, we completed with the September 2005 Investor Group a private placement that involved (i) the issuance of 47,619 of our Ordinary
Shares for cash consideration of $500,000 at a price of $10.50 per Ordinary Share, (ii) the issuance of a warrant to purchase 32,540 Ordinary Shares at an exercise price of $10.50 per share, (iii) a debt for $500,000 which is convertible
at a fixed conversion price of $11.025 per Ordinary Share into 45,352 Ordinary Shares, and (iv) the issuance of 6,508 Ordinary Shares to one of the investors as a finders fee for this transaction. Under the terms of the convertible debt,
the Company may compel conversion of the debt prior to its maturity date.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

During 2006, we raised $1.35 million of cash,
excluding transaction related expenses, in private placement transactions for our Ordinary Shares, and we also converted $3.0 million of convertible debts to equity in the form of Ordinary Shares and Preferred A Shares. The transactions consisted of
the following:



| |  |  | On June 2, 2006, we converted $2.0 million of a convertible debt held by LibertyView to Preferred A Shares at an exercise price of $7.65 per Preferred A Share.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | On June 6, 2006, we completed a private placement of our Ordinary Shares with three existing shareholders and one new institutional investor. In exchange for
$1.35 million, we issued (i) 287,540 Ordinary Shares at a price of $4.695 per Ordinary Share and (ii) warrants to purchase 57,510 Ordinary Shares at an exercise price of $5.634 per Ordinary Share.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | On September 28, 2006, we converted the $0.5 million convertible debt held by the September 2005 Investor Group and all accrued interest thereon into 114,301
Ordinary Shares of the Company at a conversion price equal to the average closing price for the Companys shares for the twenty (20) day period prior to the maturity date of the Convertible Loan of $ 4.7025 per Ordinary Share per the
terms of the convertible debt.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | On November 30, 2006, LibertyView sold $0.5 million of its convertible debt to Jerusalem High-tech Founders, Ltd. (JHTF), a company controlled by
Samuel HaCohen, the Companys Chairman of the Board of Directors, and in which Vladimir Morgenstern, a member of the Companys Board of Directors, has an economic interest. Upon the sale of the debt, we signed an agreement with JHTF, which
was approved by our shareholders and consummated on December 29, 2006, to convert the $500,000 Convertible Debt to Preferred A Shares at an exercise price of $7.65 per Preferred A Share.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

During 2007, we raised approximately $1.2 million of cash, excluding transaction related expenses, in Ordinary shares, convertible note and warrants
financing transaction involving our Ordinary Shares. The transaction consisted of the following:



| |  |  | On December 19, 2007, we completed a private placement of our Ordinary Shares with a group of new financial investors (the Lewis Opportunitiy Fund
Group) that included (i) the issuance of 363,636 Ordinary Shares at a price of $1.65 per Ordinary Share for the consideration of $600,000, (ii) a non-interest bearing convertible note in the amount of $161,000 with a conversion price
of $1.65 per Ordinary Share, (iii) a non-interest bearing convertible note in the amount of $439,000 with a conversion price of $1.65 per Ordinary Share, subject to the Companys shareholders approval and (iv) warrants to
purchase an aggregate of 600,000 Ordinary Shares at an exercise price of $2.00 per Ordinary Share, subject to the Companys shareholders approval. The convertible note has no maturity date and can only be converted into Ordinary Shares.
The warrants have a callable feature whereby we can force the conversion of up to 50% of the warrants when all Ordinary Shares issued in connection with this new investment are registered with the SEC.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

On January 31, 2008 the Companys shareholders approved the issuance of the $439,000 convertible note and the warrants mentioned above.

On July 31, 2008 the Lewis Opportunity Fund Group signed an exercise letter in which they exercise warrants to purchase 300,000
Ordinary Shares at an exercise price of $2.00 per Ordinary Share and further undertook to transfer the exercise price no later than October 30, 2008.



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Bank Financing

In February 2002, our line of credit with Bank Hapoalim, under which we were able to borrow up to $6.0 million, was extended until January 31, 2003. On January 21, 2003, that line of credit was terminated
and the $3.45 million outstanding on that date was converted to a loan subject to re-payment by July 21, 2003. On July 14, 2003, Bank Hapoalim restructured this loan by converting $2.4 million of the $3.45 million short-term loan into a
long-term loan. The balance of $1.05 million was paid back by the end of November 2003. The $2.4 million long-term loan was payable quarterly in equal installments of $267,000 beginning on January 1, 2004, with interest payable quarterly at a
rate of LIBOR plus 2.75%. This debt arrangement was subject to certain conditions, which were replaced in connection with our March 2005 arrangement with Bank Hapoalim described below.

During March 2005, Bank Hapoalim agreed to provide us with an additional credit line in the amount of $1.0 million in addition to our existing overdraft
facility with Bank Hapoalim. The credit line can be drawn in either dollars or NIS with interest payable quarterly at rates ranging between LIBOR plus 2.25% in dollars or 8% in NIS. In addition, the bank agreed to cancel the existing covenants for
the long-term loan arrangement and replaced them with covenants that applied to our overall bank financing arrangement as follows: (i) our shareholders equity, on a quarterly basis, starting on January 1, 2006, shall be at least the higher
of (a) 17% of our total assets, or (b) $3.0 million, and (ii) our cash balance, on January 1, 2006 and on a quarterly basis thereafter, shall not be less than $2.0 million.

As consideration for the additional credit line, we issued to Bank Hapoalim a warrant to purchase 10,000 of our Ordinary Shares at an exercise price of
$10.30 per Ordinary Share.

On December 22, 2005, we refinanced our debt arrangement with Bank Hapoalim by converting $1.8 million of
the outstanding short-term borrowings at that time to long-term debt payable over three years in equal quarterly installments of $150,000, with the first payment due on April 1, 2006 and with interest payable quarterly at a rate of LIBOR plus
2.25%. In conjunction with the restructuring of our long-term debt, our overall bank financing arrangement with Bank Hapoalim became subject to the following covenants: (i) our shareholders equity, on a quarterly basis, shall be at least the
higher of (a) 17% of our total assets, or (b) $3.0 million, and (ii) our cash balance (a) shall not be less than $1.0 million, and (b) on a quarterly basis, shall not be less than $1.0 million. In connection with this
refinancing, we issued 6,000 Ordinary Shares at par value NIS 5.0 per share to Bank Hapoalim Limited and agreed to register these 6,000 Ordinary Shares as part of our commitment to the bank for this issuance.

During 2006 and through the second quarter of 2007, we received a waiver from Bank Hapoalim for each period in which we were not in compliance with these
bank covenants.

On August 29, 2007, Bank Hapoalim agreed to modify our bank covenant requirements as part of our overall bank
financing arrangement such that on a quarterly basis starting August 1, 2007 (i) our shareholders equity shall be at least the higher of (a) 13% of our total assets, or (b) $1.5 million, and (ii) our cash balance shall
not be less than $0.5 million. In addition, Bank Hapoalim provided us with a waiver of these new bank covenant requirements for the remainder of 2007. In connection with the modification of these waivers and bank covenant requirements, we agreed to
pay $10,000 of fees and issue 10,000 Ordinary Shares to the bank.

As of June 30, 2008, our aggregate outstanding borrowings with Bank
Hapoalim was approximately $2.2 million, which consisted of (i) short-term borrowings of approximately $1.7 million, of which $1.6 million is drawn in dollars with interest payable quarterly at a rate of LIBOR plus 2.25% and $0.1 million is
drawn in NIS with interest payable quarterly at a rate of approximately 9%, and (ii) the outstanding balance on our long-term loan arrangement with Bank Hapoalim of approximately $0.5 million with interest payable quarterly at a rate of LIBOR
plus 2.25%.

We were not in compliance with these covenants for each quarterly period during the first half of 2008. However, on
September 28 we received a waiver of these covenants from Bank Hapoalim for each quarterly period during the first half of 2008. Bank Hapoalim also provided us with a waiver of these covenants for the remainder of 2008 and for the first quarter
of 2009. In addition, on September 29, 2008, Bank Hapoalim agreed to convert the $1.6 million of short term loan that was due on January 2, 2009 to long-term loan, such that $0.1 million will be paid on July 2, 2009, an additional $0.1
million will be paid on August 15, 2009 and the balance of $1.4 million will be paid over 14 quarterly payments starting October 2, 2009. The interest will be paid quarterly at a rate of LIBOR plus 3.25%. In connection with these waivers
and the conversion of the short-term loan to a long-term loan, we agreed to pay fees of $30,000 to the bank.

To ensure compliance with the
bank covenants explained above, we are trying to control our cost structure while maximizing our cash collection efforts. However, in the event that we are unable to maintain compliance with the bank covenants, we may request a waiver from the bank.
If we breach the covenants and are unable to obtain a waiver, the bank may call in its loan or credit line. In such an event, we would need to seek alternate financing as we deem necessary for our business operations. However, we cannot provide
assurance that any such alternate financing would be available on terms acceptable to us or at all. See the risk factor entitled We will need sufficient funds to re-pay our loans from Bank Hapoalim, which may be subject to immediate repayment
if we do not meet our repayment schedule or meet specified conditions in Item 3, above.

Sale of Receivables

From time to time, we sell receivables to Bank Hapoalim and Phoenix Platinum Ltd. under arrangements in which each financial institution pays us the
amount of the accounts receivable less an agreed upon commission, and we irrevocably assign to the bank the accounts receivable sold without recourse to us. Our ability to sell such receivables in the future to these or other institutions on current
terms and conditions is uncertain and is dependent on the creditworthiness of the customers involved, the credit risks in the specific countries concerned and the institutions policies from time to time.

Cash

As of December 31, 2007, we had
cash and cash equivalents of $0.4 million, compared to $0.7 million as of December 31, 2006. In summary, the $0.3 million decrease in cash and cash equivalents is attributable to $1.1 million of net cash used in operating activities, $0.2
million of net cash used in investing activities, offset by $1.0 million of net cash provided by financing activities.

In 2007, net cash
used in operating activities was $1.1 million resulting from our net loss from operations of $3.8 million less (i) depreciation and amortization of $0.7 million, (ii) an increase in deferred revenues of $0.9 million, (iii) a loss from
the liquidation of our Japanese subsidiary of $0.2 million, (iv) stock based compensation of $0.3 million, (v) a decrease in other receivables and prepaid expenses of $0.3 million, (vi) an increase in trade payables and accrued
expenses of $0.2 million and (vii) an increase in accrued severance pay of $0.1 million. For 2006, net cash used in operating activities was $2.7 million, resulting primarily from our loss from operations net of depreciation and amortization of
$1.1 million, from income of $1.0 million from the extinguishment of convertible debts, and from the decrease in current liabilities such as deferred revenues of $0.9 million, trade payables and other payables of $0.7 million, offset by decreases in
current assets such as receivables and prepaid expenses of $0.5 million. Net cash used in operating activities was $3.7 million in 2005, primarily resulting from our loss from operations net of depreciation and amortization of $5.4 million.

Net cash used in investing activities during 2007 was $0.2 million, resulting from purchase of property and equipment. For 2006, net cash
used in investing activities was $30,000, resulting from purchase of property and equipment. Net cash used in investing activities was $0.2 million in 2005, primarily attributable to $0.1 million of cash used in connection with the acquisition of
e-Wise Solutions and approximately $0.1 million of capital equipment purchases.



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Net cash provided by financing activities during 2007 was approximately $1.0 million, which included $0.6
million of net proceeds raised in equity financing, $0.4 million of net proceeds raised from convertible note financings, and $0.6 million related to an increase in short-term bank credit, offset by $0.6 million of repayments against long-term bank
loans. Net cash provided by financing activities was $1.3 million in 2006, which included $1.3 million of net proceeds received in the sale of our Ordinary Shares, an increase in short-term bank credit with Bank Hapoalim of approximately $0.9
million, offset by the re-payment of short-term and long-term loans with Bank Hapoalim and a related party of approximately $0.9 million. Net cash provided by financing activities was $3.0 million in 2005, which included $2.7 million of cash raised
in the sale of our Ordinary Shares, $0.9 million of net proceeds raised in convertible note financings, and an increase in short-term bank credit with Bank Hapoalim of $0.6 million, offset by the re-payment of long-term debt with Bank Hapoalim of
approximately $1.1 million.

Future Cash Needs

In addition to our need to continue to meet our payment obligations to Bank Hapoalim under the terms of our debt arrangement, our capital requirements depend on numerous factors, including market demand and acceptance
of our products, the resources we devote to developing, marketing, selling and supporting our products, and the timing and extent of establishing additional international operations. We intend to continue investing significant resources in our
selling and marketing and research and development operations in the future. We believe that our cash and cash equivalents and funds generated from operations will be sufficient to finance our operations for at least until the end of 2008. Our
ability to achieve profitability using our currently available cash and cash equivalents will depend on our ability to increase our revenues while continuing to control our expenses. We cannot assure you that we will be able to achieve
profitability, particularly given the risk factors outlined earlier in this Form 20-F. If we are not successful doing so, we will be required to seek new sources of financing. If additional funds are raised through issuance of equity or debt
securities, these securities could have rights, preferences and privileges senior to those of holders of Ordinary Shares, and the terms of these securities could impose restrictions on our operations, and will result in additional dilution to our
shareholders. Our ability to raise additional secured debt may require the consent of Bank Hapoalim and LibertyView. The delisting of our Ordinary Shares from The Nasdaq Capital Market and the OTCBB could significantly impair our ability to raise
capital should we desire to do so in the future, as it may materially impair the market price and trading market for the Ordinary Shares received by investors in a financing transaction, even when quoted on the Pink Sheets.

Research and Development

We
believe that our future success depends, to a significant extent, on our ability to maintain and extend our technological leadership through our research and development activities. We employ product managers in our research and development
activities. These managers provide a critical interface between our research engineers and customer needs and industry developments. This interface helps focus our research and development personnel on developing market-driven applications. By using
information provided by our product managers, we can also manage our research and development resources to address perceived market trends.

Our research and development net expenditures for 2005, 2006 and 2007 were $2.5 million, $2.1 million and $2.3 million, respectively (see the paragraph headed We may be unable to maintain or expand our sales, marketing, research and
development and support organizations which may hinder our ability to grow and meet customer demands in the Risk Factors set forth in Item 3 above).

Research and Development Grants

We conduct our research and development activities primarily at our principal
offices in Israel. Our research and development efforts have been financed in the past, in small part, through grants from the OCS. Under these grants, royalties are payable to the OCS at the rate of 3% to 5% of revenues derived from products
developed by us according to those programs. The aggregate amount of royalties we could be obligated to pay would be up to 100% to 150% of the amount of grants received, with annual interest at the rate of LIBOR at the time of the grant.

The State of Israel does not own proprietary rights in technology developed with OCS funding and there is no restriction on the export of products
manufactured using technology developed with OCS funding. The technology is, however, subject to transfer restrictions, as described below. These restrictions may impair our ability to sell our technology assets or to outsource manufacturing and the
restrictions continue to apply even after we have paid the full amount of royalties payable for the grants. In addition, the restrictions may impair our ability to consummate a merger or similar transaction in which the surviving entity is not an
Israeli company.

The transfer to a non-Israeli entity of technology developed with OCS funding, including pursuant to a merger or similar
transaction, and the transfer of rights related to the manufacture of more than ten percent of a product developed with OCS funding are subject to approval by an OCS committee and to the following conditions:



| |  |  | Transfer of Technology. If the committee approves the transfer of OCS-backed technology, such a transfer would be subject to the payment to the OCS of a
portion of the consideration we receive for such technology. The amount payable would be a fraction of the consideration equal to the relative amount invested by the OCS in the development of such technology compared to our total investment in the
technology, but in no event less than the amount of the grant. However, in the event that in consideration for our transfer of technology out of Israel we receive technology from a non-Israeli entity for use in Israel, we would not be required to
make payments to the OCS if the approval committee finds that such transfer of non-Israeli technology would significantly increase the future return to the OCS.
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| |  |  | Transfer of Manufacturing Rights. The committee is authorized to approve transfers of manufacturing rights only if the transfer is conditioned upon either
(1) payment of increased aggregate royalties, ranging from 120% to 300% of the amount of the grant plus interest, depending on the percentage of foreign manufacture or (2) a transfer of manufacturing rights into Israel of another product
of similar or more advanced technology.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Merger or Acquisition. If the committee approves a merger or similar transaction in which the surviving entity is not an Israeli company, such a transaction
would be subject to the payment to the OCS of a portion of the consideration paid. The amount payable would be a fraction of the consideration equal to the relative amount invested by the OCS in the development of such technology compared to the
total investment in the company, net of financial assets that the company has at the time of the transaction, but in no event less than the amount of the grant.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

In the event that the committee believes that the consideration to be paid in a transaction requiring payment to the OCS pursuant to the provisions of
the law described above does not reflect the true value of the technology or the company being acquired, it may determine an alternate value to be used as the basis for calculating the requisite payments.

In 2001 and 2002, we received approvals for grants from the OCS in the amount of $372,000, which were received by us through December 31, 2003.
During 2005, 2006, and 2007 we made royalty payments of $2,000, $0, and $6,000 respectively, to the OCS related to these grants. As of December 31, 2007, we have an outstanding contingent liability to pay royalties in the amount of
approximately $387,000, including interest.



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Impact of Inflation

Since our revenues are generated in United States dollars and currencies other than New Israeli Shekels (NIS), and a portion of our expenses is incurred and will continue to be incurred in NIS, we are exposed to risk
by the amount that the rate of inflation in Israel exceeds the rate of devaluation of the NIS in relation to the dollar and other currencies. We are also exposed to risk if the timing of the devaluation lags behind inflation in Israel. In 1994, 1995
and 1996, the inflation rate in Israel exceeded the rate of devaluation of the NIS against the dollar and other currencies. This trend was reversed during 1997 and 1998. In 1999 and in 2000, while the rate of inflation was low, there was a
devaluation of the dollar against the NIS, and in 2001 the rate of devaluation of the NIS against the dollar exceeded the rate of inflation. In 2002, the devaluation of the NIS against the dollar was similar to the rate of inflation. In 2003 and
2004, the NIS gained in value against the dollar while the rate of inflation was negative. In 2004, the NIS gained 2% in value against the dollar while the rate of inflation was 1%. In 2005, the NIS lost 6.7% in value against the dollar while the
rate of inflation was 2.4%. In 2006, the NIS gained 8.2% in value against the dollar while the rate of inflation was -0.1%. In 2007, the NIS gained 9% in value against the dollar while the rate of inflation was - 0.4%. We generally do not engage in
any hedging or other transactions intended to manage risks relating to foreign currency exchange rate or interest rate fluctuations. We also do not own any market risk sensitive instruments. However, we may in the future undertake hedging or other
transactions or invest in market risk sensitive instruments if we determine that it is necessary to offset these risks.

Effective Corporate Tax Rate

Our effective corporate tax rate will reflect a mix of the United States, United Kingdom, Australian and Israeli statutory tax
rates on our United States, United Kingdom , Australian and Israeli income. The Israeli corporate tax rate has been gradually reduced as follows: 2004  35%, 2005  34%, 2006  31%, It is currently 27% in 2008, and will be reduced
over the coming the years as follows: 2009  26% and 2010 and thereafter  25%. The majority of our income, however, is derived from our two investment programs with approved enterprise status under the Law for the Encouragement of Capital
Investments and is eligible for some tax benefits, subject to certain conditions and restrictions. However, the benefits status of one of the programs expires in 2008.

Under our investment programs we will enjoy a tax exemption on income derived during the first ten years in which these investment programs produce taxable income after the commencement of production, provided that we
do not distribute the income as dividends. All of these tax benefits are subject to various conditions and restrictions.

See the
discussion in the Tax section in Item 10.

As of December 31, 2007, we had net operating loss carryforwards for tax reporting
purposes of approximately $7.2 million in the United States, $30.3million in Israel, $18.2 million in the United Kingdom, and $0.2 million in Australia. In the United States, the internal revenue code limits the use in any future period of net
operating loss carryforwards following a significant change in ownership interests. Since we have incurred tax losses through December 31, 2007, we have not used these net operating losses. In April 2007, we dissolved our Japanese subsidiary,
ViryaNet Japan KK, and the net operating loss carryforward of approximately $1.2 million was extinguished as part of the dissolution.

Trend Information

Our quarterly results of operations related to revenues may be subject to significant fluctuations due to several
factors, primarily the timing of large orders, which represent a significant percentage of our revenues, and other factors, customer budget cycles and impact on the timing for buying decisions, competitive pressures, the ability of our partners to
become effective in selling and marketing our products, and other factors.

As a percentage of our total revenue, our software license
revenue decreased from 12.1% in 2005 to 11.0% in 2006. This decline is attributable to reduced sales of new licenses to customers while recurring revenues from existing customers related to professional services and post-contract maintenance and
support which are not dependent on the sales of new licenses, were essentially flat year to year. During 2007, our total revenues declined by 19.5% compared to 2006 while our software license revenue grew 16.4% from $1.5 million in 2006 to $1.7
million in 2007 and increased from 11.0% of total revenue in 2006 to 15.9% of total revenue in 2007. While growth of our software license revenues is a good indicator of buying interest in our products and adds favorably to our gross margins and
profitability, a portion of the increase in mix from 11.0% to 15.9% was also due to a 23.9% reduction in the amount of revenues from services which declined from $12.3 million in 2006 to $9.4 million in 2007. The decline in our services revenues is
not directly related to any changes in the amount of our software license sales but more related to the completion of some large professional services engagements that began in 2006 and did not contribute as much revenue in 2007.

In general, we do not believe that declines in revenue from software as a percentage of total revenue will have an impact on our future maintenance and
services revenue or our business as a whole since we expect to sell licenses in the future which will generate more professional services and maintenance and support revenue in addition to recurring services revenue with existing customers, assuming
that our existing customers continue to purchase additional services and renew post-contract support from us.

For information about our
expectations regarding our future cost of revenues, future operating expenses and liquidity and capital resources, please see the discussion under the Risk Factors section of Item 3 and the Operating Results section and
the Liquidity and Capital Resources section of Item 5.

Off-balance Sheet Arrangements

Other than potential royalty payments to the OCS, we are not party to any material off-balance sheet arrangements.

Tabular Disclosure of Contractual Obligations



|                                                    |  |                                          |       |                  |   |             |  |             |     |  |   |    
|--------------------------------------------------- |  | ---------------------------------------- | ----- | ---------------- | - | ----------- |  | ----------- | --- |  | - | ---
|Contractual Obligations as of December 31, 2007 (1) |  | Payments due by Period(US$ in thousands)
|                                                    |  | Total                                    |       | One Yearor Less |   | 1  3 Years |  | 4  5 Years
|Short-term bank debt                                |  | $                                        | 1,815 |                  | $ | 1,815       |  | $           |    |  | $ |   
|Long-term bank debt (1)                             |  | $                                        | 738   |                  | $ | 589         |  | $           | 149 |  | $ |   
|Long-term convertible debt (1)                      |  | $                                        | 480   |                  | $ | 480         |  | $           |    |  | $ |   
|Operating leases (2)                                |  | $                                        | 1,353 |                  | $ | 647         |  | $           | 706 |  | $ |   
|Accrued severance pay, net (3)                      |  | $                                        | 573   |                  | $ |            |  | $           |    |  | $ | 573
|Uncertain income tax position (4)                   |  | $                                        | 68    |                  | $ |            |  | $           |    |  | $ |   
|Total Contractual Cash Obligations:                 |  | $                                        | 5,027 |                  | $ | 3,531       |  | $           | 855 |  | $ | 573



|(1) | See Liquidity and Capital Resources Bank Financing.
|--- | -----------------------------------------------------



|(2) | Includes leases for facilities and automobiles.
|--- | -----------------------------------------------



|(3) | Severance pay relates to accrued severance obligations to our Israeli employees as required under Israeli labor law. These obligations are payable only upon termination, retirement
or death of the respective employee and there is no obligation if the employee voluntarily resigns. See also Note 2 to our financial statements for further information regarding accrued severance pay.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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|(4) | Uncertain income tax position under FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, (FIN 48) are due upon settlement and we are
unable to reasonably estimate the ultimate amount or timing of settlement. See Note 14 of the Notes to Consolidated Financial Statements for further information regarding the Companys liability under FIN 48.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Operating Leases

Payments under
non-cancelable operating lease agreements for facilities expire on various dates through 2011. As of the date hereof, our annual aggregate lease obligations for facilities for the period 2008 through 2011 are $395,000, $188,000, $190,000, and
$95,000, respectively.



|Item 6. | Directors, Senior Management and Employees
|------- | ------------------------------------------

Directors and Senior Management



|                      |  |     |  |                                             
|--------------------- |  | --- |  | --------------------------------------------
|Name                  |  | Age |  | Position                                    
|Samuel I. HaCohen     |  | 51  |  | Executive Chairman of the Board of Directors
|Memy Ish-Shalom       |  | 48  |  | President and Chief Executive Officer       
|Jeffrey J. Oskin      |  | 38  |  | Chief Operating Officer                     
|Nir Diskin            |  | 41  |  | Vice President, Development                 
|Mark Hosking          |  | 44  |  | Manager, ViryaNet Australia                 
|Vladimir Morgenstern  |  | 50  |  | Director                                    
|Arie Ovadia           |  | 59  |  | Director                                    
|Manuel Sanchez Ortega |  | 44  |  | Director                                    
|Nati Perry            |  | 54  |  | Director                                    
|Ronit Lerner          |  | 38  |  | Director                                    

Samuel I. HaCohen co-founded ViryaNet in March 1988. Since March 1988, Mr. HaCohen has
served as our chairman of the board of directors. From March 1988 until February 2001, Mr. HaCohen served as our chief executive officer and as the chairman of the board of directors. Before co-founding ViryaNet, Mr. HaCohen held senior
systems management positions in John Bryce Systems Ltd., a software company, and the Hadassah Hospital, Jerusalem. Mr. HaCohen holds a Bachelor of Science degree in computer science and statistics from the Hebrew University of Jerusalem and has
completed all course work for a Master of Science degree in statistics from the Hebrew University of Jerusalem.

Memy Ish-Shalom has
served as ViryaNets president and chief executive officer since January 2006 and as our chief operating officer from February 2001 until November 2002. Prior to rejoining ViryaNet, Mr. Ish-Shalom served as the chief executive officer of
Wadago, Ltd., an Israeli based privately held company that has developed a product set for enabling visibility and control for file-based application integration. Prior to Wadago, Ltd., Mr. Ish-Shalom was a co-founder and served as the chief
operating officer of Guardium Inc., a privately held company that develops and delivers innovative database security solutions for IBM, Oracle, Microsoft, and Sybase environments based in Waltham, Massachusetts. Mr. Ish-Shalom served as vice
president of customer care and billing at Amdocs from April 2000 until November 2000. During the period from May 1989 until April 2000, Mr. Ish-Shalom was employed at ViryaNet and served in a number of senior management positions, including
research and development manager, general manager of Israeli operations, and executive vice president of engineering. Mr. Ish-Shalom holds a Bachelor of Science degree in computer science from the Hebrew University of Jerusalem.

Jeffrey J. Oskin rejoined ViryaNet in January 2005 as the vice president of international, responsible for our international subsidiaries, and was
promoted to chief operating officer in January 2006. Mr. Oskin has more than 15 years of business experience with high technology and service-oriented organizations. Prior to rejoining ViryaNet, Mr. Oskin was vice president of sales at
Commerce Technologies, a provider of e-commerce solutions to the retail and manufacturing industries. During his previous tenure with ViryaNet from October 1998 to January 2004, Mr. Oskin held a number of executive positions, including as vice
president of sales for North America. Prior to ViryaNet, Mr. Oskin held a number of positions at high tech companies, including Teradyne, a leading supplier of automated test equipment to semiconductor manufacturing companies, where he managed
a global service operation. Mr. Oskin holds a Bachelor of Science in mechanical engineering from Rensselaer Polytechnic Institute and an MBA from Boston University.

Nir Diskin has served as our vice president of engineering since September 2005 and is responsible for leading ViryaNets diverse worldwide development team. Previously, Mr. Diskin held a number of
management positions within our research and development organization and was promoted to vice president of product management in 2000. Prior to joining ViryaNet in 1996, Mr. Diskin served as a major in the Israeli Air Force where he held
positions of leadership and participated in avionics software development. Mr. Diskin holds a Bachelor of Science degree in computer science from the Hebrew University in Jerusalem.

Mark Hosking joined the Company in June 2005 from e-Wise Solutions and currently serves us in our ViryaNet Australia subsidiary. Mr. Hosking
founded e-Wise Solutions in June 1998 and served as the chief executive officer and chief technical officer. Prior to the founding of e-Wise Solutions, Mr. Hosking was a senior manager at Ipex Computers Australia, a systems integrator that grew
from 40 to 450 employees during his tenure. Mr. Hosking holds a Bachelor of Science degree in Electrical Engineering from Melbourne University of Victoria, Australia.

Vladimir Morgenstern co-founded the Company with Mr. HaCohen. He has served as one of the Companys directors since July 1999.
Mr. Morgenstern currently serves as a business and technology advisor to several start-up companies and is a senior architect at EMC Software. From November 1999 until October 2001, Mr. Morgenstern served as the Companys executive
vice president, corporate programs. Mr. Morgenstern served as the Companys technical manager and chief technology officer from March 1988 until November 1999. Before co-founding ViryaNet, Mr. Morgenstern held senior systems
management positions at John Bryce Systems Ltd. and the Hadassah Hospital, Jerusalem. Currently, Mr. Morgenstern is a senior architect at EMC Software. Mr. Morgenstern holds a Bachelor of Science degree in physics from Vilnius University
in Lithuania and has completed all course work for a Master of Science degree in applied mathematics.

Arie Ovadia advises major
Israeli companies on finance, accounting and valuations and is a member of the board of directors of several corporations, including Israel Discount Bank, Phoenix Insurance Company, Elite Industries, Israel Petrochemical Industries and Tadiran
Communications. He has taught at New York University (New York, NY), Temple University (Philadelphia, PA) and, in Israel, at Tel Aviv and Bradford Universities. Dr. Ovadia serves as a member of the Israeli Accounting Board and is a 15-year
member of the Israeli Security Authority. He holds an undergraduate degree and an MBA from Tel Aviv University and earned his PhD in economics from the Wharton School at the University of Pennsylvania.

Manuel Sanchez Ortega has served as a director of ViryaNet since October 2003. Mr. Sanchez currently serves as the chairman and chief
executive officer of Telvent GIT, S.A. (Nasdaq: TLVT), a global information technology company based in Madrid, Spain. From 2000 to 2001, Mr. Sanchez was the general manager of Telvent Energia Y Medio Ambiente, a subsidiary of Telvent focused
on the energy and environmental markets. From 1995 to 1999, Mr. Sanchez was the general manager for Telvent Mexico. Prior to his employment with Telvent Mexico, Mr. Sanchez served as a manager in Telvent Energia y Medio Ambiente.
Mr. Sanchez received a Bachelor of Science degree in electrical engineering from the Universidad Pontificia Comillas (ICAI) of Madrid, and a Masters degree in Business Administration from the IPADE of Mexico.



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Nati Perry has served as a director of ViryaNet since December 2007. Mr. Perry is the former
founder and chief executive officer of Barak I.T.C., a leading ISP and telephony company based in Israel. Prior to becoming chief executive officer, Mr. Perry also served as the chief operating officer, and vice president of engineering since
founding Barak I.T.C in 1997. Prior to Barak I.T.C., Mr. Perry was with the Israeli Air Force since 1984 and served as the head of several departments of the Air Force including communications, planning and logistics. Mr. Perry received
his Bachelor of Science degree in electrical engineering from Ben-Gurion University of Negev, Israel in 1981, and his Master of Science degree in Teleprocessing from USM University in the United States in 1984.

Ronit Lerner has served as a director of ViryaNet since November 2003. Earlier this year, Ms. Lerner joined Compugen Ltd, a research company
that commercializes drug and diagnostics discovery based in Israel, as the chief financial officer. Prior to joining Compugen, Ms. Lerner served as the chief financial officer of Shunra Ltd., a privately held software company based in Israel.
Before joining Shunra in March 2006, Ms. Lerner was the chief financial officer of BMC Software Israel Ltd., a subsidiary of BMC Software, Inc. from July 2002 to March 2006. Prior to BMC, Ms. Lerner served as the director of mergers,
acquisitions and accounting for ECI Telecom from 2000 until July 2002. Ms. Lerner joined the Israel accounting standards board, an affiliate of the Israel Securities Authority, at its inception in 1997 and served as a manager and senior
research supervisor. During the period of 1996 to 2004, Ms. Lerner taught accounting at the Tel Aviv University. From 1994 to 1997, Ms. Lerner served as a senior manager at KPMG. Ms. Lerner received a Bachelor of Arts degree in
Business Administration and Accounting from Tel Aviv Management College and received a Master in Business Administration in Finance, with honors, from Bar Ilan University. Ms. Lerner is a certified public accountant in Israel.

Compensation

The aggregate remuneration we
paid for the year ended December 31, 2007 to our directors and executive officers as a group was approximately $1.47 million in salaries, fees, commissions and bonuses. Included in this amount is remuneration of approximately $0.28 million to
one of our former executive officers and to one of our former directors. The aggregate amount set aside or accrued during 2007 to provide pension, retirement or similar benefits for directors and officers of our company, pursuant to any existing
plan provided or contributed to by us, was approximately $13,000.

On November 26, 2003, our shareholders approved a compensation plan
for our directors who are not executive officers. For each calendar year, any non-executive director attending any of the five (5) scheduled meetings of the Board of Directors is entitled to receive $1,000 for each meeting attended in person,
or $500 for each meeting attended by phone only. On November 29, 2005, a revised compensation plan for our directors who are not executive officers was approved by shareholders and became effective on January 1, 2006. The revised
compensation plan includes (i) an annual fixed retainer of $3,000 for each member of the Board of Directors, (ii) an annual fixed retainer of $3,000 for each member of the Audit Committee of the Board of Directors, and (iii) a fee of
$1,000 per meeting for each of the four (4) scheduled meetings of the Board of Directors and Audit Committee during each calendar year, whether participation for such meeting is attended in person or via phone. Participation in all other
meetings of the Board of Directors or the audit committee does not entitle any director to additional compensation. All directors are reimbursed for their reasonable expenses incurred for each Board of Directors or committee meeting attended in
person. With respect to our external directors, such compensation and reimbursement of expenses are made in accordance with the applicable provisions of the Companies Law. For additional information, please see the discussion under the heading
External Directors; Independent Directors.

During 2007, 26,700 restricted shares were granted to our executive officers. These
restricted shares were granted for no consideration and the restrictions on these shares lapse at a rate of 50% per year over two years from the date of grant. No restricted shares were granted to our directors during 2007.

On January 31, 2008 our shareholders approved a grant of 90,000 restricted shares to our directors.

All the restricted shares were granted for no consideration and the restrictions on these shares lapse at a rate of 50% per year over two years from the date of grant. All restricted shares granted to executive
officers and directors are released from restriction upon the consummation of merger, acquisition or similar transaction.

Board Practices

The following table sets forth certain information concerning our current
directors and executive officers:



|                         |  |                                              |  |                       |  |                                  
|------------------------ |  | -------------------------------------------- |  | --------------------- |  | ---------------------------------
|Name                     |  | Current Office(s) Held                       |  | Commencementof Office |  | Termination/RenewalDate of Office
|                         |  |                                              | 
|Samuel I. HaCohen        |  | Executive Chairman of the Board of Directors |  | March 1998            |  | 2008 Annual Meeting              
|                         |  |                                              | 
|Memy Ish-Shalom          |  | President and Chief Executive Officer        |  | January 2006          |  | Not applicable                   
|                         |  |                                              | 
|Jeffrey J. Oskin         |  | Chief Operating Officer                      |  | January 2006          |  | Not applicable                   
|                         |  |                                              | 
|Nir Diskin               |  | Vice President, Engineering                  |  | January 2006          |  | Not Applicable                   
|                         |  |                                              | 
|Mark Hosking             |  | Manager, ViryaNet Australia                  |  | June 2005             |  | Not applicable                   
|                         |  |                                              | 
|Vladimir Morgenstern (2) |  | Director                                     |  | July 1999             |  | 2008 Annual Meeting              
|                         |  |                                              | 
|Arie Ovadia (1),(2),(3)  |  | Director                                     |  | December 2006         |  | 2009 Annual Meeting              
|                         |  |                                              | 
|Manuel Sanchez Ortega    |  | Director                                     |  | October 2003          |  | 2008 Annual Meeting              
|                         |  |                                              | 
|Nati Perry (2), (3)      |  | Director                                     |  | December 2007         |  | 2010 Annual Meeting              
|                         |  |                                              | 
|Ronit Lerner (1),(2),(3) |  | Director                                     |  | November 2003         |  | 2009 Annual Meeting              



|(1) | External Directors under the Companies Law
|--- | ------------------------------------------



|(2) | Member of Audit Committee
|--- | -------------------------



|(3) | Independent Directors
|--- | ---------------------

Other than our employment
agreement with Mr. HaCohen, we do not have any employment or service contracts with our directors that provides for benefits upon termination of employment. Mr. HaCohens employment agreement contains various provisions, including
provisions relating to acceleration of his options and/or restricted shares upon a change in the control of our company. In addition, he is entitled to 6 months of severance benefits in the event we terminate his employment without cause, under the
circumstances provided in his employment agreements or in the event that he resigns due to a demotion.

Our Articles of Association provide
that directors are elected at our annual general meeting of the shareholders by a vote of the holders of a majority of the voting power represented at that meeting. Each director, except for the external directors under the Companies Law as
described below, holds office until the next annual general meeting of the shareholders.



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External Directors; Independent Directors

Companies Law

We are subject to the provisions
of the Companies Law. Under the 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. Mr. Ovadia and
Ms. Lerner serve as our external directors.

Who May Be Appointed

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 that date, any affiliation with the company, any entity or person controlling the company or any entity controlled by
the company or by a controlling shareholder of the company. The term affiliation includes:



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



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



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



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

Under
the Companies Law, at least one of the external directors serving on a companys board of directors is required to have financial expertise and the other external director or directors are required to have professional
expertise. A director is deemed to have professional expertise if he or she either (i) has an academic degree in economics, business management, accounting, law or public service, (ii) has an academic or other degree or
completed another higher education, all in the field of business of the company or relevant for his/her position, or (iii) has at least 5 years experience as either a senior managing officer in the companys line of business with a
significant volume of business, a public office, or a senior position in the companys main line of business. A director with financial expertise is a director that due to his education, experience and skills has a high expertise
and understanding in financial and accounting matters and financial statements, in such a manner which allows him to deeply understand the financial statements of the company and initiate a discussion about the presentation of financial data. We
believe that our external directors meet these new conditions.

Conflicts of Interest

No person can serve as an external director if the persons position or other business creates, or may create conflicts of interests with the
persons responsibilities as an external director or may impair his ability to serve as an external director. Until the lapse of two years from termination of office of an external director, for any reason, a company may not engage such former
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.

How External Directors Are Elected

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



| | (a) | the majority of the shares voted at the meeting, including at least one third of the shares of non-controlling shareholders or their representatives voted at the meeting, vote in
favor of the election; or
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (b) | the total number of shares of non-controlling shareholders voted against the election of an external director does not exceed one percent of the aggregate voting rights in the
company.
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Term of Service

The initial term of an external director is three years and may be extended by the shareholders for an additional three years. If, when we elect an external director, all of our directors are of the same gender, then the next external
director must be of the other gender. Each committee exercising powers of the Board of Directors is required to include at least one external director and the audit committee of the Company is required to include all external directors.

Independent Directors.

Our Ordinary Shares
are no longer listed for quotation on The Nasdaq Capital Market and are no longer subject to the rules of The Nasdaq Capital Market applicable to quoted companies. However, we continue to follow certain Nasdaq rules, one of which is the requirement
to appoint a minimum of three independent directors. The independence standard under the Nasdaq rules excludes any person who is a current or former employee of a company as well as the immediate family members of an executive officer of a company.
Messrs. Ovadia and Perry, and Ms. Lerner serve as independent directors and meet the independence standard of the Nasdaq rules.

Audit Committee

Nasdaq Rules and Companies Law

Our Board of Directors has formed an audit committee. The audit committee exercises the powers of the Board of Directors for our accounting, reporting and financial control practices. Under the Companies Law, both of the external directors
should be members of the Audit Committee. Messrs. Ovadia and Perry, and Ms. Lerner are members of our audit committee

Under the
Companies Law, the Board of Directors of any company that is required to nominate external directors must also appoint an audit committee. The Companies Law requires that the audit committee be comprised of at least three directors, including all of
the external directors, but excluding:



| |  |  | a chairman of the Board of Directors;
| | - |  | -------------------------------------



| |  |  | a controlling shareholder or the relative of a controlling shareholder; or
| | - |  | --------------------------------------------------------------------------



| |  |  | any director employed by the company, or who provides services to the company on a regular basis.
| | - |  | -------------------------------------------------------------------------------------------------

Role of Audit Committee

Under the Nasdaq rules and
the Sarbanes-Oxley Act, the audit committee (i) has the sole authority and responsibility to select, evaluate, and, where appropriate, replace the companys independent auditors, (ii) is directly responsible for the appointment,
compensation and oversight of the work of the independent auditors for the purpose of preparing its audit report or related work, and (iii) is responsible for establishing procedures for (A) the receipt, retention and treatment of
complaints received by the company regarding accounting, internal accounting controls or auditing matters, and (B) the confidential, anonymous submission by employees of the company of concerns regarding questionable accounting or auditing
matters. The audit committee is required to consult with management but may not delegate these responsibilities.



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The roles of our audit committee under the Companies Law include identifying irregularities in the
management of the companys business and approving related party transactions as required by law.

In addition to such functions as
the audit committee may have under the Companies Law or under the Nasdaq rules, the primary purpose of our audit committee, including pursuant to other responsibilities with which it is charged under the Sarbanes-Oxley Act, is to assist the board of
directors in fulfilling its responsibility to oversee managements conduct of the financial reporting process, the systems of internal accounting and financial controls and the annual independent audit of the companys financial
statements. The audit committee reviews with management and our outside auditors the audited financial statements included in our Annual Report on Form 20-F and our interim quarterly financial results included on Form 6-K.

In discharging its oversight role, our audit committee is empowered to investigate any matter brought to its attention with full access to all books,
records, facilities and personnel of our company and the power to retain outside counsel, auditors or other experts for this purpose.

Conflicts of
Interest

An audit committee of a public company may not approve an action or a transaction with an interested party, an office
holder, a controlling shareholder, or an entity in which they have a personal interest unless at the time of approval the two external directors are serving as members of the audit committee and at least one of the external directors was present at
the meeting in which an approval was granted.

Employees

As of December 31, 2007, we had 32 employees in Israel, 46 in the United States, 9 in Australia, and 1 in Singapore. Of our 88 employees, 23 were
engaged in research and development, 13 in sales, marketing and business development, 43 in professional services and technical support and 9 in finance, administration and operations. None of our employees is represented by a labor union.

We are not a party to any collective bargaining agreement with our employees. However, some provisions of the collective bargaining
agreement between the Histadrut, the General Federation of Labor in Israel, and the Coordination Bureau of Economic Organizations, including the Industrialists Association of Israel, are applicable to our Israeli employees under expansion
orders of the Israeli Ministry of Labor and Welfare. These provisions principally concern the length of the work day and the work week, minimum wages for workers, contributions to pension funds, insurance for work-related accidents, procedures for
dismissing employees and determination of severance pay. Under these provisions, the wages of most of our employees are automatically adjusted based on changes in the Israeli consumer price index. The amount and frequency of these adjustments are
modified occasionally. We consider our relationship with our employees to be good and have never experienced a strike or work stoppage.

We
have to comply with various labor and immigration laws throughout the world, including laws and regulations in Israel, the United States, Australia, and Singapore. Compliance with these laws has not been a material burden for us. If the number of
our employees increases over time, our compliance with these regulations could become more burdensome.

Share Ownership

As of July 15, 2008, the aggregate number of our Ordinary Shares and Ordinary Shares which may be issued upon conversion of Preferred
A Shares beneficially owned by our directors and executive officers as a group was 836,828, and includes options and warrants to purchase up to 66,440 Ordinary Shares which are exercisable or will become exercisable within 60 days of July 15,
2008 (The above number does not take into effect restricted Ordinary shares, that were granted to executive officers and directors, which will be released from restriction within more than 60 days of July 15, 2008).

The aggregate number of our Ordinary Shares beneficially owned by our directors and executive officers as a group includes Ordinary Shares held by
Telvent since an affiliate of Telvent serves on our Board of Directors and, accordingly, such designee may be deemed to be the beneficial owner of the Ordinary Shares held by Telvent. Such designee disclaims beneficial ownership of such shares. See
Major Shareholders and Related Party Transactions in Item 7 below.

The aggregate number of our Ordinary Shares
beneficially owned by our directors and executive officers as a group also includes Ordinary Shares as well as Preferred A Shares held by Jerusalem High-tech Founders, Ltd. since two of its affiliates serve on our Board of Directors and,
accordingly, such designees may be deemed to be the beneficial owners of the Ordinary Shares held by Jerusalem High-tech Founders, Ltd. See Major Shareholders and Related Party Transactions in Item 7 below.

As of July 15, 2008, stock options to purchase up to 53,660 Ordinary Shares granted to our directors and executive officers were outstanding and
102,467 restricted Ordinary Shares, granted to our directors and executive officers, were not released from restrictions, under our option plans. The weighted average exercise price of these stock options was $9.75 per Ordinary Share and the
restricted Ordinary Shares were granted for no consideration. As of July 15, 2008, stock options to purchase 53,660 Ordinary Shares are exercisable within 60 days of July 15, 2008 (no restricted Ordinary Shares included as the restrictions
are not released within 60 days of July 15, 2008).

As of July 15, 2008, we had approximately 500 shareholders of record.

Option Plans

We maintain three option
plans, , the 1998 Stock Option and Incentive Plan, the 1999 Stock Option and Incentive Plan and the 2005 Share Option Plan. The purpose of the option plans is to afford an incentive to our officers, directors, employees and consultants, or any of
our subsidiaries, to acquire a proprietary interest in us, to continue as officers, directors, employees and consultants, to increase their efforts on behalf of ViryaNet and to promote the success of our business.

The 1996 Stock Option and Incentive Plan the 1997 Stock Option and Incentive Plan and the 1998 Stock Option and Incentive Plan have expired. The 60,068
Ordinary Shares that were still available for grants of additional options under these plans were transferred to the 1999 Stock Option and Incentive Plan.

The 1999 Stock Option and Incentive Plan

In 1999, we adopted the 1999 Stock Option and Incentive Plan and reserved
options to purchase an aggregate of 60,000 Ordinary Shares for issuance and transferred an additional 60,068 Ordinary Shares to the 1999 Stock Option and Incentive Plan from the 1996 Stock Option and Incentive Plan, the 1997 Stock Option and
Incentive Plan and the 1998 Stock Option and Incentive Plan.

In June 2001, November 2003, December 2004, and November 2005, our
shareholders approved the reservation of options to purchase additional Ordinary Shares in the amounts of 60,000, 40,000, 70,000, and 30,000, respectively, for an aggregate additional amount of 200,000 Ordinary Shares to be granted under the 1999
Stock Option and Incentive Plan.



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As of July 15, 2008, options to purchase 102,404 Ordinary Shares were outstanding under the 1999
Stock Option and Incentive Plan, options to purchase 36,531 Ordinary Shares had been exercised into Ordinary Shares. Additional Ordinary Shares in the amount of 189,063 that were available for grants of additional options were transferred to the
2005 Share Option Plans.

On December 30, 2005, we accelerated the vesting of 27,975 unvested stock options outstanding as of
December 30, 2005, with an exercise price equal to or greater than $ 8.20 per share, which were held by our employees, including officers. As a result, these unvested stock options became fully exercisable effective as of December 30,
2005, rather than becoming exercisable at the later dates when such options would have otherwise vested in the normal course. Our stock options have generally vested over two to four-year period.

The decision to accelerate the vesting of these stock options was made primarily to reduce compensation expense that otherwise would have been required
to be recorded in future periods following our adoption in the first quarter of 2006 of Statement of Financial Accounting Standards No. 123(R), Share-Based Payment (SFAS 123(R)) (see also Note 2 of our consolidated
financial statements included in this annual report).

The 2005 Share Option Plans

The tax rules and accounting regulations regarding the grant of share-based awards have changed significantly since we adopted our 1999 Stock Option and
Incentive Plan. Therefore, our Board of Directors believed that it was appropriate for us to adopt and approve, subject to shareholders approval, a new form of Israeli share option and restricted share plan and a new form of international
share option and restricted share plan (the 2005 Share Option Plans), which will supersede and replace all existing options plans, including the 1999 Stock Option and Incentive Plan. The 2005 Share Option Plans were approved by
shareholders at our annual general meeting held on November 29, 2005.

The 2005 Share Option Plans provide for the grants of options, restricted
shares and other share based awards to employees, directors, office holders, service providers, consultants and any other person or entity whose services our Board of Directors shall decide are considered valuable to us
or our affiliates. The 2005 Share Option Plans provides for the grant of incentive stock options (options that qualify for special tax treatment under Section 422 of the U.S. Internal Revenue Code), nonqualified stock options,
102 Share Options (options that qualify for special tax treatment under Section 102 of the Israeli Tax Ordinance (New Version) 1961 (the Ordinance)), 102 Shares (shares that qualify for special tax
treatment under Section 102 of the Ordinance) 3(I) Stock Options (options subject to tax treatment under Section 3(I) of the Ordinance), restricted shares and other share based awards.

Any options that remain available for grants under any of the Companys stock option plans shall be available for subsequent grants of awards
under the 2005 Share Option Plans. In addition, if any outstanding award under the Companys existing option plans should, for any reason, expire, be canceled or be forfeited without having been exercised in full, the shares
subject to the unexercised, canceled or terminated portion of such award shall become available for subsequent grants of awards under the 2005 Share Option Plans.

As of July 15, 2008, grants of 289,000 restricted shares to purchase Ordinary Shares were outstanding under the 2005 Share Option Plans, 47,700
Ordinary Shares were granted without restrictions, and 42,960 additional Ordinary Shares were available for grants under the 2005 Share Option Plans.

Administration of Our Option Plans

Our share option plans are administered by the Board of Directors. Under the
share option plans, options to purchase our Ordinary Shares or restricted shares may be granted to the officers, directors, employees or consultants of ViryaNet or of any of our subsidiaries. Under the share option plans, the exercise price of
options shall be determined by the Board of Directors. The Board of Directors also determines the vesting schedule of the options and the restricted shares, but generally the options and the restricted shares vest over a two to four year period.
Each option granted under the share option plans is exercisable, unless extended, until seven years from the date of the grant of the option. The 2005 Share Option Plans will expire on December 31, 2015.



|Item 7. | Major Shareholders and Related Party Transactions
|------- | -------------------------------------------------

Major Shareholders

The following table summarizes information about the beneficial ownership of
our outstanding Ordinary Shares as of July 15, 2008 for each person or group that we know owns more than 5% of our outstanding Ordinary Shares.

We determine beneficial ownership of shares under the rules of the Securities and Exchange Commission and include any Ordinary Shares over which a person exercises sole or shared voting or investment power, or of
which a person has the right to acquire ownership at any time within 60 days of July 15, 2008. Except as otherwise indicated, and subject to applicable community property laws, the persons named in the table have sole voting and investment
power for all Ordinary Shares held by them. Applicable percentage ownership in the following table is based on 3,021,489 shares outstanding as of July 15, 2008, including 326,798 Preferred A Shares which can be converted at the discretion of
their holders into Ordinary Shares on a one-to-one basis at any time.

Ordinary Shares Beneficially Owned



|                                                                                                                        |  |           |  |                  |  
|----------------------------------------------------------------------------------------------------------------------- |  | --------- |  | ---------------- | -
|Name and Address                                                                                                        |  | Number    |  | Percent of Class |  
|Lewis Opportunity Fund Group(1) 45 Rockefeller Center Suite 2570 New York, NY 10111                                     |  | 1,277,272 |  | 32.5             | %
|Jerusalem High-tech Founders, Ltd. (2) c/o Hamotal Insurance Agency 9 HaRatom Street Har Hotzvim Jerusalem 41450 Israel |  | 382,876   |  | 12.5             | %



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##### Table of Contents

|                                                                                                                                                         |  |         |  |      |  
|-------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------- |  | ---- | -
|LibertyView Special Opportunities Fund, LP (3) LibertyView Capital Management Neuberger Berman, LLC 111 River Street  Suite 1000 Hoboken, NJ 07030-5776 |  | 323,366 |  | 10.4 | %
|                                                                                                                                                         |  |        
|Telvent Investments, S.L. (4) Valgrande 6 28108 Alcobendas Madrid, Spain                                                                                 |  | 307,862 |  | 10.1 | %
|                                                                                                                                                         |  |        
|The Clal Group (5) Kiriat Atidim Ramat Hachayal P.O. Box 61581, Tel Aviv 58177 Israel                                                                    |  | 172,296 |  | 5.7  | %
|                                                                                                                                                         |  |        
|All directors and executive officers as a group (10 persons)(6)                                                                                          |  | 836,828 |  | 27.1 | %



|(1) | Includes
|--- | --------



| |  |  | (i) 283,636 Ordinary Shares, (ii) warrants to purchase 234,000 Ordinary Shares exercisable within 60 days of July 15, 2008 and (iii) 60,606
Ordinary Shares that may be issued upon a conversion of convertible note at a fixed conversion price of $1.65 per Ordinary share, held by Lewis Opportunity Fund LP.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | (ii) 80,000 Ordinary Shares and (ii) warrants to purchase 66,000 Ordinary Shares exercisable within 60 days of July 15, held by LAM Opportunity Fund
LP.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | (iii) warrants to purchase 250,000 Ordinary Shares exercisable within 60 days of July 15, 2008 and (iii) 303,030 Ordinary Shares that may be issued
upon a conversion of convertible note at a fixed conversion price of $1.65 per Ordinary share, held by W.A. Lewis IV.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) | Includes (i) 1,315 Ordinary shares held by Jerusalem High-tech Founders Ltd., (ii) 23,087 Ordinary Shares including Ordinary Shares held by Mr. HaCohen and
Mr. Morgenstern, who serve on our Board of Directors and have a financial interest in Jerusalem High-tech Founders, Ltd. and, accordingly, such designees are considered beneficial owners of the Ordinary Shares of Jerusalem High-tech Founders,
Ltd., (iii) 322,814 Preferred A Shares which can be converted to Ordinary Shares on a one-to-one basis at any time, and (iv) 35,660 options held by Mr. HaCohen and Mr. Morgenstern that are exercisable or whose restrictions lapse
within 60 days of July 15, 2008.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(3) | Includes (i) 245,845 Ordinary Shares, , (ii) 43,537 Ordinary Shares for which the balance of the convertible debt issued to LibertyView in the amount of $480,000 may be
converted at any time at a fixed conversion price of $11.025 per Ordinary Share, and (iii) warrants to purchase 33,984 Ordinary Shares exercisable within 60 days of July 15, 2008.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(4) | Includes (i) 291,082 Ordinary Shares, (ii) warrants to purchase 12,780 Ordinary Shares exercisable within 60 days of July 15, 2008, and (iii) options to purchase
4,000 Ordinary Shares exercisable within 60 days of July 15, 2008, held by Manuel Sanchez Ortega, a director of our company and the chief executive officer of Telvent, whose rights have been assigned to Telvent.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(5) | Includes
|--- | --------



| |  |  | 15,076 Ordinary Shares and warrants to purchase 67 Ordinary Shares exercisable within 60 days of July 15, 2008, held by Clal Venture Capital;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Warrants to purchase 67 Ordinary Shares exercisable within 60 days of July 15, 2008, held by Clalit Capital Fund;
| | - |  | -----------------------------------------------------------------------------------------------------------------



| |  |  | 27,661 Ordinary Shares held by Clal Industries and Investments;
| | - |  | ---------------------------------------------------------------



| |  |  | 27,971 Ordinary Shares held by Clal Electronics Industries;
| | - |  | -----------------------------------------------------------



| |  |  | 38,224 Ordinary Shares and warrants to purchase 5,497 Ordinary Shares exercisable within 60 days of July 15, 2008, held by FBR Infinity II Venture Israel LP,
which may be deemed an affiliate of the Clal Group;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 36,454 Ordinary Shares and warrants to purchase 5,270 Ordinary Shares exercisable within 60 days of July 15, 2008, held by FBR Infinity II Ventures LP, which
may be deemed an affiliate of the Clal Group;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 13,997 Ordinary Shares and warrants to purchase 2,013 Ordinary Shares exercisable within 60 days of July 15, 2008, held by FBR Infinity II Ventures (Erisa) LP,
which may be deemed an affiliate of the Clal Group;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(6) | Also includes options and restricted shares granted to our directors and executive officers that are exercisable or whose restrictions lapse within 60 days of July 15, 2008.
This number includes (i) Ordinary Shares held by Telvent since an affiliate of Telvent serves on our Board of Directors and, accordingly, such designee may be deemed to be the beneficial owner of the Ordinary Shares held by Telvent. Such
designee disclaims beneficial ownership of such shares, (ii) Ordinary Shares held by e-Wise Solutions Pty Ltd which are beneficially owned by Mark Hosking, and (iii) Ordinary shares held by Jerusalem High-tech Founders Ltd since two of its
affiliates serve on our Board of Directors and, accordingly, such designees may be deemed to be the beneficial owners of the Ordinary Shares held by Jerusalem High-tech Founders, Ltd.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Our shareholders do not have different voting rights.



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##### Table of Contents

Related Party Transactions

Registration Rights

On February 18, 2005, we entered into a Registration Rights
Agreement with Telvent Investments, S.L. in connection with a private financing that raised approximately $1.3 million. Under the terms of this agreement, we agreed to use best efforts to file a registration statement with the SEC covering the
resale of the Ordinary Shares from this transaction after receipt of a written request from Telvent. We have also provided Telvent with piggyback rights subject to certain terms and conditions.

On August 8, 2005, we completed with LibertyView a private placement that involved (i) the issuance of 66,667 of our Ordinary Shares for
consideration of $700,000, (ii) the issuance of a warrant to purchase additional 23,334 Ordinary Shares, and (iii) the replacement of the loan under the Debt with a $2.98 million loan under a new debt, which is convertible at a fixed
conversion price of $11.025 per Ordinary Shares into 270,295 Ordinary Shares. Under the terms of this agreement, we agreed to file a registration statement with the SEC covering the resale of the shares issued as part of this transaction including
any shares that may be issued in the future upon the conversion of the debt and warrants.

On May 5, 2006, we signed an agreement with
LibertyView, which was approved by our shareholders and consummated on June 2, 2006, to convert $2.0 million of its Convertible Debt to Preferred A Shares at $7.65 per Preferred A Share, which may be converted at the discretion of LibertyView
on a one-to-one basis to Ordinary Shares at any time. Under the terms of this agreement, we have agreed to file a registration statement with the SEC covering the Ordinary Shares that may be issued upon the conversion of the Preferred A Shares by no
later than sixty (60) days from the date of the agreement.

On May 5, 2006, we entered into a Registration Rights Agreement with
C.E. Unterberg, Towbin, LLC Telvent Investments SL, FBR Infinity II Ventures (Israel) LP, FBR Infinity II Ventures LP, and FBR Infinity II Ventures (Erisa) LP (collectively, the May 2006 Investors) in connection with a private financing
that raised $1.1 million. Under the terms of this agreement, we have agreed to use best efforts to file a registration statement with the SEC covering the resale of the Ordinary Shares within six months from the date of the closing for this
transaction.

On June 6, 2006, we have provided LibertyView, in connection with a private financing that raised $250,000, similar
registration rights as the ones provided to the May 2006 Investors.

On November 30, 2006, LibertyView sold $500,000 of its
Convertible Debt to Jerusalem High-tech Founders, Ltd. (JHTF), a company controlled by Samuel HaCohen, the Companys Chairman of the Board of Directors, and in which Vladimir Morgenstern, a member of the Companys Board of
Directors, has an economic interest. Upon the sale of the debt, we signed an agreement with JHTF, which was approved by our shareholders and consummated on December 29, 2006, to convert the $500,000 Convertible Debt to Preferred A Shares at
$7.65 per Preferred A Share, which may be converted at the discretion of JHTF on a one-to-one basis to Ordinary Shares at any time. Under the terms of this agreement, we have agreed to use reasonable efforts to file a registration statement with the
SEC covering the Ordinary Shares that may be issued upon the conversion of the Preferred A Shares as soon as practicable.

On
December 19, 2007, we entered into a Registration Rights Agreement with the Lewis Opportunity Fund Ltd., LAM Opportunity Fund Ltd., and W. A. Lewis IV in connection with a private financing transaction that included ordinary shares, convertible
note and warrants,. Under the terms of this agreement, we have agreed to use best efforts to register all securities underlying this private financing within 180 days of the closing of this transaction.

Insurances Policies with Clal Credit Insurance and Clal Insurance

During the period 2005 through 2007, we purchased several insurance policies with Clal Insurance, which is affiliated with The Clal Group, our 5.7% shareholder as set forth above. All of these insurance policies were
contracted on an arms-length basis. In 2006 and 2007, the policy we purchased included the following items: Fire and general liability insurance and employers liability insurance for payments that total approximately $6,000 and $7,000,
respectively.

Unsecured Debt Agreement with an Officer

As part of the e-Wise acquisition in June 2005, we assumed an amount of approximately $285,000 of unsecured debt payable to e-Wises major shareholder, Mark Hosking. As a result of our acquisition of e-Wise,
Mr. Hosking became a shareholder, officer and employee of our Company. On August 28, 2007, a revision in the payment terms for the $115,000 remaining balance of the unsecured debt payable to e-Wise was reached with Mr. Hosking.
Accordingly, we paid $30,000 to Mr. Hosking on October 1, 2007 and the balance will be paid by us in eight equal monthly installments beginning January 1, 2008. As of December 31, 2007, the balance of the outstanding debt to
Mr. Hosking was $90,000.

Consulting Agreement with a Director

On July 21, 2003, the Board of Directors and audit committee approved an agreement with Vladimir Morgenstern, a director of our Company, to provide
project management services to us in connection with our engagements with high profile customers and prospects. The compensation provided under the terms of this agreement is based on the average compensation provided to employees providing similar
services to us. During 2005, Mr. Morgenstern was paid $8,000 for services provided to us under this agreement. During 2006 and 2007, Mr. Morgenstern did not provide any consulting services and received no compensation from us related to
this consulting agreement.

Loans

In June 1999, the Board of Directors issued Mr. HaCohen 3,478 Series C-2 Preferred Shares, in consideration of $100,000, which we loaned to Mr. HaCohen. The loan was approved by the shareholders in June 2000 and bears an annual
interest at the rate of 6.5%. Repayment of the loan is due when Mr. HaCohen sells or otherwise disposes of the shares subject to the loan. In addition, the Company, at its sole discretion, may call for immediate payment of the loan and the
interest thereon in the event that (i) Mr. HaCohen becomes bankrupt or files a motion for bankruptcy, or (ii) Mr. HaCohen ceases to remain in the employment of the Company for any reason.

Commercial Transactions with Telvent

On
June 30, 2004, we entered into a value added reseller agreement with Telvent, under which Telvent became a non-exclusive reseller of our products at normal reseller terms. As part of the reseller agreement Telvent paid us support and
maintenance in 2005, 2006, and 2007 in the amounts of $140,000, $137,000, and $105,000, respectively.

On December 1, 2004, we entered
into an agreement with Telvent under which Telvent provides us with certain technical consulting services on a time and materials basis, relating to our agreement with our customer, Las Vegas Valley Water. During 2005, we paid Telvent $163,000 for
services provided to us in support of this customer under the terms of this agreement. No services were provided by Telvent to us during 2006 and 2007.

Directors and Officers Insurance

We have obtained directors and officers liability insurance for the benefit of our
directors and office holders and intend to continue and obtain such insurance and pay all premiums thereunder to the fullest extent permitted by the Companies Law.



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##### Table of Contents

Indemnification of Office Holders

Our Articles of Association provide that we may indemnify an office holder against:



| |  |  | a financial liability imposed on him/her in favor of another person by any judgment, including a settlement or an arbitrators award approved by a court
concerning an act performed in his/her capacity as an office holder;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | reasonable litigation expenses, including attorneys fees, expended by the office holder or charged to him/her by a court in proceedings we institute against
him/her, instituted on our behalf, or instituted by another person, in each case relating to an act performed in his/her capacity as an office holder; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | reasonable litigation expenses relating to an act performed in his/her capacity as an office holder, including attorneys fees, expended by the office holder
or charged to him/her by a court in a criminal proceeding from which he/she was acquitted, or a criminal proceeding in which he/she was convicted for a criminal offense that does not require proof of intent.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Our Articles of Association also include:



| |  |  | authorization to undertake, in advance, to indemnify an office holder, provided that the undertaking is limited to specified events which the board of directors
believes are anticipated and limited in amount determined by the board of directors to be reasonable under the circumstances; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | authorization to indemnify retroactively an office holder.
| | - |  | ----------------------------------------------------------

We have agreed to indemnify our office holders under indemnification agreements with each office holder. We have also exempted and agreed to indemnify our office holders from liabilities resulting from acts performed
by them in their capacity as an officer holder to the maximum extent permitted under the Companies Law.

Interests of Experts
and Counsel

Not applicable.



|Item 8. | Financial Information
|------- | ---------------------

Consolidated Statements and Other Financial Information

See Item 18 Financial Statements and included herein by
reference.

Legal Proceedings

We are
not involved in any legal proceedings that we believe, individually or in the aggregate, will have a material adverse effect on the Company.

Dividend
Distribution Policy

We have never declared or paid dividends to our shareholders and we do not intend to pay dividends in the future.
We anticipate that we will retain all of our future earnings, if any, for use in the expansion and operation of our business and, therefore, do not expect to pay any dividends in the future.

Significant Changes

Not
applicable.



|Item 9. | The Offer and Listing
|------- | ---------------------

Market Price Information

Through June 30, 2008, the high and low reported sales prices for our Ordinary Shares were as
follows:



|                                         |  |      |       |     |   |     
|---------------------------------------- |  | ---- | ----- | --- | - | ----
|Period                                   |  | High |       | Low
|Year ending                              |  |      |       |     |   |     
|December 31, 2007                        |  | $    | 4.40  |     | $ | 1.01
|December 31, 2006                        |  |      | 9.60  |     |   | 3.60
|December 31, 2005                        |  |      | 15.40 |     |   | 8.05
|Quarters ending:                         |  |      |       |     |   |     
|2008                                     |  |      |       |     |   |     
|Second Quarter, ending June 30, 2008     |  |      | 1.55  |     |   | 0.95
|First Quarter, ending March 31, 2008     |  |      | 1.90  |     |   | 1.10
|2007                                     |  |      |       |     |   |     
|Fourth Quarter, ending December 31, 2007 |  |      | 2.38  |     |   | 1.01
|Third Quarter, ending September 30, 2007 |  |      | 2.65  |     |   | 2.38
|Second Quarter, ending June 30, 2007     |  |      | 3.43  |     |   | 2.50
|First Quarter, ending March 31, 2007     |  |      | 4.40  |     |   | 3.30



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##### Table of Contents

|                                         |  |       |  |      
|---------------------------------------- |  | ----- |  | -----
|2006                                     |  |       |  |      
|Fourth Quarter, ending December 31, 2006 |  | 5.45  |  | 3.60 
|Third Quarter, ending September 30, 2006 |  | 5.25  |  | 3.85 
|Second Quarter, ending June 30, 2006     |  | 6.25  |  | 3.75 
|First Quarter, ending March 31, 2006     |  | 9.60  |  | 4.95 
|2005                                     |  |       |  |      
|Fourth Quarter, ending December 31, 2005 |  | 11.75 |  | 8.05 
|Third Quarter, ending September 30, 2005 |  | 11.95 |  | 10.05
|Second Quarter, ending June 30, 2005     |  | 14.25 |  | 11.40
|First Quarter, ending March 31, 2005     |  | 15.4  |  | 10.30



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##### Table of Contents

|                     |  |      |  |     
|-------------------- |  | ---- |  | ----
|Most Recent 6 months |  | High |  | Low 
|August 2008          |  | 1.54 |  | 1.54
|July 2008            |  | 1.55 |  | 1.54
|June 2008            |  | 1.55 |  | 0.51
|May 2008             |  | 1.55 |  | 1.01
|April 2008           |  | 1.10 |  | 0.95
|March 2008           |  | 1.50 |  | 1.10

Markets on Which Our Ordinary Shares Trade

Our Ordinary Shares were listed on The Nasdaq National Market on September 19, 2000, under the symbol VRYA. Prior to September 19,
2000, there was no public market for our Ordinary Shares. On October 29, 2001 our Ordinary Shares were listed for trading on the Tel Aviv Stock Exchange (TASE) as well, and were delisted from trading on the TASE on June 3,
2004.

On September 5, 2002, we were notified by The Nasdaq National Market that we were not in compliance with Marketplace Rule
4450(a)(2) by failing to maintain a minimum market value of $5,000,000 for our publicly held shares and had until December 4, 2002 to regain compliance. Due to the economic and market conditions affecting our valuation, we concluded that we
would request a transfer of our securities listing from The Nasdaq National Market to The Nasdaq Capital Market. The transfer was approved on December 20, 2002, and our trading on The Nasdaq Capital Market began on December 31, 2002.

On June 4, 2007, we voluntarily requested that The Nasdaq National Market delist our Ordinary Shares from The Nasdaq Capital Market.
Subsequent to this request, NASDAQ formally notified us in writing that our Ordinary Shares would be delisted from The Nasdaq Capital Market on June 12, 2007. Effective on December 14, 2007, our Ordinary Shares were approved for trading on
the Over-The-Counter Bulletin Board (OTCBB) under the ticker symbol VRYAF.OB.

On September 11, 2008, due to
our delinquency with respect to the filing of our annual report on Form 20-F for the period ended December 31, 2007, our Ordinary shares ceased to be eligible for quotation on the OTC Bulletin Board (OTCBB) and have been removed
from OTCBB. Following the removal from OTCBB, our Ordinary shares became immediately eligible for quotation and trading on the Pink Sheets. After the filing of this Form 20-F we will review our alternatives for the reinstatement of our quotation on
the OTC Bulletin Board.

For further information, see Risk FactorsOur shares were delisted from The Nasdaq Capital Market which
could adversely affect the market price and trading market of our Ordinary Shares.



|Item 10. | Additional Information
|-------- | ----------------------

Share Capital

Not applicable.

Memorandum and Articles of Association

Companys Objectives

The Companys objectives, as set forth in section 3 of our Articles of Association, are to carry on any business and do any act, which is not
prohibited by law. We may also make contributions of reasonable sums to worthy purposes even if such contributions are not made on the basis of business considerations.

Directors

Any director is entitled to vote in a meeting of our Board of Directors, except
that a director who has a personal interest in an extraordinary transaction (as defined below) which is considered at a meeting of our Board of Directors, may not be present at this meeting or vote on this matter. An extraordinary
transaction is defined in the Companies Law as a transaction that is either (i) not in the ordinary course of business; (ii) not on market terms; or (iii) that is likely to have a material impact on the Companys
profitability, assets or liabilities.

Until otherwise decided by our Board of Directors, a quorum at a meeting of our Board of Directors
shall be constituted by the presence in person, by alternate or by telephone or similar communication equipment, of a majority of the directors then in office who are lawfully entitled to participate and vote at the meeting. If within one-half hour
(or within such longer time not to exceed one (1) hour, as the Chairman of the meeting, at his discretion, may decide) from the time appointed for the convening of the board meeting, a quorum is not present, the board meeting shall stand
adjourned to the same day in the next week at the same time and place (unless such day shall fall on a public holiday either in Israel or the United States, in which case the meeting will be adjourned to the first day, not being a Friday, Saturday
or Sunday, which follows such public holiday). If, at such adjourned board meeting, a quorum is not present within half an hour from the time appointed for holding the meeting, the directors present, in person, by alternate or by telephone or
similar communication equipment who are lawfully entitled to participate and vote at such meeting, shall be a quorum.

Our business is
managed by the Board of Directors, which may exercise all such company powers and perform on our behalf all such acts as may be exercised and performed by us as are not by the Companies Law or by our Articles of Association required to be exercised
or done by us through a general meeting of our shareholders. Our Articles of Association provide that the board of directors may from time to time, at its discretion, cause us to borrow or secure the payment of any sum or sums of money for the
Companys purposes, and may secure or provide for the repayment of such sum or sums in such manner, at such times and upon such terms and conditions as it deems 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 of the whole or any part of our property, both present and future, including its uncalled or called but unpaid capital for the time being.

There is no age limit as to the ability of individuals to serve as members of our Board of Directors.

A director is not required to hold our shares as a condition to his nomination or election as a director.



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##### Table of Contents

Rights attached to our shares

We have two types of shares authorized and outstanding: Ordinary Shares and Preferred A Shares. The rights attached to the Preferred A Shares are the same rights attached to our Ordinary Shares and the Preferred A
Shares are deemed to be Ordinary Shares for all purposes hereunder, except for the Preferred A Shares have superior liquidation preference, as set forth below.

All dividends shall be declared by our Board of Directors and paid in proportion to the amount paid up on account of the nominal value of the Ordinary Shares in respect of which the dividend is being paid. As regards
to Ordinary Shares not fully paid throughout the period in respect of which the dividend is paid, dividends in respect thereto shall be apportioned and paid pro rata according to amounts deemed under our Articles of Association to be paid up on
account of the nominal value of such shares during any portion or portions of the period in respect of which the dividend is paid.

Under
our Articles of Association, every shareholder who is present, in person, by proxy, or by written ballot or is deemed under the Companies Law to be present at a general meeting of the shareholders, shall be entitled to one vote for each ordinary
share of which he or she is the holder.

The distribution of dividends is under the discretion of our Board of Directors, which is under no
obligation to distribute dividends to our shareholders out of the Companys profits.

In the event of any liquidation, dissolution or
winding up of the Company, the Preferred A Shares will entitle their holders to receive (from assets and funds legally available for distribution to the shareholders), and prior to the pro-rata distribution to all the Ordinary Shares of the Company,
per each such Preferred A Share, an amount equal to the Preferred A Shares original issue price (adjusted for share combinations or subdivisions or other recapitalizations of the Companys shares) (the Preferred A Shares Liquidation
Preference). Following such distribution of the Preferred A Shares Liquidation Preference to the holders of Preferred A Shares, the Preferred A Shares shall not participate in the distribution of the remaining assets to the shareholders of the
Company and their holders shall not be entitled to any additional distributions.

Changes of rights attached to our shares

Changes to the rights attached to our Ordinary Shares require the approval of shareholders present, in person, by proxy, or by written ballot, or deemed
under the Companies Law to be present, holding greater than fifty percent (50%) of the total voting power attached to the Ordinary Shares whose holders were present, in person, by proxy, or by written ballot, or deemed under the Companies Law
to be present, at such general meeting, and voted thereon. If, at any time, the share capital of the Company is divided into different classes of shares, the right attached to any class (unless otherwise provided by the terms of issue of the shares
of that class) may be varied only upon consent of a separate general meeting of the holders of the shares of that class and the provisions of our Articles of Association relating to general meetings shall apply to every such separate general
meeting. The enlargement of an authorized class of shares, or the issuance of additional shares thereof out of the authorized and unissued share capital, shall not be deemed to vary, modify or abrogate the rights attached to previously issued shares
of such class or of any other class of shares.

General Meetings

We are required to hold an annual general shareholders meeting once in every calendar year within a period of not more than fifteen (15) months after
the last preceding annual general shareholders meeting. All general shareholders meetings other than annual general shareholders meeting are deemed to be special shareholders meetings. Our Board of Directors may call for a general meeting whenever
it sees fit, and, under the Companies Law, is required to call a general meeting upon a demand in writing by (i) a shareholder or shareholders holding at least 5% of the outstanding shares and 1% of the voting rights in the company, or
(ii) a shareholder or shareholders holding at least 5% of the voting rights in the company. Subject to applicable law and regulations, prior notice of at least 21 days of any general shareholders meeting, specifying the place, date and hour of
the meeting, shall be given to the shareholders of the Company. No business shall be transacted at any general Shareholders meeting unless a quorum is present when the meeting proceeds to business. For all purposes, the quorum shall not be
less than two (2) shareholders present in person, or by proxy, or deemed by the Companies Law to be present at such meeting, holding, in the aggregate, at least, thirty-three and one-third percent (33 and 1/3%) of the voting rights in our
issued share capital. If, within half an hour from the time appointed for the meeting, a quorum is not present (or within such longer time not exceeding one (1) hour as the Chairman of the meeting may decide), the meeting, if convened upon the
requisition of the shareholders, shall be dissolved; in any other case, it shall stand adjourned to the same day in the next week at the same place and time (unless such day shall fall on a public holiday either in Israel or the United States, in
which case the meeting will be adjourned to the first day, not being a Friday, Saturday or Sunday, which follows such public holiday), or any other day, hour and/or place as the directors shall notify the shareholders. If a quorum is not present at
the second meeting within half an hour from the time appointed for the meeting, any two shareholders present personally or by proxy or any other valid instrument, shall constitute a quorum, and shall be entitled to deliberate and to resolve in
respect of the matters for which the meeting was convened.

Ownership of our shares

Our Articles of Association and the laws of the State of Israel do not restrict in anyway the ownership or voting of our shares by non-residents of
Israel.

Change of Control

Our
Articles of Association do not contain specific provisions intended to delay, defer or prevent a change of control.

Material
Contracts

We have not entered into any material contracts other than in the ordinary course of business and other than those discussed
in the Property, Plant and Equipment section, the Liquidity and Capital Resources section under Item 5 Operating and Financial Review and Prospects, and in the Related Party Transactions section under Item 7 Major
Shareholders and Related Party Transactions.

Exchange Controls

Until May 1998, Israel imposed restrictions on transactions in foreign currency. These restrictions affected our operations in various ways, and also
affected the right of non-residents of Israel to convert into foreign currency amounts they received in Israeli currency, such as the proceeds of a judgment enforced in Israel. Despite these restrictions, foreign investors who purchased shares with
foreign currency were able to repatriate in foreign currency both dividends (after deduction of withholding tax) and the proceeds from the sale of the shares. In 1998, the Israeli currency control regulations were liberalized significantly, as a
result of which Israeli residents generally may freely deal in foreign currency and non-residents of Israel generally may freely purchase and sell Israeli currency and assets. There are currently no Israeli currency control restrictions on
remittances of dividends on the Ordinary Shares or the proceeds from the sale of the shares; however, legislation remains in effect pursuant to which currency controls can be imposed by administrative action at any time.

Neither our Memorandum of Association nor our Articles of Association nor the laws of the State of Israel restrict in any way the ownership or voting of
Ordinary Shares by non-residents of Israel.



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Taxation

United States Federal Income Tax Consideration

The following discussion describes the
material United States federal income tax consequences to a person from the purchase, ownership, and disposition of our Ordinary Shares. The following discussion is based on the internal revenue code, current and proposed treasury regulations,
judicial decisions and published positions of the Internal Revenue Service, all as in effect on the date of this form, and all of which are subject to change, possibly with retroactive effect. This discussion does not address all aspects of United
States federal income taxation that may be relevant to a person based on particular circumstances. For example, the following discussion does not address the United States federal income tax consequences of the purchase, ownership and disposition of
the Ordinary Shares if the person:



| |  |  | controls or owns, directly, indirectly or through attribution 10% or more of our shares by vote or value;
| | - |  | ---------------------------------------------------------------------------------------------------------



| |  |  | is a broker-dealer, insurance company, tax-exempt organization, or financial institution;
| | - |  | -----------------------------------------------------------------------------------------



| |  |  | holds Ordinary Shares as part of an integrated investment comprised of Ordinary Shares and one or more other positions; or
| | - |  | --------------------------------------------------------------------------------------------------------------------------



| |  |  | has a functional currency that is not the United States dollar.
| | - |  | ---------------------------------------------------------------

The following discussion also does not address any aspect of state, local or non-United States tax laws or any aspect of United States estate or gift taxation and does not address aspects of United States federal
income taxation applicable to United States holders holding options, warrants or other rights to acquire our Ordinary Shares, or who otherwise receive our Ordinary Shares as compensation. Further, this summary generally considers only United States
holders that hold their Ordinary Shares as capital assets and does not consider the tax treatment of holders who are partnerships or who hold Ordinary Shares through a partnership or other pass-through entity. This discussion also assumes that we
will not be treated as a controlled foreign corporation. Under the internal revenue code, a controlled foreign corporation generally means any foreign corporation if, on any day during its taxable year, more than fifty percent of either the total
combined voting power of all classes of stock of the corporation entitled to vote, or the total value of the stock of the corporation is owned, directly, indirectly or by attribution, by United States persons who, in turn, own directly, indirectly
or by attribution, ten percent or more of the total combined voting power of all classes of stock of the corporation entitled to vote. This discussion does not apply to any person who is not a United States holder or to any person, which holds
shares other than Ordinary Shares.

For purposes of this discussion, a person is a United States holder if such person holds Ordinary
Shares and if such person is:



| |  |  | a citizen or resident of the United States;
| | - |  | -------------------------------------------



| |  |  | a partnership or a corporation or other entity taxable as a corporation organized under the laws of the United States or of any state of the United States or the
District of Columbia;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | an estate the income of which is includible in gross income for United States federal income tax purposes regardless of source; or
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------



| |  |  | a trust, if a United States court is able to exercise primary supervision over its administration and one or more United States persons have the authority to
control all of its substantial decisions.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

You should be aware that this summary is not a comprehensive description of
all the tax considerations that may be relevant to your purchase, ownership or disposition of our Ordinary Shares. United States holders of our Ordinary Shares are advised to consult their own tax advisors concerning the United States federal, state
and local tax consequences, as well as the tax consequences in Israel and other jurisdictions, of the purchase, ownership and disposition of our Ordinary Shares in their particular situations.

Distributions

We have never paid dividends,
and do not intend to pay dividends in the future. In general, and subject to the discussion below, if we do make a distribution on the Ordinary Shares, the distribution will be treated as a dividend for United States federal income tax purposes to
the extent of our current and accumulated earnings and profits, as calculated under United States federal income tax principles. If the amount of the distribution exceeds our earnings and profits, the excess will first be treated as a non-taxable
return of a United States holders tax basis in the Ordinary Shares that reduces that United States holders tax basis dollar-for-dollar, and then as gain from the constructive disposition of the Ordinary Shares.

The amount received by a United States holder that is treated as a dividend for United States federal income tax purposes:



| |  |  | will be includible in the United States holders gross income;
| | - |  | --------------------------------------------------------------



| |  |  | will be subject to tax at the rates applicable to ordinary income; and
| | - |  | ----------------------------------------------------------------------



| |  |  | will not qualify for the dividends received deduction applicable in some cases to United States corporations.
| | - |  | -------------------------------------------------------------------------------------------------------------

The amount of dividend income will include the amount of Israeli taxes, if any, withheld by us on the dividends we paid, as described below in this
filing under Israeli Taxation and Investment Programs. Thus, if withholding taxes are imposed, a United States holder will be required to report income in an amount greater than the cash or the value of other property it receives on the Ordinary
Shares. However, a United States holder may be eligible to claim as a credit against its United States federal income tax liability the amount of tax withheld by us on the dividends we paid.

The amount of foreign income taxes, which may be claimed as a credit in any year, is subject to complex limitations and restrictions, which must be
determined on an individual basis by each United States holder. In general, the total amount of allowable foreign tax credits in any year cannot exceed the pre- credit United States tax liability for the year attributable to each of nine categories
of foreign source taxable income. Dividends received by a United States holder on stock of a foreign corporation, such as our Ordinary Shares, are generally treated as foreign source income within the category of passive income for this purpose, but
are subject to being reclassified as United States source income in specific circumstances. Because distributions in excess of our current and accumulated earnings and profits generally will not give rise to foreign source income, a person may be
unable to claim a foreign tax credit for Israeli withholding tax imposed on the excess amount unless, subject to applicable limitations, such person has other foreign source income. A United States holders foreign tax credit may be further
limited or restricted based on that United States holders particular circumstances, including the length of time the United States holder owned our Ordinary Shares and whether the alternative minimum tax provisions of the internal revenue code
apply. If a United States holders foreign tax credit is restricted in one taxable year, the excess foreign tax credit generally can be carried back for two taxable years and forward for five taxable years, subject to the limitations described
above.

If a United States holder receives a dividend in NIS or other non-United States currency, the amount of the distribution for United
States federal income tax purposes will be the United States dollar value of the distribution determined by the spot rate of exchange on the date the distribution is received, or is treated as received. A United States holder will have a tax basis
in the foreign currency for United States federal income tax purposes equal to the United States dollar value of the foreign currency as determined under the preceding sentence. A United States holder generally will recognize exchange gain or loss
upon the subsequent disposition of the foreign currency equal to the difference between the amount realized on the disposition and the United States holders tax basis in the foreign currency. The gain or loss generally will be ordinary gain or
loss and will generally be treated as United States source gain or loss for United States federal income tax purposes.

Alternatively, a
United States holder may elect to claim a United States federal income tax deduction for the Israeli tax paid or withheld, but only for a taxable year in which the United States holder elects to deduct all foreign income taxes. A non-corporate
United States holder, however, may not elect to deduct Israeli taxes if that United States holder does not itemize deductions.



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Because the tax rules that limit the availability or use of foreign tax credits are complex, we are
unable to provide United States holders with any assurance as to the effect of limitations on United States foreign tax credits and deductions for foreign taxes, and United States holders should consult with, and rely solely upon, their personal tax
advisors with respect to such matters.

Sale, Exchange or Other Disposition

Subject to the discussion below, a United States holder generally will recognize capital gain or loss for United States federal income tax purposes upon
the sale or other disposition of the United States holders Ordinary Shares equal to the difference between the amount realized on the sale or other disposition and the United States holders tax basis in its Ordinary Shares. The capital
gain or loss will be long-term capital gain or loss if the Ordinary Shares have been held for more than one year at the time of sale or other disposition. In general, any gain or loss recognized by a United States holder on the sale or other
disposition of Ordinary Shares will be United States source income or loss for foreign tax credit purposes. In some cases, however, losses upon the sale or other disposition of Ordinary Shares may be required to be allocated to foreign source
income.

Personal Holding Companies

A foreign corporation may be classified as a personal holding company for United States federal income tax purposes if both of the following two tests are satisfied:



| |  |  | if at any time during the last half of the companys taxable year, five or fewer individuals without regard to their citizenship or residency actually or
constructively own, under attribution rules, more than 50% of the stock of the corporation by value; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 60% or more of the foreign corporations gross income derived from United States sources or effectively connected with a United States trade or business, as
specifically adjusted, is from passive sources like dividends and royalty payments.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

A personal holding company generally
is taxed at a rate of 38.6% of its undistributed personal holding company income, which is generally calculated based on the corporations taxable income, after making adjustments including deducting dividends paid and income taxes. We cannot
provide any assurance that either test will not be satisfied in 2008 or future years because it is difficult to make accurate predictions of future income and the amount of stock an individual will actually or constructively own in us.

Foreign Personal Holding Companies

A
foreign corporation will be classified as a foreign personal holding company for United States federal income tax purposes if both of the following two tests are satisfied:



| |  |  | five or fewer individuals who are United States citizens or residents actually or constructively own, under attribution rules, more than 50% of all classes of the
corporations stock measured by voting power or value at any time during the corporations taxable year; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the corporation receives at least 60%, 50% if previously a foreign personal holding company, of its gross income regardless of source, as specifically adjusted,
from passive sources.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

If a corporation is classified as a foreign personal holding company, a portion of its
undistributed foreign personal holding company income, as defined for United States federal income tax purposes, would be imputed to all of its shareholders who are United States holders on the last day of the corporations taxable year, or, if
earlier, the last day on which the United States ownership test set forth above is met. The imputed income would be taxable as a dividend, even if no cash dividend is actually paid. United States holders who dispose of their shares before that date
would not be subject to United States federal income tax under these rules. We cannot provide any assurance that we will not qualify as a foreign personal holding company because it is difficult to make accurate predictions of future income and the
amount of stock a United States citizen or resident will actually or constructively own in us.

Foreign Investment Companies

A foreign corporation may be classified as a foreign investment company if, at any time during a taxable year when 50% or more by vote or value of the
corporations outstanding stock is owned, directly or indirectly, by United States holders, it is:



| |  |  | registered under the Investment Company Act of 1940 as a management company or unit investment trust; or
| | - |  | --------------------------------------------------------------------------------------------------------



| |  |  | engaged, or holding itself out as being engaged, primarily in the business of investing, reinvesting, or trading in securities, commodities, or any interest,
including a futures or forward contract or option, in securities or commodities.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

In general, if a corporation is
classified as a foreign investment company at any time during the period a United States holder holds the corporations stock, any gain from the sale or exchange, or distribution treated as an exchange, of stock in that corporation by the
United States holder will be taxable as ordinary income to the extent of the United States holders ratable share of the corporations accumulated earnings and profits. We cannot provide any assurance that we will not qualify as a foreign
investment company because it is difficult to make accurate predictions of the amount of stock United States holders will directly or indirectly own in us.

Passive Foreign Investment Company Rules

In general, a foreign corporation will be a passive foreign investment
company if:



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



| |  |  | at least 50% of the average value of the assets of the corporation, including the pro rata share of the assets of any United States or foreign company in which the
corporation is 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. If the foreign corporation is a publicly traded corporation for its entire taxable year, this 50% test
is based on the average value of its assets. This 50% test may instead be based on the adjusted bases of the foreign corporations assets, rather than value, if the foreign corporation is not a publicly traded corporation for a portion of its
taxable year and either the foreign corporation is a controlled foreign corporation or elects to use the adjusted bases of its assets for purposes of this test.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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If we were a passive foreign investment company, and a United States holder did not make a qualifying
election either to treat us as a qualified electing fund or mark our shares to market:



| |  |  | excess distributions by us to a United States holder would be taxed in a special way. Excess distributions are amounts received by a United States holder concerning
our Ordinary Shares in any taxable year that exceed 125% of the average distributions received by the United States holder from us in the shorter of either the three previous years or the United States holders holding period for Ordinary
Shares before the current taxable year. Excess distributions must be allocated ratably to each day that a United States holder has held our Ordinary Shares. A United States holder must include amounts allocated to the current taxable year and to
pre-passive foreign investment company years in its gross income as ordinary income for the current taxable year. A United States holder must pay tax on amounts allocated to each prior taxable year for which we were a passive foreign investment
company at the highest rate in effect for that year on ordinary income and the tax is subject to an interest charge at the rate applicable to deficiencies for income tax.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the entire amount of gain that is recognized by a United States holder upon the sale or other disposition of Ordinary Shares will also be considered an excess
distribution and will be subject to tax as described above.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | if a corporation is a passive foreign investment company, a United States holder who acquires Ordinary Shares in the corporation from a decedent who was a United
States shareholder is denied the normally available step-up in the tax basis of the Ordinary Shares to fair market value at the date of death and instead will hold the Ordinary Shares with a tax basis equal to the decedents basis, if lower
than the fair market value. A United States holder cannot avoid this result, however, by electing to mark our Ordinary Shares to market.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

If a United States holder has made a qualified electing fund election for all taxable years during which the United States holder owned our Ordinary Shares and we were a passive foreign investment company, the passive
foreign investment company rules described above will not apply to the United States holder. Instead, a United States holder of a qualified electing fund is required for each taxable year to include in income a pro rata share of the ordinary
earnings of the qualified electing fund as ordinary income and a pro rata share of the net capital gain of the qualified electing fund as long-term capital gain, subject to a separate election to defer payment of taxes and incur an interest charge.
The qualified electing fund election is made on a shareholder-by-shareholder basis and can be revoked only with the consent of the Internal Revenue Service. A United States holder generally makes a qualified electing fund election by obtaining and
retaining the passive foreign investment company annual information statement, attaching a completed Internal Revenue Service Form 8621 to a timely filed United States federal income tax return and by filing the form with the Internal Revenue
Service center in Philadelphia, Pennsylvania. Even if a qualified electing fund election is not made, a shareholder in a passive foreign investment company who is a United States holder generally must file a completed Internal Revenue Service Form
8621 every year.

A United States holder of publicly traded passive foreign investment company stock could elect to mark the stock to
market annually and generally could be subject to specific rules for each of the United States holders taxable years, including:



| |  |  | if the fair market value of the United States holders passive foreign investment company stock exceeds the United States holders adjusted tax basis in
that stock as of the close of the United States holders taxable year, the United States holder will recognize the amount of the excess as ordinary income;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | if the fair market value of the United States holders passive foreign investment company stock is less than the United States holders adjusted tax basis
in that stock as of the close of the United States holders taxable year, the United States holder may recognize the amount of the difference as ordinary loss. Losses would be allowed only for the amount of net gain previously included by the
United States holder under the election for prior taxable years; and
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | if the United States holder has elected to mark our Ordinary Shares to market for all taxable years during which the United States holder owned our Ordinary Shares
and we were a passive foreign investment company, the passive foreign investment company rules generally will not apply to the United States holder.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

United States holders who hold Ordinary Shares during a period when we are a passive foreign investment company will be subject to the preceding rules, even if we cease to be a passive foreign investment company,
subject to exceptions for United States holders who made a qualified electing fund election. United States holders are urged to consult their tax advisors about the passive foreign investment company rules, including the specific rules and
requirements applicable to making qualified electing fund and other elections.

Status of ViryaNet as a Passive Foreign Investment Company
(PFIC)

Although we do not believe that we were a PFIC in 2007, there can be no assurance that the IRS will agree with
that conclusion or that we will not become a PFIC in 2008 or in a subsequent year. Passive foreign investment company status is determined as of the end of each taxable year and is dependent upon a number of factors, including the value of a
corporations assets and the amount and type of its gross income. The determination of whether we are or will become a passive foreign investment company will be affected by how rapidly we use our cash and investment assets in our business.

Also, a significant decline in the market price of our Ordinary Shares may result in our being classified as a passive foreign investment
company.

Backup Withholding and Information Reporting

Dividends on our Ordinary Shares, and payments of the proceeds of a sale of our Ordinary Shares, paid within the United States or through certain United States-related financial intermediaries are subject to
information reporting and may be subject to backup withholding at a 30% rate unless (i) the payer is entitled to, and does in fact, presume the United States holder of our Ordinary Shares is a corporation or other exempt recipient or
(ii) the United States holder provides a taxpayer identification number on a properly completed Form W-9 and certifies that no loss of exemption from backup withholding has occurred. The amount of any backup withholding will be allowed as a
credit against a United States holders United States federal income tax liability and may entitle that United States holder to a refund, provided that required information is furnished to the Internal Revenue Service.

Israeli Taxation and Investment Programs

The
following is a summary of the principal tax laws applicable to companies in Israel, including special reference to their effect on us, and Israeli government programs benefiting us. This section also contains a discussion of the material Israeli tax
consequences to you if you acquire Ordinary Shares of our company. This summary does not discuss all the acts of Israeli tax law that may be relevant to you in light of your personal investment circumstances or if you are subject to special
treatment under Israeli law. 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 this discussion will be accepted
by the tax authorities. The discussion should not be understood as legal or professional tax advice and is not exhaustive of all possible tax considerations.



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General Corporate Tax Structure

In August 2005, the Israeli Government passed the Amendment to the Income Tax Ordinance (No. 147), which progressively reduces the tax rates applicable to
companies to the following: 200435%, 200534%, 200631%, 200729%, 200827%, 200926% and 2010 and thereafter25%. The amendment had no impact on our financial statements. However, the effective tax rate payable
by a company that derives income from an approved enterprise may be considerably less.

Law for the Encouragement of Industry, Taxes, 1969

We qualify as an industrial company under the Law for the Encouragement of Industry (Taxes), 1969, otherwise known as the industry
encouragement law. A company qualifies as an industrial company under the industry encouragement law if it resides in Israel and at least 90% of its income in a given tax year, exclusive of income from specified loans, capital gains, interest and
dividends, is derived from an industrial enterprise owned by it. An industrial enterprise is defined as an enterprise whose major activity in a given tax year is industrial manufacturing.

Under the industry encouragement law, an industrial company is entitled to deduct the purchase price of know how, patents or rights over a period of
eight years beginning with the year in which the rights were first used.

The tax laws and regulations dealing with the adjustment of
taxable income for inflation in Israel also provide that industrial enterprises, like ours, are eligible for special rates of depreciation deductions. These rates vary in the case of plant and machinery according to the number of shifts in which the
equipment is operated and range from 20% to 40% on a straight-line basis, or from 30% to 50% on a declining balance basis for equipment first put into operation on or after June 1, 1989, instead of the regular rates, which are applied on a
straight-line basis.

Industrial enterprises which are approved enterprises can also choose between



| |  |  | the special rates referred to above; and
| | - |  | ----------------------------------------



| |  |  | accelerated rates of depreciation applied on a straight-line basis on property and equipment, generally ranging from 200% on equipment to 400% of the ordinary
depreciation rates on buildings during the first five years of service of the assets subject to a ceiling of 20% per year on depreciation of buildings.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Qualification as an industrial company under the industrial encouragement law is not conditioned upon the receipt of prior approval from any Israeli
government authority. No assurance can be given that we will continue to qualify as an industrial company or will in the future be able to avail ourselves of any benefits available to companies so qualifying.

Law for the Encouragement of Capital Investments, 1959

The Law for Encouragement of Capital Investments, 1959, which is referred to below as the capital investments law, provides that capital investments in a production facility or other eligible assets may, upon application to the Israeli
Investment Center of the Ministry of Industry and Commerce, be designated as an approved enterprise. Each certificate of approval for an approved enterprise relates to a specific investment program in the approved enterprise, delineated both by the
financial scope of the investment and by the physical characteristics of the facility or the asset. An approved enterprise is entitled to benefits, including Israeli government cash grants and tax benefits.

An April 2005 amendment to the Investment Law (the Amendment) significantly changed the provisions of the Investment Law. The Amendment
limits the scope of enterprises, which may be approved by the Investment Center by setting criteria for the approval of a facility as an Approved Enterprise. Additionally, the Amendment enacted major changes in the manner in which tax benefits are
awarded under the Investment Law so that companies no longer require Investment Center approval in order to qualify for tax benefits. However, the Amendment provides that terms and benefits included in any certificate of approval already granted
will remain subject to the provisions of the law as they were on the date of such approval.

Tax Benefits

Taxable income derived from an approved enterprise is subject to a reduced corporate tax rate of 25%. That income is eligible for further reductions in
tax rates depending on the percentage of the foreign investment in our share capital and the percentage of our combined share and loan capital owned by non-Israeli residents. The tax rate is 20% if the foreign investment is 49% or more but less than
74%, 15% if the foreign investment is 74% or more but less than 90% and 10% if the foreign investment is 90% or more. The lowest level of foreign investment during the year will be used to determine the relevant tax rate for that year. These tax
benefits described above are granted for a limited period of time and begin when a company is operational and profitable. The benefits are granted for up to 7 years, or 10 years for a company that has 25% or more of its shares owned by non-Israeli
shareholders, from the first year in which the approved enterprise has taxable income, other than income subject to capital gains tax. The period of benefits may not, however, exceed the lesser of 12 years from the year in which the production began
or 14 years from the year of receipt of approved enterprise status.

An approved enterprise approved after April 1, 1986, may elect to
forego any entitlement to the grants otherwise available under the capital investments law or may participate in an alternative benefits program, under which the undistributed income from the approved enterprise is fully exempt from corporate tax
for a defined period of time. The period of tax exemption ranges between two and ten years, depending upon the location within Israel of the approved enterprise and the type of the approved enterprise. Alternatively, approved enterprises approved
after January 1, 1997 in national priority region A, may elect to receive grants and a two-year tax exemption for undistributed profits derived from the approved enterprise program. We cannot assure you that the current benefit programs will
continue to be available or that we will continue to qualify for benefits under the current programs.

On March 29, 2005, the Israeli Parliament
passed an amendment to the Investment Law, which revamps the Israeli tax incentives for future industrial and hotel investments (the 2005 Amendment). A tax holiday package can now be elected for up to 15 years for a
Privileged Enterprise as defined in the 2005 Amendment, if certain conditions are met, without needing to obtain approval. The extent of the tax benefits available depends upon the level of foreign investment.

The 2005 Amendment became effective on April 1, 2005. Taxpayers may, under certain conditions, claim Privileged Enterprise status for new and expanded enterprises
with respect to 2004 or subsequent years, unless the Investment Center granted such taxpayer Approved Enterprise status prior to December 31, 2004.

Subject to certain conditions, various alternative tax-only benefit packages can now be elected with respect to investments in a Privileged Enterprise, without prior approval. Companies in industry or tourism in Israel may elect
between:

(i) Tax holiday package  for a Privileged Enterprise: a tax exemption applies to undistributed profits for 2 to 15
years depending on geographical location of the Privileged Enterprise and the level of foreign ownership. Company tax rates of between 10% and 25% apply to distributed exempt profits or profits derived subsequent to the exempt period.
The total period of tax benefits is 7 to 15 years, or

(ii) Grant / Reduced tax package  for an Approved Enterprise: Fixed asset grants
of between 20% and 32% for enterprises in a development area and reduced company tax rates between 0% and 25% for a period of 7 to 15 years.



45



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We currently have two approved enterprise programs under the capital investments law, before the 2005
Amendment, which entitle us to some tax benefits. The Companys production facilities have been granted an approved enterprise status under the law, for three separate investment programs, which were approved in February
1989, March 1995 and April 1998. The status of "approved enterprise granted for the February 1989 investment program has expired and the status of approved enterprise granted for the March 1995 investment program will expire
in 2008.

The tax benefits period for the April 1998 program has not yet begun. Income derived from this alternative benefit programs is exempted from tax
for a period of ten years, starting in the first year in which the Company generates taxable income from the approved enterprise, subject to a condition that we will have a certain minimum number of professional employees. We have not yet met this
condition; however we have applied for relief, and adjustment of this requirement. There can be no assurance that the relief will be granted to us, and if the relief is not granted we will lose our entitlement to future benefits under Law.

Generally, Approved Enterprise tax benefits are limited to 12 years from commencement of production or 14 years from the date
of approval, whichever is earlier. Pursuant to the Law, we have elected for our two investment programs the alternative benefits track and waived Government grants in return for a tax exemption. Our offices and research and development
center are located in Jerusalem, in a region defined as a Priority A Development Region. Therefore, income derived from these programs will be tax-exempt for a period of ten years commencing with the year in which it first earns taxable
income, subject to certain conditions.

As the Company currently has no taxable income, the benefits from all these programs have not been
yet utilized

If dividends are paid out of tax-exempt profit derived from our approved enterprise, we will be liable for corporate tax on
the gross amount of distributed profits before company tax at the rate that would have been applied if we had not elected the alternative tax benefit. This rate is generally 10% to 25%, depending on the percentage of a companys shares held by
foreign shareholders. We will also be required to withhold on behalf of the dividend recipients 15% of the amount distributed as dividends. Cash dividends paid by an Israeli company are normally subject to a withholding tax, except for dividends
that are paid to an Israeli company, in which case no tax is withheld unless the dividend is paid from earnings from an approved enterprise. Since we have received some benefits under Israeli laws relating to approved enterprises, payment of
dividends may subject us to some Israeli taxes to which we would not otherwise be subject.

The benefits available to an approved
enterprise are conditional upon the fulfillment of conditions stipulated in the capital investments law and its regulations and the criteria in the specific certificate of approval, as described above. If these conditions are violated, in whole or
in part, we would be required to refund the amount of tax benefits and linkage differences to the Israeli consumer price index and interest.

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.

Taxation Under Inflationary Conditions

The
Income Tax, Inflationary Adjustment, Law, 1985, which is referred to below as the inflationary adjustments law, attempts to overcome some of the problems presented to a traditional tax system by an economy experiencing rapid inflation, which was the
case in Israel at the time the law was enacted. Generally, the inflationary adjustments law provides significant tax adjustments, based on net equity less fixed assets, to depreciation methods and tax loss carry forwards to compensate for loss of
value resulting from an inflationary economy. Our taxable income is subject to the provisions of this law.

The Knesset has approved the cancellation
(subject to transitional provisions) of the Income Tax, Inflationary Adjustment, Law, 1985, commencing from tax year 2008 .

Tax Benefits of Research
and Development

Israeli tax law permits, under some conditions, a tax deduction in the year incurred for expenditures, including
capital expenditures, in scientific research and development projects, if the expenditures are approved by the relevant government ministry and if the research and development is for the promotion of the enterprise and is carried out by, or on
behalf of, a company seeking the deduction.

The OCS has approved some of our research and development programs and we have been able to
deduct, for tax purposes, a portion of our research and development expenses net of the grants received. Other research and development expenses that are not approved may be deducted for tax purposes in 3 equal installments during a 3-year period.

Withholding and Capital Gains Taxes Applicable to Non-Israeli Shareholders

Nonresidents of Israel are subject to income tax on income accrued or derived from sources in Israel or received in Israel. These sources of income
include passive income like dividends, royalties and interest, as well as non-passive income from business conducted or services rendered in Israel. We are generally required to withhold income tax at the rate of 25%, 15% for dividends generated by
an approved enterprise, on all distributions of dividends.

Israeli law generally imposes a capital gains tax on the sale of publicly
traded securities. Pursuant to changes made to the Israeli Income Tax Ordinance in January 2003 and August 2005, capital gains on the sale of our Ordinary Shares will be subject to Israeli capital gains tax, generally at a rate of 20% unless the
holder holds 10% or more of our voting power during the 12 months preceding the sale, in which case it will be subject to a 25% capital gains tax. As of January 1, 2003 nonresidents of Israel are exempt from capital gains tax in relation to the
sale of our Ordinary Shares for so long as (a) our Ordinary Shares are listed for trading on a stock exchange outside of Israel, (b) the capital gains are not accrued or derived by the nonresident shareholders permanent enterprise in
Israel, (c) the Ordinary Shares in relation to which the capital gains are accrued or derived were acquired by the nonresident shareholder after the initial listing of the Ordinary Shares on a stock exchange outside of Israel, and
(d) neither the shareholder nor the particular capital gain is otherwise subject to certain sections of the Israeli Income Tax Ordinance. However, non-Israeli corporations will not be entitled to the foregoing exemptions if an Israeli resident
(a) has a controlling interest of 25% of more in such non-Israeli corporation or (b) is the beneficiary of or is entitled to 25% or more of the revenues or profits of such non-Israeli corporation, whether directly or indirectly.

The convention between the United States and the government of the State of Israel on taxes on income, which shall be referred to as the
treaty, is generally effective as of January 1, 1995.

Under the treaty, the following entities or individuals generally are exempt
from Israeli capital gains tax on income derived from the sale, exchange or disposition of Ordinary Shares if these entities or individuals own, directly or indirectly, less than 10% of the voting power in our Company during the twelve month period
preceding the sale, exchange or disposition of their Ordinary Shares:



| |  |  | individuals that are residents of the United States;
| | - |  | ----------------------------------------------------



| |  |  | corporations, or entities taxable as corporations, that are not residents of Israel and that are organized under the laws of the United States or of any state of
the United States or the District of Columbia; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | other entities, to the extent that the other entities income is taxable in the United States as the income of residents of the United States.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------



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The application of the treaty provisions applying to dividends and capital gains described above and
below is conditioned upon the fact that this income is not effectively connected with a permanent establishment maintained by the non-Israeli residents in Israel. Under the treaty, a permanent establishment generally means a fixed place of business
through which industrial or commercial activity is conducted, directly or indirectly through agents.

Unless an exemption applies under
domestic Israeli law, residents of the United States who own the requisite 10% or more of our outstanding voting shares are subject to Israeli tax on any gain realized on the sale, exchange or disposition of those shares but would generally be
permitted under the treaty to claim a credit for those taxes against the United States income tax imposed on any gain from the sale, exchange or disposition, subject to the limitations applicable to foreign tax credits.

Under the treaty, the maximum tax on dividends paid to a holder of Ordinary Shares who is a resident of the United States under the treaty generally is
25%. However, dividends generally paid to a United States corporation by an Israeli company that does not enjoy the benefits of an approved enterprise will generally be subject to a 12.5% dividend withholding tax if:



| |  |  | the recipient corporation owns at least 10% of the outstanding voting shares of the Israeli company during the portion of the current taxable year and during the
whole of the prior taxable year of the Israeli company preceding the date of the dividend; and not more than 25% of the gross income of the Israeli company during the prior taxable year of the Israeli company preceding the date of the dividend
consists of interest or dividends.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

If the Israeli company is entitled to the Israeli tax benefits applicable to an
approved enterprise and the requirements listed above are met, the withholding tax rate on dividends paid to a United States corporation is 15%.

Documents on Display

We are subject to the informational requirements of the Securities and 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 100 F Street, N.E., Washington, D.C. 20549. Certain of our SEC filings are also available to the public at the SECs website at
http://www.sec.gov. Copies of such material may be obtained by mail from the Public References Branch of the SEC at such address, at prescribed rates. Please call the SEC at 1-800-SEC-0330 for further information on the public reference room. In
addition, all documents concerning ViryaNet referred to in this document and required to be made available to the public are available at our offices located at 8 HaMarpe Street, Science Based Industries Campus, Har Hotzvim, Jerusalem, Israel 91450.



|Item 11. | Quantitative And Qualitative Disclosures About Market Risk
|-------- | ----------------------------------------------------------

Revenues generated and costs incurred outside of the United States are generally denominated in non-dollar currencies. Costs not effectively denominated in United States dollars are remeasured to United States
dollars, when recorded, at the prevailing exchange rates for the purposes of our financial statements. Consequently, fluctuations in the rates of exchange between the dollar and non-dollar currencies will affect our results of operations. An
increase in the value of a particular currency relative to the dollar will increase the dollar reporting value for transactions in that particular currency, and a decrease in the value of that currency relative to the dollar will decrease the dollar
reporting value for those transactions. This effect on the dollar reporting value for transactions is generally only partially offset by the impact that currency fluctuations may have on costs. We do not generally engage in currency hedging
transactions to offset the risks associated with variations in currency exchange rates. Consequently, significant foreign currency fluctuations and other foreign exchange risks may have a material adverse effect on our business, financial condition
and results of operations. Since our revenues are generated in United States dollars and currencies other than United States dollars, and a substantial portion of our expenses are incurred and will continue to be incurred in NIS, we are exposed to
risk by the amount that the rate of inflation in Israel is different from the rate of devaluation or appreciation of the NIS in relation to the dollar and other currencies or if the timing of the devaluation or appreciation lags behind inflation in
Israel. We do not engage in any hedging or other transactions intended to manage risks relating to foreign currency exchange rate or interest rate fluctuations. We also do not own any market risk sensitive instruments. However, we may in the future
undertake hedging or other transactions or invest in market risk sensitive instruments if we determine that it is necessary to offset these risks.



|Item 12. | Description Of Securities Other Than Equity Securities
|-------- | ------------------------------------------------------

Not applicable.

PART II



|Item 13. | Defaults, Dividend Arrearages And Delinquencies
|-------- | -----------------------------------------------

None.



|Item 14. | Material Modifications To The Rights Of Security Holders And Use Of Proceeds
|-------- | ----------------------------------------------------------------------------

Use of Proceeds

On September 19, 2000, we commenced an IPO of 80,000 of our Ordinary Shares,
pursuant to our final prospectus dated September 19, 2000 (the Prospectus). The Prospectus was contained in our Registration Statement on Form F-1, which was declared effective by the Securities and Exchange Commission (SEC File
No. 333-42158) on September 19, 2000. The IPO closed on September 22, 2000 upon the sale of 80,000 Ordinary Shares to the underwriters. Chase Securities Inc., Salomon Smith Barney, Inc., and Dain Rauscher Incorporated acted as the
representatives of the underwriters in the IPO.

The aggregate offering price of the IPO to the public was $32,000,000, with proceeds to
us, after deduction of the underwriting discount, of $29,760,000 (before deducting offering expenses payable by us). The aggregate amount of expenses incurred by us in connection with the issuance and distribution of Ordinary Shares offered and sold
in the IPO was approximately $6,376,000, including $2,240,000 in underwriting discounts and commissions, $428,000 in payments to directors and officers and $3,708,000 in other expenses.

The net proceeds to us from the IPO, after deducting underwriting discounts and commissions and other expenses, were approximately $25,624,000. These net
proceeds were used for the purchase of equipment and software in the amount of approximately $2,339,000, and approximately $23,285,000 was used for working capital purposes.



47



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##### Table of Contents

|Item 15. | Controls and Procedures
|-------- | -----------------------

(a)
Disclosure Controls and Procedures. Our management, with the participation of our Executive Chairman and Chief Executive Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)
under the Securities Exchange Act of 1934, as amended) as of December 31, 2007. Based on this evaluation, our Executive Chairman and Chief Executive Officer have concluded that, as of such date, our disclosure controls and procedures were
effective to provide reasonable assurance that information required to be disclosed by us in the reports we file or submit under the Securities and Exchange Act of 1934, as amended, (i) is recorded, processed, summarized, and reported, within
the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to our management, including our Executive Chairman and Chief Executive Officer, as appropriate to allow timely decisions regarding required
disclosures.

(b) Report of Management on Internal Control Over Financial Reporting.

Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in
Exchange Act Rule 13a-15(f). Management assessed the effectiveness of internal control over financial reporting as of December 31, 2007 based on the criteria in Internal Control-Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO).

Based on that assessment, management has concluded that our internal control over financial
reporting was effective as of December 31, 2007, based on those criteria, at providing reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with
generally accepted accounting principles.

Due to its inherent limitations, internal controls over financial reporting may not prevent or
detect misstatements, and can only provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements. Also, projections of any evaluation of effectiveness to future periods are subject to the
risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

(c) Not yet applicable

(d) Changes in Internal Control Over Financial Reporting. There has been no change
in the Companys internal control over financial reporting that occurred during 2007, that has materially affected, or is reasonably likely to materially affect, the Companys internal control over financial reporting.



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



|Item 16A. | Audit Committee Financial Expert
|--------- | --------------------------------

Our Board of Directors has
determined that we have at least one audit committee financial expert, Mr. Arie Ovadia.



|Item 16B. | Code of Ethics
|--------- | --------------

We have in place a Code of Ethics that applies to
all of our directors, officers and employees. .This code was adopted within the meaning of Section 406 of the Sarbanes-Oxley Acot of 2002 and the rules promulgated thereunder. The full text of the Code of Ethics is available on our website,
www.viryanet.com/company/investors, or, you may request a copy of our code of ethics, at no cost, by writing to or telephoning us as follows:

ViryaNet, Inc.

2 Willow Street

Southborough

MA 01745-1027

Telephone: 508-490-8600



|Item 16C. | Principal Accountant Fees and Services
|--------- | --------------------------------------

During each of the last two
fiscal years, Kost Forer Gabbay & Kasierer, a member of Ernst and Young Global, has acted as the Companys independent auditors.

Audit
fees

Ernst & Young billed the Company approximately $102,000 for audit services for fiscal 2007, including fees associated with the annual
audit and reviews of the Companys quarterly financial results submitted on Form 6-K, and consultations on various accounting issues. Ernst & Young billed the Company approximately $115,000 for audit services for fiscal 2006.

Tax fees

Ernst & Young billed the Company
approximately $42,000 for tax services, including fees associated with tax compliance services, tax planning services and other tax consulting services in fiscal 2007. Ernst & Young billed the Company approximately $36,000 for tax services,
including fees associated with tax compliance services, tax planning services and other tax consulting services in fiscal 2006.

All other fees

We did not pay Ernst & Young for any fees other than the Audit Fees and Tax Fees described above for fiscal 2007 and 2006.

Pre-Approval Policies for Non-Audit Services

Prior to the engagement
of Ernst & Young each year, the engagement is approved by the Audit Committee of the Board of Directors and by vote of the Companys shareholders at the Companys Annual General Meeting of Shareholders. The Companys Audit
Committee has also adopted its own rules of procedure. The Audit Committees rules of procedure provide for a process with respect to the prior approval of all services, including non-audit services, to be performed by the independent auditors
for the Company. In fiscal 2007, the Companys Audit Committee approved all of the services provided by Ernst & Young.



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##### Table of Contents

|Item 16D. | Exemption From The Listing Standards For Audit Committees
|--------- | ---------------------------------------------------------

Not
applicable.



|Item 16E. | Purchases of Equity Securities By The Issuer And Affiliated Purchasers
|--------- | ----------------------------------------------------------------------

Not applicable.

PART III



|Item 17. | Financial Statements
|-------- | --------------------

Not
applicable.



|Item 18. | Financial Statements
|-------- | --------------------

See the
Index to Consolidated Financial Statements and related Financial Statements accompanying this report-beginning page F-1.



|Item 19. | Exhibits
|-------- | --------



|              |  |                         |  |                                                                                                                                  |  |                                                                                                                                
|------------- |  | ----------------------- |  | -------------------------------------------------------------------------------------------------------------------------------- |  | -------------------------------------------------------------------------------------------------------------------------------
|Exhibit Index |  | Description of Document |  |                                                                                                                                 
|              |  |                         | 
|1             |  | 1)                      |  | Memorandum of Association of Registrant (English translation) dated March 8, 1988                                                |  | Filed as Exhibit 3.1 to the Companys Registration Statement on Form F-1, No. 333-42158 and incorporated herein by reference.  
|              |  |                         | 
|              |  | 2)                      |  | Amended Articles of Association of ViryaNet                                                                                      |  | Filed as Exhibit 1(2) of the Companys 20-F for the year ending December 31, 2001 and incorporated herein by reference.        
|              |  |                         | 
|4(a)26        |  | 3)                      |  | Amended Articles of Association of ViryaNet                                                                                      |  |                                                                                                                                
|              |  |                         | 
|              |  | 4)                      |  | The 2000 Amendment and Restatement to the Investors Rights Agreement among ViryaNet and the Investors dated April 5, 2000        |  | Filed as Exhibit 10.5 to the Companys Registration Statement on Form F-1, No. 333-42158 and incorporated herein by reference. 
|              |  |                         | 
|              |  | 5)                      |  | The Registration Rights Agreement, among ViryaNet and the previous shareholders of iMedeon, Inc. dated February 25, 2002.        |  | Filed as Exhibit 4(a) of the Companys 20-F for the year ending December 31, 2001 and incorporated herein by reference.        
|              |  |                         | 
|              |  | 6)                      |  | The Agreement and Plan of Merger among ViryaNet, iMedeon, Inc. and the stockholders of iMedeon, Inc, dated February 25, 2002.    |  | Filed as Exhibit 4(a) of the Companys 20-F for the year ending December 31, 2001 and incorporated herein by reference.        
|              |  |                         | 
|              |  | 7)                      |  | Warrant issued by ViryaNet to Hapoalim Nechasim (Menayot) Ltd. to purchase Ordinary Shares.                                      |  | Filed as Exhibit 10.10 to the Companys Registration Statement on Form F-1, No. 333-42158 and incorporated herein by reference.
|              |  |                         | 
|              |  | 8)                      |  | Warrant issued by ViryaNet to Hapoalim Nechasim (Menayot) Ltd. to purchase Ordinary Shares.                                      |  | Filed as Exhibit 10.11 to the Companys Registration Statement on Form F-1, No. 333-42158 and incorporated herein by reference.
|              |  |                         | 
|              |  | 9)                      |  | Form of warrant issued by ViryaNet to customers prior to July 1, 2000 to purchase Ordinary Shares.                               |  | Filed as Exhibit 10.12 to the Companys Registration Statement on Form F-1, No. 333-42158 and incorporated herein by reference.
|              |  |                         | 
|              |  | 10)                     |  | Form of warrant issued by ViryaNet to customers after July 1, 2000 to purchase Ordinary Shares.                                  |  | Filed as Exhibit 10.17 to the Companys Registration Statement on Form F-1, No. 333-42158 and incorporated herein by reference 
|              |  |                         | 
|              |  | 11)                     |  | Warrant issued by ViryaNet to Bank Hapoalim Ltd. to purchase Ordinary Shares dated effective February 13, 2002.                  |  | Filed as Exhibit 4(a) of the Companys 20-F for the year ending December 31, 2001 and incorporated herein by reference.        
|              |  |                         | 
|              |  | 12)                     |  | Warrant issued by ViryaNet to GE Capital Equity Investments, Inc. to purchase Ordinary Shares dated effective February 21, 2002. |  | Filed as Exhibit 4(a) of the Companys 20-F for the year ending December 31, 2001 and incorporated herein by reference.        
|              |  |                         | 
|              |  | 13)                     |  | Letter of Credit issued by Bank Hapoalim B.M. to ViryaNet dated February 10, 2002.                                               |  | Filed as Exhibit 4(a) of the Companys 20-F for the year ending December 31, 2001 and incorporated herein by reference.        



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|              |  |                         |  |                                                                                                                                                                                                                              |  |                                                                                                                                                               
|------------- |  | ----------------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Index |  | Description of Document |  |                                                                                                                                                                                                                             
|              |  |                         | 
|              |  | 14)                     |  | Letter from Bank Hapoalim B.M. to ViryaNet dated July 14, 2003.                                                                                                                                                              |  | Translation. Filed as exhibit 11 of the Companys 20-F for the year ending December 31, 2002 and incorporated herein by reference.                            
|              |  |                         | 
|              |  | 15)                     |  | Share Purchase Agreement dated July 28, 2003, by and among the company and Telvent GIT, S.A., and exhibits thereof                                                                                                           |  | Filed as Exhibit 4(a) of the Companys 20-F for the year ending December 31, 2003 and incorporated herein by reference.                                       
|              |  |                         | 
|              |  | 16)                     |  | Share Purchase Agreement dated October 30, 2003, among ViryaNet and the investors identified in such agreement, and exhibits thereof                                                                                         |  | Filed as Exhibit 4(a) of the Companys 20-F for the year ending December 31, 2003 and incorporated herein by reference.                                       
|              |  |                         | 
|              |  | 17)                     |  | Agreements dated November 6, 2003, among ViryaNet and the investors identified in such agreements                                                                                                                            |  | Filed as Exhibit 4(a) of the Companys 20-F for the year ending December 31, 2003 and incorporated herein by reference.                                       
|              |  |                         | 
|              |  | 18)                     |  | Agreement and Plan of Merger dated July 9, 2004, among Utility Partners, Inc., ViryaNet and ViryaNet Acquisition Inc.                                                                                                        |  | Filed as Exhibit 4(a)15 of the Companys 20-F for the year ending December 31, 2004 and incorporated herein by reference.                                     
|              |  |                         | 
|              |  | 19)                     |  | Note Purchase Agreement dated July 27, 2004, between ViryaNet and LibertyView Special Opportunities Fund LP, and exhibits thereof                                                                                            |  | Filed as Exhibit 4(a)16 of the Companys 20-F for the year ending December 31, 2004 and incorporated herein by reference.                                     
|              |  |                         | 
|              |  | 20)                     |  | Share Purchase Agreement dated February 7, 2005, between ViryaNet and Telvent Investments, S.L. and exhibits thereof                                                                                                         |  | Filed as Exhibit 4(a)17 of the Companys 20-F for the year ending December 31, 2004 and incorporated herein by reference.                                     
|              |  |                         | 
|              |  | 21)                     |  | Letter dated March 14, 2005, between ViryaNet and Bank Hapoalim Ltd.                                                                                                                                                         |  | Translated from the Hebrew original. Filed as Exhibit 4(a)18 of the Companys 20-F for the year ending December 31, 2004 and incorporated herein by reference.
|              |  |                         | 
|              |  | 22)                     |  | Warrant dated March 14, 2005, issued by ViryaNet to Bank Hapoalim Ltd. to purchase Ordinary Shares                                                                                                                           |  | Filed as Exhibit 4(a)19 of the Companys 20-F for the year ending December 31, 2004 and incorporated herein by reference.                                     
|              |  |                         | 
|              |  | 23)                     |  | Asset Purchase Agreement dated June 1, 2005, between ViryaNet and e-Wise Solutions                                                                                                                                           |  | Filed as Exhibit 4(a)20 of the Companys 20-F for the year ending December 31, 2004 and incorporated herein by reference.                                     
|              |  |                         | 
|              |  | 24)                     |  | Purchase Agreement, and Amended and Restated Notes dated August 5, 2005 among ViryaNet and LibertyView Special Opportunities Fund LP, and exhibits thereof                                                                   |  | Filed as Exhibit 4(a)21 of the Companys 20-F for the year ending December 31, 2005 and incorporated herein by reference.                                     
|              |  |                         | 
|              |  | 25)                     |  | Subscription Agreement dated September 26, 2005 among ViryaNet and the investors identified in such agreement, and exhibits thereof                                                                                          |  | Filed as Exhibit 4(a)22 of the Companys 20-F for the year ending December 31, 2005 and incorporated herein by reference.                                     
|              |  |                         | 
|              |  | 26)                     |  | Letter dated December 22, 2005 between ViryaNet and Bank Hapoalim Ltd.                                                                                                                                                       |  | Translated from the Hebrew original. Filed as Exhibit 4(a)23 of the Companys 20-F for the year ending December 31, 2005 and incorporated herein by reference.
|              |  |                         | 
|              |  | 27)                     |  | Conversion Agreement to Preferred A Shares dated May 5, 2006 between ViryaNet and LibertyView Special Opportunities Fund, LP                                                                                                 |  | Filed as Exhibit 4(a)24 of the Companys 20-F for the year ending December 31, 2005 and incorporated herein by reference.                                     
|              |  |                         | 
|              |  | 28)                     |  | Share Purchase Agreement dated May 5, 2006 among ViryaNet and the investors identified in such agreement, and exhibits thereof                                                                                               |  | Filed as Exhibit 4(a)25 of the Companys 20-F for the year ending December 31, 2005 and incorporated herein by reference.                                     
|              |  |                         | 
|              |  | 29)                     |  | Letter dated August 29, 2007, between ViryaNet and Bank Hapoalim Ltd.                                                                                                                                                        |  | Translated from the Hebrew original. Filed as Exhibit 4(a)26 of the Companys 20-F for the year ending December 31, 2006 and incorporated herein by reference.
|              |  |                         | 
|4(a)27        |  | 30)                     |  | Equity and Convertible Note Financing Agreements dated December 19, 2007 among ViryaNet and the investors identified in such agreement, and exhibits thereof                                                                 |  |                                                                                                                                                               
|              |  |                         | 
|              |  | 31)                     |  | Lease for approximately 16,950 square feet of office space in Jerusalem, Israel.                                                                                                                                             |  | Filed as Exhibit 10.14 to the Companys Registration Statement on Form F-1, No. 333-42158 and incorporated herein by reference.                               
|              |  |                         | 
|              |  | 32)                     |  | A new Lease agreement reducing the current Company premises leased in Jerusalem, Israel, to an area of approximately 7,600 square feet of office space, dated February 25, 2002 (as
summarized and translated into English). |  | Filed as Exhibit 4(a) of the Companys 20-F for the year ending December 31, 2001 and incorporated herein by reference.                                       



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|              |  |                         |  |                                                                                                                                  |  |                                                                                                                                
|------------- |  | ----------------------- |  | -------------------------------------------------------------------------------------------------------------------------------- |  | -------------------------------------------------------------------------------------------------------------------------------
|Exhibit Index |  | Description of Document |  |                                                                                                                                 
|              |  |                         | 
|              |  | 33)                     |  | Lease for approximately 13,807 square feet in Southborough, Massachusetts.                                                       |  | Filed as Exhibit 10.15 to the Companys Registration Statement on Form F-1, No. 333-42158 and incorporated herein by reference.
|              |  |                         | 
|              |  | 34)                     |  | Lease for approximately 20,000 square feet located in Alpharetta, Georgia.                                                       |  | Filed as Exhibit 4(a) of the Companys 20-F for the year ending December 31, 2001 and incorporated herein by reference.        
|              |  |                         | 
|4(a)29        |  | 35)                     |  | Lease for approximately 10,000 square feet of office space in Southborough, Massachusetts.                                       |  |                                                                                                                                
|              |  |                         | 
|4(b)5         |  | 36)                     |  | Consent of Kost, Forer, Gabbay & Kasierer, a member of Ernst and Young Global                                                    |  |                                                                                                                                
|              |  |                         | 
|              |  | 37)                     |  | First Amendment to the Lease Agreement by and between the Company and Three and 400 Northwinds Center L.P., dated June 10, 2003. |  | Filed as Exhibit 4(b) of the Companys 20-F for the year ending December 31, 2002.                                             
|              |  |                         | 
|              |  | 38)                     |  | Promissory Notes by and between the Company and Three and 400 Northwinds Center L.P., dated June 10, 2003.                       |  | Filed as Exhibit 4(b) of the Companys 20-F for the year ending December 31, 2002.                                             
|              |  |                         | 
|4(b)8         |  | 39)                     |  | Consent of Nexia ASR, for the audit of ViryaNet Pty Ltd.                                                                         |  |                                                                                                                                
|              |  |                         | 
|              |  | 40)                     |  | The Companys 1996 Stock Option and Incentive Plan.                                                                              |  | Filed as Exhibit 10.1 to the Companys Registration Statement on Form F-1, No. 333-42158 and incorporated herein by reference. 
|              |  |                         | 
|              |  | 41)                     |  | The Companys 1997 Stock Option and Incentive Plan.                                                                              |  | Filed as Exhibit 10.2 to the Companys Registration Statement on Form F-1, No. 333-42158 and incorporated herein by reference. 
|              |  |                         | 
|              |  | 42)                     |  | The Companys 1998 Stock Option and Incentive Plan.                                                                              |  | Filed as Exhibit 10.3 to the Companys Registration Statement on Form F-1, No. 333-42158 and incorporated herein by reference. 
|              |  |                         | 
|              |  | 43)                     |  | The Companys 1999 Stock Option and Incentive Plan.                                                                              |  | Filed as Exhibit 10.4 to the Companys Registration Statement on Form F-1, No. 333-42158 and incorporated herein by reference. 
|              |  |                         | 
|              |  | 44)                     |  | Form of Indemnification Agreement entered into with directors and officers of the Company.                                       |  | Filed as Exhibit 10.16 to the Companys Registration Statement on Form F-1, No. 333-42158 and incorporated herein by reference.
|              |  |                         | 
|              |  | 45)                     |  | Tender Offer Statement under Section 13(e)(1) of the Securities Exchange Act of 1934.                                            |  | Filed on Form SC TO-I, No. 005-60313 and incorporated herein by reference.                                                     
|              |  |                         | 
|              |  | 46)                     |  | The Companys 2005 Israeli Share Option and Restricted Share Plan.                                                               |  | Filed as Exhibit 4(c)7 of the Companys 20-F for the year ending December 31, 2005.                                            
|              |  |                         | 
|              |  | 47)                     |  | The Companys 2005 International Share Option and Restricted Share Plan.                                                         |  | Filed as Exhibit 4(c)8 of the Companys 20-F for the year ending December 31, 2005.                                            
|              |  |                         | 
|12.1          |  | 48)                     |  | Certifications of Chief Executive Officer pursuant to Rule 13a-14(a)/Rule 15d-14(a)                                              |  |                                                                                                                                
|              |  |                         | 
|12.2          |  | 49)                     |  | Certifications of Executive Chairman pursuant to Rule 13a-14(a)/Rule 15d-14(a)                                                   |  |                                                                                                                                
|              |  |                         | 
|13.1          |  | 50)                     |  | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350                                                      |  |                                                                                                                                
|              |  |                         | 
|13.2          |  | 51)                     |  | Certification of Executive Chairman pursuant to 18 U.S.C. Section 1350                                                           |  |                                                                                                                                



SIGNATURES

Pursuant to the requirements of the Securities Act of 1933, 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 Form 20-F to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Jerusalem, Israel, on this 29th day of September, 2008.



|              |  |                                      
|------------- |  | -------------------------------------
|VIRYANET LTD.
|              | 
|By:           |  | /s/ Memy Ish-Shalom                  
|              |  | Memy Ish-Shalom                      
|              |  | President and Chief Executive Officer



51



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VIRYANET LTD. AND ITS SUBSIDIARIES

CONSOLIDATED FINANCIAL STATEMENTS

AS OF DECEMBER 31, 2007

IN U.S. DOLLARS

INDEX



|                                                        |  |        
|------------------------------------------------------- |  | -------
|                                                        |  | Page   
|Report of Independent Registered Public Accounting Firm |  | 2 - 3  
|                                                        | 
|Consolidated Balance Sheets                             |  | 4 - 5  
|                                                        | 
|Consolidated Statements of Operations                   |  | 6      
|                                                        | 
|Statements of Changes in Shareholders Equity           |  | 7 - 9  
|                                                        | 
|Consolidated Statements of Cash Flows                   |  | 10 - 11
|                                                        | 
|Notes to Consolidated Financial Statements              |  | 12 - 48







---

##### Table of Contents

|     |  |                                                                                                                      
|---- |  | ---------------------------------------------------------------------------------------------------------------------
|LOGO |  | Kost Forer Gabbay & Kasierer 2
Pal-Yam Ave. Haifa 33095, Israel  Tel: 972 (4)8654000 Fax: 972(3)5633443 www.ey.com.il

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the shareholders of

VIRYANET
LTD.

We have audited the accompanying consolidated balance sheets of ViryaNet Ltd. (the Company) and its subsidiaries as
of December 31, 2007 and 2006, and the related consolidated statements of operations, changes in shareholders equity and cash flows for each of the three years in the period ended December 31, 2007. These financial statements are the
responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the financial statements of a wholly-owned subsidiary, whose statements reflect total
assets constituting 12% and 16% as of December 31, 2007 and 2006, respectively and whose total revenues constituting 9%, 14% and 7% of the related consolidated totals for each of the three years in the period ended December 31, 2007. Those
statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for this subsidiary, is based solely on the report of the other auditors.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Companys internal control over financial reporting. Our
audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the
Companys internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits and the report of the other auditors provide a reasonable basis for our opinion.

In our opinion, based on our audits and the report of the other auditors, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of the Company and its subsidiaries as of December 31, 2007 and 2006, and the consolidated results of their operations and their cash flows for each of the three years in the period
ended December 31, 2007, in conformity with U.S. generally accepted accounting principles.



|                   |  |                                 
|------------------ |  | --------------------------------
|Haifa, Israel      |  | KOST FORER GABBAY & KASIERER    
|September 23, 2008 |  | A Member of Ernst & Young Global



- 2 -



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##### Table of Contents

LOGO

INDEPENDENT AUDIT REPORT

TO THE MEMBERS OF VIRYANET PTY LTD. (AUSTRALIA)

Scope

We have audited the balance sheets of ViryaNet Pty Ltd. (Australia) (the Company) as of December 31, 2007 and the related statements of operations for the year in the period ended December 31,
2007. 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.

Audit approach

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Companys
internal control over financial reporting. Our audits included consideration of internal control over the 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.

Audit opinion

In our opinion, the financial
statements referred to above present fairly, in all material respects, the financial position of ViryaNet Pty Ltd (Australia) as of 31 December, 2007, and the results of its operations for the year in the period ended 31 December, 2007, in
conformity with United States generally accepted accounting principles.

NEXIA ASR

ABN 16 847 721 257

GEORGE S. DAKIS

Partner

Audit & Assurance Services

Melbourne, Victoria, Australia.

23 September 2008.



|     |  |     
|---- |  | ----
|LOGO |  | LOGO

Liability limited by a scheme approved under Professional Standards Legislation other than for the
acts or omissions of financial services licensees



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##### Table of Contents

VIRYANET LTD. AND ITS SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

U.S. dollars in thousands



|                                                                                                   |  |              |        |      |   |       
|-------------------------------------------------------------------------------------------------- |  | ------------ | ------ | ---- | - | ------
|                                                                                                   |  | December 31,
|                                                                                                   |  | 2006         |        | 2007
|ASSETS                                                                                             |  |              |        |      |   |       
|CURRENT ASSETS:                                                                                    |  |              |        |      |   |       
|Cash and cash equivalents                                                                          |  | $            | 736    |      | $ | 413   
|Trade receivables (net of allowance for doubtful accounts of $52 as of December 31, 2007 and 2006) |  |              | 731    |      |   | 788   
|Unbilled receivables                                                                               |  |              | 314    |      |   | 311   
|Other accounts receivable and prepaid expenses (Note 3)                                            |  |              | 522    |      |   | 226   
|                                                                                                   |  |              |        |      |   |       
|Total current assets                                                                               |  |              | 2,303  |      |   | 1,738 
|                                                                                                   |  |              |        |      |   |       
|SEVERANCE PAY FUND                                                                                 |  |              | 830    |      |   | 995   
|                                                                                                   |  |              |        |      |   |       
|PROPERTY AND EQUIPMENT, NET (Note 4)                                                               |  |              | 163    |      |   | 238   
|                                                                                                   |  |              |        |      |   |       
|INTANGIBLE ASSETS:                                                                                 |  |              |        |      |   |       
|GOODWILL (Notes 1, 6)                                                                              |  |              | 7,088  |      |   | 7,152 
|CUSTOMER RELATIONSHIP, NET (Notes 1, 5c)                                                           |  |              | 875    |      |   | 653   
|OTHER INTANGIBLE ASSETS AND DEBT ISSUANCE COSTS, NET (Notes 1, 5)                                  |  |              | 660    |      |   | 414   
|                                                                                                   |  |              |        |      |   |       
|Total intangible assets:                                                                           |  |              | 8,623  |      |   | 8,219 
|                                                                                                   |  |              |        |      |   |       
|Total assets                                                                                       |  | $            | 11,919 |      | $ | 11,190
|                                                                                                   |  |              |        |      |   |       

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



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##### Table of Contents

VIRYANET LTD. AND ITS SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

U.S. dollars in thousands, except share and per share data



|                                                                                                                                                                                                                                                                 |  |              |          |   |      |   |          |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | -------- | - | ---- | - | -------- | -
|                                                                                                                                                                                                                                                                 |  | December 31, |         
|                                                                                                                                                                                                                                                                 |  | 2006         |          |   | 2007 |  
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                                                                                                                                             |  |              |          |   |      |   |          |  
|CURRENT LIABILITIES:                                                                                                                                                                                                                                             |  |              |          |   |      |   |          |  
|Short-term bank credit (Note 7)                                                                                                                                                                                                                                  |  | $            | 1,187    |   |      | $ | 1,815    |  
|Current maturities of long-term bank loans (Note 10)                                                                                                                                                                                                             |  |              | 574      |   |      |   | 589      |  
|Trade payables                                                                                                                                                                                                                                                   |  |              | 702      |   |      |   | 821      |  
|Deferred revenues                                                                                                                                                                                                                                                |  |              | 2,361    |   |      |   | 2,212    |  
|Other accounts payable and accrued expenses (Note 8)                                                                                                                                                                                                             |  |              | 1,884    |   |      |   | 2,070    |  
|Loan from related party (Notes 1b, 17e)                                                                                                                                                                                                                          |  |              | 115      |   |      |   | 90       |  
|Payment on account of convertible note and warrants (Note 9)                                                                                                                                                                                                     |  |              |         |   |      |   | 239      |  
|                                                                                                                                                                                                                                                                 |  |              |          |   |      |   |          |  
|Total current liabilities                                                                                                                                                                                                                                        |  |              | 6,823    |   |      |   | 7,836    |  
|                                                                                                                                                                                                                                                                 |  |              |          |   |      |   |          |  
|LONG-TERM LIABILITIES:                                                                                                                                                                                                                                           |  |              |          |   |      |   |          |  
|Long-term bank loan, net of current maturities (Note 10)                                                                                                                                                                                                         |  |              | 718      |   |      |   | 149      |  
|Long-term convertible debt (Note 11)                                                                                                                                                                                                                             |  |              | 568      |   |      |   | 556      |  
|Long-term deferred revenues                                                                                                                                                                                                                                      |  |              |         |   |      |   | 1,031    |  
|Accrued severance pay                                                                                                                                                                                                                                            |  |              | 1,276    |   |      |   | 1,568    |  
|                                                                                                                                                                                                                                                                 |  |              |          |   |      |   |          |  
|Total long-term liabilities                                                                                                                                                                                                                                      |  |              | 2,562    |   |      |   | 3,304    |  
|                                                                                                                                                                                                                                                                 |  |              |          |   |      |   |          |  
|COMMITMENTS AND CONTINGENT LIABILITIES (Note 12)                                                                                                                                                                                                                 |  |              |          |   |      |   |          |  
|SHAREHOLDERS EQUITY:                                                                                                                                                                                                                                            |  |              |          |   |      |   |          |  
|Share capital (Note 13) *) -                                                                                                                                                                                                                                     |  |              |          |   |      |   |          |  
|Ordinary shares of NIS 5.0 par value - Authorized: 4,600,000 shares at December 31, 2006 and 2007; Issued and outstanding: 1,922,711 and
2,570,240 shares at December 31, 2006 and 2007, respectively                                                            |  |              | 2,266    |   |      |   | 3,087    |  
|Preferred A shares of NIS 5.0 par value - Authorized: 400,000 shares at December 31, 2006 and 2007; Issued and outstanding: 326,797
shares at December 31, 2006 and 2007, respectively. Aggregate liquidation preference of $2,500 at December 31, 2006 and 2007 |  |              | 369      |   |      |   | 369      |  
|Additional paid-in capital                                                                                                                                                                                                                                       |  |              | 115,937  |   |      |   | 116,121  |  
|Accumulated other comprehensive income (loss)                                                                                                                                                                                                                    |  |              | (314     | ) |      |   | 62       |  
|Accumulated deficit                                                                                                                                                                                                                                              |  |              | (115,724 | ) |      |   | (119,589 | )
|                                                                                                                                                                                                                                                                 |  |              |          |   |      |   |          |  
|Total shareholders equity                                                                                                                                                                                                                                       |  |              | 2,534    |   |      |   | 50       |  
|                                                                                                                                                                                                                                                                 |  |              |          |   |      |   |          |  
|Total liabilities and shareholders equity                                                                                                                                                                                                                       |  | $            | 11,919   |   |      | $ | 11,190   |  
|                                                                                                                                                                                                                                                                 |  |              |          |   |      |   |          |  



|*) | All share data are reported after the effect of the 1 for 5 reverse split that occurred on January 17, 2007.
|-- | ------------------------------------------------------------------------------------------------------------

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



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##### Table of Contents

VIRYANET LTD. AND ITS SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

U.S. dollars in thousands, except share and per
share data



|                                                                                                     |  |                         |           |   |      |   |           |      |  |   |           |  
|---------------------------------------------------------------------------------------------------- |  | ----------------------- | --------- | - | ---- | - | --------- | ---- |  | - | --------- | -
|                                                                                                     |  | Year ended December 31, |          
|                                                                                                     |  | 2005                    |           |   | 2006 |   |           | 2007 | 
|Revenues (Notes 15a, 16):                                                                            |  |                         |           |   |      |   |           |      |  |   |           |  
|Software licenses                                                                                    |  | $                       | 1,720     |   |      | $ | 1,520     |      |  | $ | 1,769     |  
|Maintenance and services                                                                             |  |                         | 12,487    |   |      |   | 12,340    |      |  |   | 9,390     |  
|                                                                                                     |  |                         |           |   |      |   |           |      |  |   |           |  
|Total revenues                                                                                       |  |                         | 14,207    |   |      |   | 13,860    |      |  |   | 11,159    |  
|                                                                                                     |  |                         |           |   |      |   |           |      |  |   |           |  
|Cost of revenues:                                                                                    |  |                         |           |   |      |   |           |      |  |   |           |  
|Software licenses                                                                                    |  |                         | 358       |   |      |   | 356       |      |  |   | 358       |  
|Maintenance and services                                                                             |  |                         | 7,855     |   |      |   | 6,831     |      |  |   | 5,633     |  
|                                                                                                     |  |                         |           |   |      |   |           |      |  |   |           |  
|Total cost of revenues                                                                               |  |                         | 8,213     |   |      |   | 7,187     |      |  |   | 5,991     |  
|                                                                                                     |  |                         |           |   |      |   |           |      |  |   |           |  
|Gross profit                                                                                         |  |                         | 5,994     |   |      |   | 6,673     |      |  |   | 5,168     |  
|                                                                                                     |  |                         |           |   |      |   |           |      |  |   |           |  
|Operating expenses:                                                                                  |  |                         |           |   |      |   |           |      |  |   |           |  
|Research and development                                                                             |  |                         | 2,504     |   |      |   | 2,121     |      |  |   | 2,290     |  
|Selling and marketing                                                                                |  |                         | 5,214     |   |      |   | 3,692     |      |  |   | 3,429     |  
|General and administrative                                                                           |  |                         | 3,004     |   |      |   | 2,735     |      |  |   | 2,485     |  
|                                                                                                     |  |                         |           |   |      |   |           |      |  |   |           |  
|Total operating expenses                                                                             |  |                         | 10,722    |   |      |   | 8,548     |      |  |   | 8,204     |  
|                                                                                                     |  |                         |           |   |      |   |           |      |  |   |           |  
|Operating loss                                                                                       |  |                         | (4,728    | ) |      |   | (1,875    | )    |  |   | (3,036    | )
|Financial expenses, net (Note 16)                                                                    |  |                         | (1,330    | ) |      |   | (44       | )    |  |   | (535      | )
|Loss from liquidation of a subsidiary (1)                                                            |  |                         |          |   |      |   |          |      |  |   | (239      | )
|                                                                                                     |  |                         |           |   |      |   |           |      |  |   |           |  
|Net loss                                                                                             |  | $                       | (6,058    | ) |      | $ | (1,919    | )    |  | $ | (3,810    | )
|                                                                                                     |  |                         |           |   |      |   |           |      |  |   |           |  
|Basic and diluted net loss per share                                                                 |  | $                       | (4.68     | ) |      | $ | (1.03     | )    |  | $ | (1.66     | )
|                                                                                                     |  |                         |           |   |      |   |           |      |  |   |           |  
|Weighted average number of shares used in computing basic and diluted net loss per Ordinary share *) |  |                         | 1,294,834 |   |      |   | 1,857,217 |      |  |   | 2,292,190 |  
|                                                                                                     |  |                         |           |   |      |   |           |      |  |   |           |  



|*) | All share data are reported after the effect of the 1 for 5 reverse split that occurred on January 17, 2007.
|-- | ------------------------------------------------------------------------------------------------------------



|(1) | (See also Note 1a).
|--- | -------------------

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



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##### Table of Contents

VIRYANET LTD. AND ITS SUBSIDIARIES

STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY

U.S. dollars in thousands, except
share data



|                                                                                                                           |  |                 |  |                  |       |           |   |        |   |                          |  |                            |         |  |                                            |      |   |                    |   |          |                        |  |   |                          |   |  |   |        |   |  |   |        |  
|-------------------------------------------------------------------------------------------------------------------------- |  | --------------- |  | ---------------- | ----- | --------- | - | ------ | - | ------------------------ |  | -------------------------- | ------- |  | ------------------------------------------ | ---- | - | ------------------ | - | -------- | ---------------------- |  | - | ------------------------ | - |  | - | ------ | - |  | - | ------ | -
|                                                                                                                           |  |                 |  |                  |       |           |   |        |   | Additionalpaid-incapital |  | Deferred stockcompensation |         |  | Accumulatedothercomprehensiveincome (loss) |      |   | Accumulateddeficit |   |          | Totalcomprehensiveloss |  |   | Totalshareholdersequity |  
|                                                                                                                           |  | Ordinary Shares |  | Preferred shares |       |           |   |        |   |                         
|                                                                                                                           |  | Number *)       |  | Amount           |       | Number *) |   | Amount |   |                          |  |                            |         | 
|Balance as of January 1, 2005                                                                                              |  | 1,082,778       |  | $                | 1,312 |           |  |        | $ |                         |  | $                          | 108,511 |  | $                                          | (50  | ) |                    | $ | (348     | )                      |  | $ | (107,747                 | ) |  |   |        |   |  | $ | 1,678  |  
|Issuance of shares, net of issuance expenses                                                                               |  | 230,618         |  |                  | 263   |           |  |        |   |                         |  |                            | 2,057   |  |                                            |     |   |                    |   |         |                        |  |   |                          |   |  |   |        |   |  |   | 2,320  |  
|Proceeds allocated to warrants in connection with issuance of convertible debts                                            |  |                |  |                  |      |           |  |        |   |                         |  |                            | 337     |  |                                            |     |   |                    |   |         |                        |  |   |                         |   |  |   |        |   |  |   | 337    |  
|Issuance of shares in connection with the acquisition of e-Wise                                                            |  | 111,156         |  |                  | 126   |           |  |        |   |                         |  |                            | 1,129   |  |                                            |     |   |                    |   |         |                        |  |   |                         |   |  |   |        |   |  |   | 1,255  |  
|Issuance of shares, in connection with interest expenses, waivers and debt issuance costs related to the convertible notes |  | 38,891          |  |                  | 45    |           |  |        |   |                         |  |                            | 415     |  |                                            |     |   |                    |   |         |                        |  |   |                         |   |  |   |        |   |  |   | 460    |  
|Compensation related to warrants granted to a bank                                                                         |  |                |  |                  |      |           |  |        |   |                         |  |                            | 61      |  |                                            |     |   |                    |   |         |                        |  |   |                         |   |  |   |        |   |  |   | 61     |  
|Issuance of shares in connection with refinancing short-term bank loan on a long-term basis                                |  | 6,000           |  |                  | 7     |           |  |        |   |                         |  |                            | 50      |  |                                            |     |   |                    |   |         |                        |  |   |                         |   |  |   |        |   |  |   | 57     |  
|Exercise of stock options                                                                                                  |  | 725             |  |                  | 1     |           |  |        |   |                         |  |                            | 5       |  |                                            |     |   |                    |   |         |                        |  |   |                         |   |  |   |        |   |  |   | 6      |  
|Beneficial conversion feature of convertible debt                                                                          |  |                |  |                  |      |           |  |        |   |                         |  |                            | 58      |  |                                            |     |   |                    |   |         |                        |  |   |                         |   |  |   |        |   |  |   | 58     |  
|Compensation related to warrants granted to consultants                                                                    |  |                |  |                  |      |           |  |        |   |                         |  |                            | 42      |  |                                            |     |   |                    |   |         |                        |  |   |                         |   |  |   |        |   |  |   | 42     |  
|Deferred stock compensation related to issuance of restricted shares to directors                                          |  |                |  |                  |      |           |  |        |   |                         |  |                            | 139     |  |                                            | (139 | ) |                    |   |         |                        |  |   |                         |   |  |   |        |   |  |   |       |  
|Amortization of deferred stock compensation                                                                                |  |                |  |                  |      |           |  |        |   |                         |  |                            |        |  |                                            | 54   |   |                    |   |         |                        |  |   |                         |   |  |   |        |   |  |   | 54     |  
|Comprehensive loss:                                                                                                        |  |                 |  |                  |       |           |   |        |   |                          |  |                            |         |  |                                            |      |   |                    |   |          |                        |  |   |                          |   |  |   |        |   |  |   |        |  
|Foreign currency translation adjustments                                                                                   |  |                |  |                  |      |           |  |        |   |                         |  |                            |        |  |                                            |     |   |                    |   | (87      | )                      |  |   |                         |   |  | $ | (87    | ) |  |   | (87    | )
|Net loss                                                                                                                   |  |                |  |                  |      |           |  |        |   |                         |  |                            |        |  |                                            |     |   |                    |   |         |                        |  |   | (6,058                   | ) |  |   | (6,058 | ) |  |   | (6,058 | )
|                                                                                                                           |  |                 |  |                  |       |           |   |        |   |                          |  |                            |         |  |                                            |      |   |                    |   |          |                        |  |   |                          |   |  |   |        |   |  |   |        |  
|Total comprehensive loss                                                                                                   |  |                 |  |                  |       |           |   |        |   |                          |  |                            |         |  |                                            |      |   |                    |   |          |                        |  |   |                          |   |  | $ | (6,145 | ) |  |   |        |  
|                                                                                                                           |  |                 |  |                  |       |           |   |        |   |                          |  |                            |         |  |                                            |      |   |                    |   |          |                        |  |   |                          |   |  |   |        |   |  |   |        |  
|Balance as of December 31, 2005                                                                                            |  | 1,470,168       |  |                  | 1,754 |           |  |        |   |                         |  |                            | 112,804 |  |                                            | (135 | ) |                    |   | **) (435 | )                      |  |   | (113,805                 | ) |  |   |        |   |  |   | 183    |  
|                                                                                                                           |  |                 |  |                  |       |           |   |        |   |                          |  |                            |         |  |                                            |      |   |                    |   |          |                        |  |   |                          |   |  |   |        |   |  |   |        |  



|*) | All share data are reported after the effect of the 1 for 5 reverse split that occurred on January 17, 2007.
|-- | ------------------------------------------------------------------------------------------------------------



|**) | All accumulated other comprehensive loss derived from foreign currency translation adjustment.
|--- | ----------------------------------------------------------------------------------------------

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



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##### Table of Contents

VIRYANET LTD. AND ITS SUBSIDIARIES

STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY

U.S. dollars in thousands, except share data



|                                                                                           |  |                 |  |                  |  |           |  |        |  |                          |         |   |                           |      |   |                                            |         |   |                    |          |   |                        |   |        |                          |  |        |  
|------------------------------------------------------------------------------------------ |  | --------------- |  | ---------------- |  | --------- |  | ------ |  | ------------------------ | ------- | - | ------------------------- | ---- | - | ------------------------------------------ | ------- | - | ------------------ | -------- | - | ---------------------- | - | ------ | ------------------------ |  | ------ | -
|                                                                                           |  |                 |  |                  |  |           |  |        |  | Additionalpaid-incapital |         |   | Deferredstockcompensation |      |   | AccumulatedothercomprehensiveIncome (loss) |         |   | Accumulateddeficit |          |   | Totalcomprehensiveloss |   |        | Totalshareholdersequity | 
|                                                                                           |  | Ordinary Shares |  | Preferred shares |  |           |  |        |  |                         
|                                                                                           |  | Number *)       |  | Amount           |  | Number *) |  | Amount |  |                          |         |   |                           |     
|Balance as of January 1, 2006                                                              |  | 1,470,168       |  | 1,754            |  |          |  |       |  | $                        | 112,804 |   |                           | (135 | ) |                                            | (435    | ) |                    | (113,805 | ) |                        |   |        |                          |  | 183    |  
|Issuance of shares, net of issuance expenses                                               |  | 287,540         |  | 323              |  |          |  |       |  |                          | 1,020   |   |                           |     |   |                                            |        |   |                    |         |   |                        |   |        |                          |  | 1,343  |  
|Issuance of shares in connection with the conversion of long-term convertible debt         |  |                |  |                 |  | 326,797   |  | 369    |  |                          | 1,598   |   |                           |     |   |                                            |        |   |                    |         |   |                        |   |        |                          |  | 1,967  |  
|Issuance of shares in connection with the conversion of short-term convertible debt        |  | 106,326         |  | 124              |  |          |  |       |  |                          | 376     |   |                           |     |   |                                            |        |   |                    |         |   |                        |   |        |                          |  | 500    |  
|Issuance of shares, in connection with interest expenses, related to the convertible debts |  | 36,883          |  | 41               |  |          |  |       |  |                          | 164     |   |                           |     |   |                                            |        |   |                    |         |   |                        |   |        |                          |  | 205    |  
|Issuance of shares in connection with compensation to consultant                           |  | 4,000           |  | 4                |  |          |  |       |  |                          | 17      |   |                           |     |   |                                            |         |   |                    |          |   |                        |   |        |                          |  | 21     |  
|Exercise of stock options                                                                  |  | 200             |  |                 |  |          |  |       |  |                          | 2       |   |                           |     |   |                                            |        |   |                    |         |   |                        |   |        |                          |  | 2      |  
|Restricted shares to employees and directors, net                                          |  | 7,000           |  | 8                |  |          |  |       |  |                          | 76      |   |                           |     |   |                                            |        |   |                    |         |   |                        |   |        |                          |  | 84     |  
|Exercise of warrants by way of cashless exercise                                           |  | 10,594          |  | 12               |  |          |  |       |  |                          | (12     | ) |                           |     |   |                                            |        |   |                    |         |   |                        |   |        |                          |  |       |  
|Reclassification of deferred stock compensation due to implementation of SFAS123(R)        |  |                |  |                 |  |          |  |       |  |                          | (135    | ) |                           | 135  |   |                                            |        |   |                    |         |   |                        |   |        |                          |  |       |  
|Share-based compensation                                                                   |  |                |  |                 |  |          |  |       |  |                          | 27      |   |                           |     |   |                                            |        |   |                    |         |   |                        |   |        |                          |  | 27     |  
|Comprehensive loss:                                                                        |  |                 |  |                  |  |           |  |        |  |                          |         |   |                           |      |   |                                            |         |   |                    |          |   |                        |   |        |                          |  |        |  
|Foreign currency translation adjustments                                                   |  |                |  |                 |  |          |  |       |  |                          |        |   |                           |     |   |                                            | 121     |   |                    |         |   |                        | $ | 121    |                          |  | 121    |  
|Net loss                                                                                   |  |                |  |                 |  |          |  |       |  |                          |        |   |                           |     |   |                                            |        |   |                    | (1,919   | ) |                        |   | (1,919 | )                        |  | (1,919 | )
|                                                                                           |  |                 |  |                  |  |           |  |        |  |                          |         |   |                           |      |   |                                            |         |   |                    |          |   |                        |   |        |                          |  |        |  
|Total comprehensive loss                                                                   |  |                 |  |                  |  |           |  |        |  |                          |         |   |                           |      |   |                                            |         |   |                    |          |   |                        | $ | (1,798 | )                        |  |        |  
|                                                                                           |  |                 |  |                  |  |           |  |        |  |                          |         |   |                           |      |   |                                            |         |   |                    |          |   |                        |   |        |                          |  |        |  
|Balance as of December 31, 2006                                                            |  | 1,922,711       |  | 2,266            |  | 326,797   |  | 369    |  |                          | 115,937 |   |                           |     |   |                                            | **)(314 | ) |                    | (115,724 | ) |                        |   |        |                          |  | 2,534  |  
|                                                                                           |  |                 |  |                  |  |           |  |        |  |                          |         |   |                           |      |   |                                            |         |   |                    |          |   |                        |   |        |                          |  |        |  



|*) | All share data are reported after the effect of the 1 for 5 reverse split that occurred on January 17, 2007.
|-- | ------------------------------------------------------------------------------------------------------------



|**) | All accumulated other comprehensive loss derived from foreign currency translation adjustment.
|--- | ----------------------------------------------------------------------------------------------

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



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##### Table of Contents

VIRYANET LTD. AND ITS SUBSIDIARIES

STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY

U.S. dollars in thousands, except share data



|                                                                                                                        |  |                 |  |                  |       |           |         |        |   |                          |  |   |                           |   |                                            |   |   |                    |  |          |                        |  |   |                          |   |  |   |        |   |  |   |        |  
|----------------------------------------------------------------------------------------------------------------------- |  | --------------- |  | ---------------- | ----- | --------- | ------- | ------ | - | ------------------------ |  | - | ------------------------- | - | ------------------------------------------ | - | - | ------------------ |  | -------- | ---------------------- |  | - | ------------------------ | - |  | - | ------ | - |  | - | ------ | -
|                                                                                                                        |  |                 |  |                  |       |           |         |        |   | Additionalpaid-incapital |  |   | Deferredstockcompensation |   | AccumulatedothercomprehensiveIncome (loss) |   |   | Accumulateddeficit |  |          | Totalcomprehensiveloss |  |   | Totalshareholdersequity |  
|                                                                                                                        |  | Ordinary Shares |  | Preferred shares |       |           |         |        |   |                         
|                                                                                                                        |  | Number *)       |  | Amount           |       | Number *) |         | Amount |   |                          |  |   |                           |  
|Balance as of January 1, 2007                                                                                           |  | 1,922,711       |  |                  | 2,266 |           | 326,797 |        |   | 369                      |  |   | 115,937                   |   |                                            |   |  |                    |  | (314     | )                      |  |   | (115,724                 | ) |  |   |        |   |  |   | 2,534  |  
|Issuance of shares and convertible note to an investor, net of issuance cost (see also note 13t)                        |  | 363,636         |  |                  | 461   |           |        |        |   |                         |  |   | 239                       |   |                                            |   |  |                    |  |         |                        |  |   |                         |   |  |   |        |   |  |   | 700    |  
|Issuance of shares in connection with a conversion of short-term convertible note                                       |  | 211,457         |  |                  | 268   |           |         |        |   |                          |  |   | (268                      | ) |                                            |   |   |                    |  |          |                        |  |   |                          |   |  |   |        |   |  |   |       |  
|Issuance of shares, in connection with interest expenses, related to the convertible debts                              |  | 14,546          |  |                  | 17    |           |        |        |   |                         |  |   | 23                        |   |                                            |   |  |                    |  |         |                        |  |   |                         |   |  |   |        |   |  |   | 40     |  
|Issuance of shares and release of restricted shares in connection with compensation to consultants                      |  | 38,500          |  |                  | 50    |           |        |        |   |                         |  |   | (19                       | ) |                                            |   |  |                    |  |          |                        |  |   |                          |   |  |   |        |   |  |   | 31     |  
|Stock based compensation                                                                                                |  |                |  |                  |      |           |        |        |   |                         |  |   | 208                       |   |                                            |   |  |                    |  |         |                        |  |   |                         |   |  |   |        |   |  |   | 208    |  
|Release of restricted shares to employees and directors, net                                                            |  | 9,390           |  |                  | 13    |           |        |        |   |                         |  |   | (13                       | ) |                                            |   |  |                    |  |         |                        |  |   |                         |   |  |   |        |   |  |   |       |  
|Issuance of shares in connection with restructuring bank covenants and credit line                                      |  | 10,000          |  |                  | 12    |           |        |        |   |                         |  |   | 14                        |   |                                            |   |  |                    |  |         |                        |  |   |                         |   |  |   |        |   |  |   | 26     |  
|Comprehensive loss:                                                                                                     |  |                 |  |                  |       |           |         |        |   |                          |  |   |                           |   |                                            |   |   |                    |  |          |                        |  |   |                          |   |  |   |        |   |  |   |        |  
|Cumulative effect of adjustment upon adoption of FIN 48                                                                 |  |                |  |                  |      |           |        |        |   |                         |  |   |                          |   |                                            |   |  |                    |  |         |                        |  |   | (55                      | ) |  |   |        |   |  |   | (55    | )
|Foreign currency translation adjustments recognized as loss resulting from dissolution of Companys subsidiary in Japan |  |                |  |                  |      |           |        |        |   |                         |  |   |                          |   |                                            |   |  |                    |  | 239      |                        |  |   |                         |   |  |   |        |   |  |   | 239    |  
|Foreign currency translation adjustments                                                                                |  |                |  |                  |      |           |        |        |   |                         |  |   |                          |   |                                            |   |  |                    |  | 137      |                        |  |   |                         |   |  | $ | 137    |   |  |   | 137    |  
|Net loss                                                                                                                |  |                |  |                  |      |           |        |        |   |                         |  |   |                          |   |                                            |   |  |                    |  |         |                        |  |   | (3,810                   | ) |  |   | (3,810 | ) |  |   | (3,810 | )
|                                                                                                                        |  |                 |  |                  |       |           |         |        |   |                          |  |   |                           |   |                                            |   |   |                    |  |          |                        |  |   |                          |   |  |   |        |   |  |   |        |  
|Total comprehensive loss                                                                                                |  |                 |  |                  |       |           |         |        |   |                          |  |   |                           |   |                                            |   |   |                    |  |          |                        |  |   |                          |   |  | $ | (3,673 | ) |  |   |        |  
|                                                                                                                        |  |                 |  |                  |       |           |         |        |   |                          |  |   |                           |   |                                            |   |   |                    |  |          |                        |  |   |                          |   |  |   |        |   |  |   |        |  
|Balance as of December 31, 2007                                                                                         |  | 2,570,240       |  | $                | 3,087 |           | 326,797 |        | $ | 369                      |  | $ | 116,121                   |   |                                            | $ |  |                    |  | $ **) 62 |                        |  | $ | (119,589                 | ) |  |   |        |   |  | $ | 50     |  
|                                                                                                                        |  |                 |  |                  |       |           |         |        |   |                          |  |   |                           |   |                                            |   |   |                    |  |          |                        |  |   |                          |   |  |   |        |   |  |   |        |  



|*) | All share data are reported after the effect of the 1 for 5 reverse split that occurred on January 17, 2007.
|-- | ------------------------------------------------------------------------------------------------------------



|**) | All accumulated other comprehensive loss derived from foreign currency translation adjustments.
|--- | -----------------------------------------------------------------------------------------------

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



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##### Table of Contents

VIRYANET LTD. AND ITS SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

U.S. dollars in thousands



|                                                                                       |  |                         |        |   |      |   |        |      |  |   |        |  
|-------------------------------------------------------------------------------------- |  | ----------------------- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                                                       |  | Year ended December 31, |       
|                                                                                       |  | 2005                    |        |   | 2006 |   |        | 2007 | 
|Cash flows from operating activities:                                                  |  |                         |        |   |      |   |        |      |  |   |        |  
|Net loss                                                                               |  | $                       | (6,058 | ) |      | $ | (1,919 | )    |  | $ | (3,810 | )
|Adjustments to reconcile net loss to net cash used in operating activities:            |  |                         |        |   |      |   |        |      |  |   |        |  
|Depreciation and amortization                                                          |  |                         | 672    |   |      |   | 783    |      |  |   | 680    |  
|Amortization of deferred debt issuance cost related to convertible notes               |  |                         | 18     |   |      |   | 44     |      |  |   | 1      |  
|Amortization of convertible notes premium, discounts and beneficial conversion feature |  |                         | (8     | ) |      |   | 50     |      |  |   | (12    | )
|Accrued severance pay, net                                                             |  |                         | (43    | ) |      |   | 4      |      |  |   | 127    |  
|Stock based compensation related to directors and employees                            |  |                         | 54     |   |      |   | 111    |      |  |   | 208    |  
|Stock based compensation related to restricted shares and shares to a bank             |  |                         | 53     |   |      |   | 29     |      |  |   | 46     |  
|Stock based compensation related to restricted shares and shares to consultants        |  |                         | 67     |   |      |   | 45     |      |  |   | 31     |  
|Interest expenses paid in shares                                                       |  |                         | 231    |   |      |   | 148    |      |  |   | 48     |  
|Loss (gain) from extinguishment of convertible note                                    |  |                         | 787    |   |      |   | (974   | )    |  |   |       |  
|Loss from liquidation of a subsidiary                                                  |  |                         |       |   |      |   |       |      |  |   | 239    |  
|Decrease (increase) in trade receivables, net and unbilled receivables                 |  |                         | 144    |   |      |   | 312    |      |  |   | (26    | )
|Decrease in other accounts receivable and prepaid expenses                             |  |                         | 109    |   |      |   | 240    |      |  |   | 303    |  
|Increase (decrease) in trade payables                                                  |  |                         | (43    | ) |      |   | (379   | )    |  |   | 110    |  
|Increase (decrease) in long-term and short-term deferred revenues, net                 |  |                         | 461    |   |      |   | (857   | )    |  |   | 863    |  
|Increase (decrease) in other accounts payable and accrued expenses                     |  |                         | (114   | ) |      |   | (318   | )    |  |   | 61     |  
|Other                                                                                  |  |                         | 1      |   |      |   |       |      |  |   |       |  
|                                                                                       |  |                         |        |   |      |   |        |      |  |   |        |  
|Net cash used in operating activities                                                  |  |                         | (3,669 | ) |      |   | (2,681 | )    |  |   | (1,131 | )
|                                                                                       |  |                         |        |   |      |   |        |      |  |   |        |  
|Cash flows from investing activities:                                                  |  |                         |        |   |      |   |        |      |  |   |        |  
|Purchase of property and equipment                                                     |  |                         | (104   | ) |      |   | (30    | )    |  |   | (194   | )
|Acquisitions of subsidiary (a)                                                         |  |                         | (100   | ) |      |   |       |      |  |   |       |  
|                                                                                       |  |                         |        |   |      |   |        |      |  |   |        |  
|Net cash used in investing activities                                                  |  |                         | (204   | ) |      |   | (30    | )    |  |   | (194   | )
|                                                                                       |  |                         |        |   |      |   |        |      |  |   |        |  
|Cash flows from financing activities:                                                  |  |                         |        |   |      |   |        |      |  |   |        |  
|Short-term bank credit                                                                 |  |                         | 555    |   |      |   | 934    |      |  |   | 628    |  
|Repayment of short-term bank credit and long-term loan                                 |  |                         | (1,066 | ) |      |   | (728   | )    |  |   | (600   | )
|Repayment of loan from related party                                                   |  |                         |       |   |      |   | (190   | )    |  |   | (38    | )
|Proceeds from issuance of share capital and convertible debt                           |  |                         | 3,520  |   |      |   | 1,343  |      |  |   | 761    |  
|Proceeds from payment on account of convertible debt                                   |  |                         |       |   |      |   |       |      |  |   | 239    |  
|Debt issuance costs related to convertible debts                                       |  |                         | (47    | ) |      |   |       |      |  |   |       |  
|Proceeds from exercise of stock options                                                |  |                         | 6      |   |      |   | 2      |      |  |   |       |  
|                                                                                       |  |                         |        |   |      |   |        |      |  |   |        |  
|Net cash provided by financing activities                                              |  |                         | 2,968  |   |      |   | 1,361  |      |  |   | 990    |  
|                                                                                       |  |                         |        |   |      |   |        |      |  |   |        |  
|Effect of exchange rate differences on cash and cash equivalents                       |  |                         | 2      |   |      |   | 46     |      |  |   | 12     |  
|                                                                                       |  |                         |        |   |      |   |        |      |  |   |        |  
|Decrease in cash and cash equivalents                                                  |  |                         | (903   | ) |      |   | (1,304 | )    |  |   | (323   | )
|Cash and cash equivalents at the beginning of the year                                 |  |                         | 2,943  |   |      |   | 2,040  |      |  |   | 736    |  
|                                                                                       |  |                         |        |   |      |   |        |      |  |   |        |  
|Cash and cash equivalents at the end of the year                                       |  | $                       | 2,040  |   |      | $ | 736    |      |  | $ | 413    |  
|                                                                                       |  |                         |        |   |      |   |        |      |  |   |        |  

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



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VIRYANET LTD. AND ITS SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

U.S. dollars in thousands



|                                                                                                                         |  |                         |       |      |   |       |  |   |    
|------------------------------------------------------------------------------------------------------------------------ |  | ----------------------- | ----- | ---- | - | ----- |  | - | ---
|                                                                                                                         |  | Year ended December 31,
|                                                                                                                         |  | 2005                    |       | 2006 |   | 2007 
|Supplemental disclosure of cash flow activities:                                                                         |  |                         |       |      |   |       |  |   |    
|Cash paid during the year for:                                                                                           |  |                         |       |      |   |       |  |   |    
|Interest                                                                                                                 |  | $                       | 180   |      | $ | 261   |  | $ | 319
|                                                                                                                         |  |                         |       |      |   |       |  |   |    
|Supplemental disclosure of non-cash investing and financing activities:                                                  |  |                         |       |      |   |       |  |   |    
|Refinancing of short-term bank loan on a long-term basis                                                                 |  | $                       | 1,800 |      | $ |      |  | $ |   
|                                                                                                                         |  |                         |       |      |   |       |  |   |    
|Compensation related to warrants to a bank                                                                               |  | $                       | 61    |      | $ |      |  | $ |   
|                                                                                                                         |  |                         |       |      |   |       |  |   |    
|Issuance of shares in connection with refinancing of short-term bank loan on a long-term basis                           |  | $                       | 50    |      | $ |      |  | $ |   
|                                                                                                                         |  |                         |       |      |   |       |  |   |    
|Accrued issuance expenses to be paid                                                                                     |  | $                       | 32    |      | $ |      |  | $ | 61 
|                                                                                                                         |  |                         |       |      |   |       |  |   |    
|Conversion to shares of accrued interest expenses, waivers and deferred charges related to the convertible debt and note |  | $                       | 462   |      | $ | 205   |  | $ | 67 
|                                                                                                                         |  |                         |       |      |   |       |  |   |    
|Debt issuance cost                                                                                                       |  | $                       | 34    |      | $ |      |  | $ |   
|                                                                                                                         |  |                         |       |      |   |       |  |   |    
|Compensation related to options and warrants to consultants and a settlement agreement with a customer                   |  | $                       | 42    |      | $ |      |  | $ |   
|                                                                                                                         |  |                         |       |      |   |       |  |   |    
|Conversion of convertible notes into shares                                                                              |  | $                       |      |      | $ | 2,507 |  | $ |   
|                                                                                                                         |  |                         |       |      |   |       |  |   |    



|(a) | Acquisition of e-Wise
|--- | ---------------------

In June 2005, the Company,
through its Australian subsidiary, acquired assets and assumed liabilities of e- Wise (see also Note 1b). The estimated fair value of the assets acquired and liabilities assumed as of the date of acquisition was as follows:



|                                                                       |  |   |       |  
|---------------------------------------------------------------------- |  | - | ----- | -
|Working capital deficiency (no cash and cash equivalents was acquired) |  | $ | 25    |  
|Assumption of unsecured debt related to the acquisition of e-Wise      |  |   | 285   |  
|Property and equipment                                                 |  |   | (31   | )
|Current technology                                                     |  |   | (690  | )
|Customer relationship                                                  |  |   | (420  | )
|Goodwill                                                               |  |   | (550  | )
|Less - amounts acquired by issuance of shares                          |  |   | 1,268 |  
|Less - accrued acquisition costs                                       |  |   | 13    |  
|                                                                       |  |   |       |  
|                                                                       |  | $ | (100  | )
|                                                                       |  |   |       |  

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



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##### Table of Contents

VIRYANET LTD. AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and
per share data

NOTE 1:- GENERAL



| | a. | ViryaNet Ltd. (the Company), an Israeli corporation, was established in 1988. The Company develops, markets and supports integrated mobile and Web-based software
applications for workforce management and the automation of field service delivery. The Company also provides additional software applications.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The Company has five wholly-owned subsidiaries: three in the United States (ViryaNet Inc. and its subsidiaries iMedeon Inc. and Utility Partners Inc., collectively ViryaNet
U.S.), one in Australia (ViryaNet Australia), which is a subsidiary of ViryaNet Inc, one in the United Kingdom (ViryaNet U.K.) which is not active. The Companys subsidiary in Japan (ViryaNet Japan),
was dissolved in April 2007.

The Companys sales are generated in the United States, Europe, and Asia-Pacific. As for major customers,
see Note 15b.

The Ordinary shares of the Company were traded until June 11, 2007 on the Nasdaq Capital Market. On June 12, 2007,
the Companys Ordinary shares were delisted from the Nasdaq Capital Market and on November 14, 2007 became eligible for quotation and trading on the OTC Bulletin Board (OTCBB). On September 11, 2008 the Companys
Ordinary shares ceased to be eligible for quotation and trading on the OTCBB and became eligible for quotation and trading on the Pink Sheets.

The Company is devoting substantial efforts towards activities such as marketing its products, financial planning and capital raising. In the course of such activities, the Company and its subsidiaries have sustained operating losses. The
Company and its subsidiaries have generated variable levels of revenues over the past several years and have not achieved profitable operations or positive cash flows from operations or positive working capital. The Companys accumulated
deficit aggregated to $119,589 through December 31, 2007. There is no assurance that profitable operations or positive cash flows from operations, if ever achieved, could be sustained on a continuing basis, and no assurance that capital raising
activities will be sufficient to offset the impact of non-positive cash flows from operations.

All share data in this report are reported
after the effect of the 1 for 5 reverse split that occurred on January 17, 2007 (see Note 13).



| | b. | Acquisition of e-Wise Solutions:
| | -- | --------------------------------

On June 15, 2005,
the Company, through its newly wholly-owned Australian subsidiary, ViryaNet Pty Ltd. (ViryaNet Australia), acquired substantially all of the assets of privately-held e-Wise Solutions (e-Wise). e-Wise, based in Melbourne,
Australia, developed and implemented front-office automation solutions for mobile and desktop platforms for large organizations in the utility, government, and oil and gas services market segments, across Australia and New Zealand. Through ViryaNet
Australia, the Company acquired substantially all of the assets of e-Wise, including intellectual property rights, and assumed certain customer and partnership agreements. The acquisition of e-Wise provides the Company with an installed base of
customers and organization in Australia to expand its presence in the Asia Pacific region. The aggregate purchase price for this transaction consisted of the issuance of 111,156 of the Companys Ordinary shares (including 56,503 Ordinary shares
issued on August 9, 2005, under the amendment to the agreement as described below) at an estimated fair value of $ 1,268, assumption of approximately $ 285 of unsecured debt, and transaction expenses of approximately $ 113. The
unsecured debt is payable to e-Wises major shareholder, who became a shareholder and an employee of the Company as a result of the acquisition. As of December 31, 2007, $ 90 of the unsecured debt is unpaid.



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##### Table of Contents

VIRYANET LTD. AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in
thousands, except share and per share data



NOTE 1:- GENERAL (CONT.):

The purchase price included an additional consideration of up to $ 700 in unregistered Ordinary shares to be issued to e-Wise in 2006 based on the achievement of certain performance objectives for 2005 (the
Contingent Consideration). On July 5, 2005, the Company signed an amendment to the agreement with e-Wise under which the Company received an option to pay 90% of the Contingent Consideration at any time before October 15, 2005,
as satisfaction of its payment obligation in connection with such Contingent Consideration. On August 9, 2005, the Company exercised its option and issued 56,503 of its Ordinary shares (estimated fair value of $ 604) as the second
component of consideration of the acquisition of e-Wises business.

The total purchase price was comprised as follows:



|                                     |  |   |      
|------------------------------------ |  | - | -----
|Fair value of Ordinary shares issued |  | $ | 1,268
|Assumption of unsecured debt         |  |   | 285  
|Acquisition related costs            |  |   | 113  
|                                     |  |   |      
|Total purchase price                 |  | $ | 1,666
|                                     |  |   |      

The Company determined the fair value of the issued shares using Emerging Issues Task Force
No. 99-12, Determination of the Measurement Date For the Market Price of Acquirer Securities Issued in a Purchase Business Combination (EITF No. 99-12). According to EITF No. 99-12, the fair value is determined
based on the average market price of the Companys Ordinary shares two days before and after the transaction date.

The operations of
e-Wise are included in the consolidated statements from the date of acquisition.

The acquisition was accounted for under the purchase
method of accounting, in accordance with Statement of Financial Accounting Standards No. 141, Business Combinations (SFAS No. 141), and accordingly, based upon a valuation, the purchase price has been allocated to
the assets acquired and the liabilities assumed based on their estimated fair value at the date of acquisition. The excess of the purchase price over the estimated fair value of the net identifiable assets acquired has been recorded as goodwill.

The following table summarizes the estimated fair value of assets acquired and liabilities assumed at the date of acquisition:



|                          |  |   |       |  
|------------------------- |  | - | ----- | -
|Current assets            |  | $ | 97    |  
|Property and equipment    |  |   | 31    |  
|Technology (1)            |  |   | 690   |  
|Customer relationship (1) |  |   | 420   |  
|Goodwill                  |  |   | 550   |  
|                          |  |   |       |  
|Total assets acquired     |  |   | 1,788 |  
|                          |  |   |       |  
|Current liabilities       |  |   | (122  | )
|                          |  |   |       |  
|Total liabilities assumed |  |   | (122  | )
|                          |  |   |       |  
|Net assets acquired       |  | $ | 1,666 |  
|                          |  |   |       |  



| | (1) | See also Note 5.
| | --- | ----------------



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VIRYANET LTD. AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in
thousands, except share and per share data



NOTE 1:- GENERAL (CONT.)

Amortization of acquired intangible assets is calculated using the following estimated useful lives:



|                      |  |      
|--------------------- |  | -----
|                      |  | Years
|Technology            |  | 5    
|Customer relationship |  | 5    

Goodwill of $ 550 represents the excess of the purchase price over the fair market value of
the net tangible and intangible assets acquired. Goodwill will not be amortized and will be tested for impairment at least annually. The Company believes that the goodwill represents synergies as the acquisition of e-Wise provides the Company with
technology, an installed base of customers, a talented organization in Australia, and infrastructure to expand its presence in the Asia Pacific region.

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES

Basis of presentation:

The consolidated financial statements were prepared in accordance with United States generally accepted accounting principles (U.S. GAAP).

Use of estimates:

The
preparation of financial statements in conformity with U.S. 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.

Financial statements in U.S. dollars:

Substantially all of the revenues of the Company and ViryaNet U.S. are generated in U.S. dollars (dollars). In addition, a substantial portion
of the costs of the Company and certain of its subsidiaries is incurred in dollars. Financing and investment activities are made in U.S. dollars. Since management believes that the dollar is the primary currency in the economic environment in which
the Company and certain of its subsidiaries operate, thus, the dollar is the functional and reporting currency. Accordingly, amounts in currencies other than U.S. dollars have been remeasured as follows:

Monetary balances - at the exchange rate in effect on the balance sheet date.

Non-monetary balances - at the historical rate in effect as of the date of recognition of the transaction.

Revenues and cost - at the exchange rate in effect as of the date of recognition of the transaction.

All the exchange gain and losses from the remeasurement mentioned above are reflected in the statement of operations in financial expenses (income), net.

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



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VIRYANET 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.):

Principles of consolidation:

The
consolidated financial statements include the accounts of the Company and its subsidiaries (the Group). Intercompany balances and transactions including profit from intercompany sales not yet realized outside the Group have been
eliminated upon consolidation.

Cash equivalents:

Cash equivalents are short-term, highly liquid investments that are readily convertible to cash, with original maturities of three months or less.

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, peripheral equipment and software |  | 33                                                             
|Office furniture and equipment               |  | 6 - 25                                                         
|Leasehold improvements                       |  | By the shorter of the term of the leaseor the life of the asset

Goodwill, other intangible assets and debt issuance cost:

Goodwill reflects the excess of the purchase price of business acquired over the fair value of net assets acquired. Identifiable intangible assets consist
mainly of acquired technology, trade names and customer relationships.

Under Statement of Financial Accounting Standards No. 142,
Goodwill and Other Intangible Assets (SFAS No. 142), Goodwill is not amortized for financial reporting purposes. Instead, the Company is required to test, annually (or more frequently if certain indicators exist) for
impairment of goodwill using a two-phase process. The first phase screens for impairment; while the second phase (if necessary) measures impairment.

In the first phase of impairment testing, goodwill is tested for impairment by comparing the fair value of the reporting unit with its carrying value. As of December 31, 2007, no instances of impairment were found.

Finite-lived intangible assets are amortized using a method of amortization that reflects the pattern in which the economic benefits of the intangible
assets are consumed or otherwise used up in accordance with SFAS No. 142.



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VIRYANET LTD. AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in
thousands, except share and per share data



Costs incurred in respect of issuance of debentures are deferred and amortized as a component of
interest expense over the contractual life of the debenture using the effective interest method. The amortization periods for the Companys finite-lived intangibles and debt issuance costs are as follows:

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)



|                         |  |                            
|------------------------ |  | ---------------------------
|                         |  | Amortization periodin years
|Technology               |  | 3-5                        
|Customer relationship    |  | 5-6                        
|Database                 |  | 2                          
|Trademark and trade name |  | 4                          
|Debt issuance costs      |  | 7                          

Impairment of long-lived assets other than goodwill:

The Companys and its subsidiaries long-lived assets, including identifiable intangibles assets, are reviewed for impairment in accordance with
Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS No. 144), whenever events or changes in circumstances indicate that the carrying amount of an
asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the future undiscounted cash flows expected to be generated by the asset. If an asset is considered to be
impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds its fair value. During 2005, 2006 and 2007, no impairment losses have been identified.

Income taxes:

The Company and its
subsidiaries account for income taxes in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (SFAS No. 109), using the liability method whereby deferred tax assets and
liability account balances are determined based on the differences between financial reporting and the tax basis for 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 the amounts that are more likely-than-not to be realized.

On January 1, 2007, the Company adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an Interpretation of FASB
Statement No. 109 (FIN 48). FIN 48 contains a two-step approach to recognizing and measuring uncertain tax positions accounted for in accordance with SFAS No. 109. The first step is to evaluate the tax position taken or
expected to be taken in a tax return by determining if the weight of available evidence indicates that it is more likely than not that, on an evaluation of the technical merits, the tax position will be sustained on audit, including resolution of
any related appeals or litigation processes. The second step is to measure the tax benefit as the largest amount that is more than 50% likely to be realized upon ultimate settlement. The Company recognizes interest and penalties, if any, related to
unrecognized tax benefits in its provision for income tax.

Revenue recognition:

The Company generates revenues from licensing the rights to use its software products directly to end-users. The Company also enters into license
arrangements with indirect channels such as resellers and systems integrators resellers whereby revenues are recognized upon sale through to the end user by the reseller.

The Company also generates revenues from rendering professional services, including consulting, customization, implementation, training and post-contract maintenance and support.



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VIRYANET 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.)

Revenues from software license agreements are recognized in accordance with Statement of Position No. 97-2, Software Revenue Recognition,
as amended (SOP No. 97-2). SOP No. 97-2 generally requires revenue earned on software arrangements involving multiple elements to be allocated to each element based on the relative fair value of the elements. The Company has
adopted Statement of Position No. 98-9, Modification of SOP No. 97-2, Software Revenue Recognition with Respect to Certain Transactions (SOP No. 98-9). SOP No. 98-9 requires that revenue be recognized
under the residual method when vendor specific objective evidence (VSOE) of fair value exists for all undelivered elements and VSOE does not exist for all of the delivered elements. Under the residual method any discount in
the arrangement is allocated to the delivered elements. The VSOE of fair value of the undelivered elements is determined based on the price charged for the undelivered element when sold separately. If VSOE of fair value does not exist for all
elements to support the allocation of the total fee among all delivered and undelivered elements of the arrangement, revenue is deferred until such evidence exists for the undelivered elements, or until all elements are delivered, whichever is
earlier.

Generally, revenue from license fees is recognized when persuasive evidence of an agreement exists, delivery of the product has
occurred, the fee is fixed or determinable and collectibility is probable. The Company does not grant a right of return to its customers. If the fee due from the customer is not fixed or determinable, revenue is recognized as payments become due
from the customer, assuming all other revenue recognition criteria have been met.

Post-contract maintenance and support arrangements
provide technical support and the right to unspecified updates on an if-and-when available basis. Maintenance and support revenue is deferred and recognized on a straight-line basis over the term of the agreement, which is, in most cases, one year.
Revenue from rendering services such as consulting, implementation and training are recognized as work is performed.

Arrangements that
include services are evaluated to determine whether those services are essential to the functionality of other elements of the arrangement. Services that are considered essential consist primarily of significant production, customization, or
modification. When such services are provided, revenues under the arrangement are recognized 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 contract, in accordance with Statement of Position No. 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts (SOP No. 81-1). When services are
not considered essential, the revenues allocable to the software services are recognized as the services are performed.

Provisions for
estimated losses on uncompleted contracts are made in the period in which such losses are first determined, in the amount of the estimated loss on the entire contract. During 2005, 2006 and 2007, no such estimated losses were identified.

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

Research and development costs:

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

Statement of Financial Accounting Standards No. 86, Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed (SFAS No. 86), requires capitalization of certain software
development costs subsequent to the establishment of technological feasibility.



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VIRYANET 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.)

Based on the Companys product development process, technological feasibility is established upon completion of a working model. Costs incurred by
the Company between the completion of the working model and the point at which the product is ready for general release, have been insignificant. Due to the relatively short time between the date the products achieve technological feasibility and
the date they generally become available to customers, costs subject to capitalization under SFAS No. 86 have been immaterial and have been expensed as incurred.

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, trade receivables and unbilled receivables.

The majority of the Companys cash and cash equivalents are invested in dollar instruments with major banks in the United States, Israel, and Australia. Such cash and cash equivalents may be in excess of insured limits and may not be
insured at all in some 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 and its subsidiaries trade and unbilled receivables are derived from sales to customers located
primarily in the United States, Europe, Australia and the Far East. The Company and its subsidiaries perform ongoing credit evaluations of their customers and insure certain trade receivables under foreign trade risks insurance. An allowance for
doubtful accounts is determined with respect to specific receivables for which collection may be doubtful. In managements opinion, the allowance for doubtful accounts adequately covers anticipated losses with respect to its accounts
receivable.

From time to time, the Company sells certain of its accounts receivable to financial institutions, within the normal course of
business. Where receivables are sold without recourse to the Company and such sales constitute a true sale as this term is determined in Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities (SFAS No. 140), the relevant receivable is de-recognized and cash recorded. Where receivables are sold and the transfers of the rights to future cash receipts are related to
underlying sales transactions for which the revenue has not been recognized, the receivable is not de-recognized and a liability reflecting the obligation to the financial institution is recorded within the short-term bank credit until the liability
is discharged through the financial institution receiving payment.

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

Long term convertible debt:

The Company presents the outstanding principal amount of its long term convertible debts as a long-term liability, in accordance with
APB No. 14, Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants (APB 14). The debt is classified as a long-term liability until the date of conversion on which it would be reclassified to equity,
or at the first contractual redemption date, on which it would be reclassified as a short-term liability (see also Note 11). Accrued interest on the convertible debt is included in other accounts payable and accrued expenses.



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VIRYANET 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.)

Convertible note:

The Company
presents the outstanding principal amount of the convertible note as a separate component in the shareholders equity in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities and SFAS
No. 150,  Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. The Note was classified as an equity component since it has no repayment date, does not bear any interest and may be
converted only to the Companys Ordinary shares. The note will be classified as a separate component in shareholders equity until the date of actual conversion.

Accounting for stock-based compensation:

On January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), Share-based Payment (SFAS No. 123(R)) which requires the measurement and recognition of
compensation expense for all share-based payment awards made to employees and directors based on estimated fair values. SFAS No. 123(R) supersedes the Companys previous accounting under Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees (APB 25), for periods beginning in fiscal 2006. In March 2005, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 107 (SAB 107) relating to
SFAS No. 123(R). The Company has applied the provisions of SAB 107 in its adoption of SFAS No. 123(R).

SFAS No. 123(R)
requires companies to estimate the fair value of equity-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as an expense over the requisite
service periods in the Companys consolidated statements of operations. Prior to the adoption of SFAS No. 123(R), the Company accounted for equity-based awards to employees and directors using the intrinsic value method in accordance with
APB 25 as allowed under Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (SFAS No. 123).

The Company adopted SFAS No. 123(R) using the modified prospective transition method, which requires the application of the accounting standard as of January 1, 2006, the first day of the Companys
fiscal year 2006. Under that transition method, compensation cost recognized in the year ended December 31, 2006, included: (a) compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006,
based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, and (b) compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value
estimated in accordance with the provisions of SFAS No. 123(R). As required by the modified prospective method, results for prior periods have not been restated.

The Company recognizes compensation expenses for the value of these awards, which has graded vesting, based on the straight line method over the requisite service period of each of the awards, net of estimated
forfeitures. Estimated forfeitures are based on actual historical pre-vesting forfeitures.

As a result of adopting SFAS No. 123(R) on
January 1, 2006, the Companys net loss for the year ended December 31, 2006, was $ 27 higher than if it had continued to account for stock-based compensation under APB 25. Basic and diluted net loss per share for the year ended
December 31, 2006, was $ 0.01 higher than if the Company had continued to account for share-based compensation under APB 25.

Prior to January 1, 2006, the Company applied the intrinsic value method of accounting for stock options as prescribed by APB 25, whereby compensation expense is equal to the excess, if any, of the quoted market price of the stock over
the exercise price at the grant date of the award.



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VIRYANET 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.)

The pro forma table below illustrates the effect of the Companys stock-based compensation expense on net loss and basic and diluted loss per share
for 2005, had the Company applied the fair value recognition provisions of SFAS No. 123.

The fair value for options granted in 2005 is
amortized over their vesting period and estimated at the date of grant using a Black-Scholes options pricing model with the following weighted average assumptions:



|                    |  |         |  
|------------------- |  | ------- | -
|                    |  | 2005    |  
|Dividend yield      |  | 0       | %
|Expected volatility |  | 73      | %
|Risk-free interest  |  | 4       | %
|Expected life       |  | 4 years |  

Pro forma information under SFAS No. 123:



|                                                                                       |  |                            |        |  
|-------------------------------------------------------------------------------------- |  | -------------------------- | ------ | -
|                                                                                       |  | Year endedDecember 31,2005 |       
|Net loss as reported                                                                   |  | $                          | (6,058 | )
|Add - stock-based employee compensation expenses recorded in reported net loss         |  |                            | 54     |  
|Deduct - stock-based employee compensation expenses determined under fair value method |  |                            | (409   | )
|                                                                                       |  |                            |        |  
|Pro forma net loss                                                                     |  | $                          | (6,413 | )
|                                                                                       |  |                            |        |  
|Basic and diluted net loss per share, as reported                                      |  | $                          | (4.68  | )
|                                                                                       |  |                            |        |  
|Pro forma basic and diluted loss per share                                             |  | $                          | (4.95  | )
|                                                                                       |  |                            |        |  

The assumptions below are relevant to options granted in 2005 as it relates to Black-Scholes
calculations:

The dividend yield assumption is based on the Companys historical experience and expectation of future dividend payouts
and may be subject to substantial change in the future.

The Company used its historical volatility in accordance with SFAS No. 123.

The expected life of employee stock options represents the weighted-average period the stock options are expected to remain outstanding.
The expected life for options granted by the Company for the year ended December 31, 2005 is 4 years and the risk-free interest rate assumption is the implied yield available on United States treasury zero-coupon issues with a remaining term
equal to the expected life term of the Companys options.

The assumptions below are relevant to restricted shares granted in 2005,
2006 and 2007:

In accordance with FAS123(R), restricted shares are measured at their fair value as if it was vested and issued on the grant
date. All restricted shares to employees granted in 2007, 2006 and 2005 were granted for no consideration; therefore their fair value was equal to the share price at the date of grant. No stock options were granted in 2006 and 2007.



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VIRYANET 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.)

The fair value of all restricted shares was determined based on the opening trading price of the Companys shares on the grant day. The weighted
average grant date fair value of shares granted during the years 2007, 2006 and 2005 was $ 3.34, $ 4.15 and $ 9.95, respectively.

The
Company applies SFAS No. 123 and EITF No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services, with respect to options 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 measurement date.

Severance pay:

The Companys liability for severance pay to its Israeli employees is calculated
pursuant to Israels Severance Pay Law based on the most recent salary of the employees multiplied by the number of years of employment, as of the balance sheet date. Employees are entitled to one months salary for each year of employment
or a portion thereof. The Companys liability for all of its employees in Israel is fully provided for by monthly deposits with insurance policies and by an accrual. The value of these policies is recorded as an asset in the Companys
balance sheet.

The deposited funds for the Companys Israeli employees include profits accumulated up to the balance sheet date. The
deposited funds may be withdrawn only upon the fulfillment of the obligation pursuant to Israels Severance Pay Law or labor agreements. The value of the deposited funds is based on the cash surrendered value of these policies, and includes
immaterial profits.

Severance expenses for the years ended December 31, 2005, 2006 and 2007 amounted to approximately $ 45,
$ 68 and $ 149, respectively.

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, trade receivables, unbilled receivables, other accounts
receivable, short-term bank credit, trade payables and other accounts payable approximates their fair values due to the short-term maturity of such instruments.

Long-term bank loan and long and short-term convertible debt are estimated by discounting the future cash flows using current interest rates for loans of similar terms and maturities. The carrying amount of such
long-term debts approximates their fair value.

Net loss per share:

Basic net loss per share is computed based on the weighted average number of shares outstanding during each year. Diluted net loss per share is computed
based on the weighted-average number of shares outstanding during each year, plus dilutive potential shares considered outstanding during the year, in accordance with Statement of Financial Accounting Standards No. 128, Earnings per
Share (SFAS No. 128).



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VIRYANET 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 and non vested restricted shares, warrants and shares issuable upon conversion of the convertible debts and note have been
excluded from the calculation of the diluted net loss per share because all such securities are anti-dilutive for all periods presented. The total weighted-average number of shares related to the outstanding options and unvested restricted shares,
warrants and shares issuable upon conversion of the convertible debts and note excluded from the calculations of diluted net loss per share, was 348,255, 355,218 and 465,087 for the years ended December 31, 2005, 2006 and 2007, respectively.

Impact of recently issued accounting standards:

SFAS No. 157:

In September 2006, the FASB issued Statement of Financial Accounting Standards
No. 157, Fair Value Measurements (SFAS 157) which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS 157 applies to other accounting pronouncements that
require or permit fair value measurements and, accordingly, does not require any new fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007 for financial assets and liabilities, as well as for any
other assets and liabilities that are carried at fair value on a recurring basis, and should be applied prospectively. The adoption of the provisions of SFAS 157 related to financial assets and liabilities and other assets and liabilities that are
carried at fair value on a recurring basis is not anticipated to materially impact the Companys consolidated financial position and results of operations. Subsequently, the FASB provided for a one-year deferral of the provisions of SFAS 157
for non-financial assets and liabilities that are recognized or disclosed at fair value in the consolidated financial statements on a non-recurring basis. The company does not expect the adoption of SFAS No. 157 will have an impact on its
consolidated financial statements.

SFAS No. 159:

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (SFAS No. 159). SFAS No. 159 permits companies to choose to
measure certain financial instruments and certain other items at fair value. The standard requires that unrealized gains and losses on items for which the fair value option has been elected be reported in earnings. The provisions of
SFAS No. 159 are effective for the Company beginning January 1, 2008. The Company does not expect the adoption of SFAS No. 159 will have an impact on its consolidated financial statements.

SAB No. 110:

On December 21,
2007, the SEC staff issued Staff Accounting Bulletin No. 110 (SAB 110), which, effective January 1, 2008, amends and replaces SAB 107, Share-Based Payment. SAB 110 expresses the views of the SEC staff regarding the
use of a simplified method in developing an estimate of expected term of plain vanilla share options in accordance with FASB Statement No. 123(R), Share-Based Payment. Under the simplified method,
the expected term is calculated as the midpoint between the vesting date and the end of the contractual term of the option.

The use of the
simplified method, which was first described in Staff Accounting Bulletin No. 107, was scheduled to expire on December 31, 2007. SAB 110 extends the use of the simplified method for plain vanilla awards
in certain situations. The SEC staff does not expect the simplified method to be used when sufficient information regarding exercise behavior, such as historical exercise data or exercise information from external sources, becomes
available.



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##### Table of Contents

VIRYANET 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.)

The Company does not expect the adoption of SAB No. 110 will have significant impact on its consolidated financial statement.

SFAS No. 141(R)

In December 2007, the
FASB issued SFAS 141(R), Business Combinations (SFAS 141(R)). This Statement replaces SFAS 141, Business Combinations, and requires an acquirer to recognize the assets acquired, the liabilities assumed, including
those arising from contractual contingencies, any contingent consideration, and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date, with limited exceptions specified in the statement.
SFAS 141(R) also requires the acquirer in a business combination achieved in stages (sometimes referred to as a step acquisition) to recognize the identifiable assets and liabilities, as well as the noncontrolling interest in the acquiree, at the
full amounts of their fair values (or other amounts determined in accordance with SFAS 141(R)). In addition, SFAS 141(R)s requirement to measure the noncontrolling interest in the acquiree at fair value will result in recognizing the goodwill
attributable to the noncontrolling interest in addition to that attributable to the acquirer. SFAS 141(R) amends SFAS No. 109, Accounting for Income Taxes, to require the acquirer to recognize changes in the amount of its deferred
tax benefits that are recognizable because of a business combination either in income from continuing operations in the period of the combination or directly in contributed capital, depending on the circumstances. It also amends SFAS 142,
Goodwill and Other Intangible Assets, to, among other things, provide guidance on the impairment testing of acquired research and development intangible assets and assets that the acquirer intends not to use. SFAS 141(R) applies
prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. SFAS 141R will have an impact on accounting for future business
combinations once adopted and not on prior acquisitions. As such, the nature and magnitude of the specific effects will dependent upon the nature, terms and size of the acquisitions it consummates after the effective date.

SFAS No. 160

In December 2007, the
FASB issued SFAS 160, Noncontrolling Interests in Consolidated Financial Statements (SFAS 160). SFAS 160 amends Accounting Research Bulletin 51, Consolidated Financial Statements, to establish accounting and
reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It also clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be
reported as equity in the consolidated financial statements. SFAS 160 also changes the way the consolidated income statement is presented by requiring consolidated net income to be reported at amounts that include the amounts attributable to both
the parent and the noncontrolling interest. It also requires disclosure, on the face of the consolidated statement of income, of the amounts of consolidated net income attributable to the parent and to the noncontrolling interest. SFAS 160 requires
that a parent recognize a gain or loss in net income when a subsidiary is deconsolidated and requires expanded disclosures in the consolidated financial statements that clearly identify and distinguish between the interests of the parent owners and
the interests of the noncontrolling owners of a subsidiary. SFAS 160 is effective for fiscal periods, and interim periods within those fiscal years, beginning on or after December 15, 2008. The Company is currently assessing the potential
impact that the adoption of SFAS 160 could have on its financial statements.



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##### Table of Contents

VIRYANET LTD. AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in
thousands, except share and per share data



NOTE 3:- OTHER ACCOUNTS RECEIVABLE AND PREPAID EXPENSES



|                       |  |              |     |      |   |    
|---------------------- |  | ------------ | --- | ---- | - | ---
|                       |  | December 31,
|                       |  | 2006         |     | 2007
|Prepaid expenses       |  | $            | 469 |      | $ | 217
|Employees              |  |              | 6   |      |   | 3  
|Government authorities |  |              | 47  |      |   | 6  
|                       |  |              |     |      |   |    
|                       |  | $            | 522 |      | $ | 226
|                       |  |              |     |      |   |    

NOTE 4:- PROPERTY AND EQUIPMENT



| | a. | Composition:
| | -- | ------------



|                                             |  |              |       |      |   |      
|-------------------------------------------- |  | ------------ | ----- | ---- | - | -----
|                                             |  | December 31,
|                                             |  | 2006         |       | 2007
|Cost:                                        |  |              |       |      |   |      
|Computers, peripheral equipment and software |  | $            | 5,259 |      | $ | 5,442
|Office furniture and equipment               |  |              | 818   |      |   | 819  
|Leasehold improvements                       |  |              | 533   |      |   | 533  
|                                             |  |              |       |      |   |      
|                                             |  |              | 6,610 |      |   | 6,794
|Accumulated depreciation                     |  |              | 6,447 |      |   | 6,556
|                                             |  |              |       |      |   |      
|Depreciated cost                             |  | $            | 163   |      | $ | 238  
|                                             |  |              |       |      |   |      

Depreciation expenses for the years ended December 31, 2005, 2006 and 2007 were approximately
$ 537, $ 150 and $ 117, respectively.



| | b. | As for charges, see Note 12c.
| | -- | -----------------------------

NOTE 5:- OTHER INTANGIBLE ASSETS AND
DEBT ISSUANCE COSTS, NET



| | a. | Other intangible assets and debt issuance costs composition:
| | -- | ------------------------------------------------------------



|                                                 |  |              |       |      |   |      
|------------------------------------------------ |  | ------------ | ----- | ---- | - | -----
|                                                 |  | December 31,
|                                                 |  | 2006         |       | 2007
|Costs:                                           |  |              |       |      |   |      
|Technology                                       |  | $            | 1,484 |      | $ | 1,566
|Database                                         |  |              | 21    |      |   | 21   
|Trademark and trade name                         |  |              | 110   |      |   | 110  
|Debt issuance costs related to convertible debts |  |              | 112   |      |   | 112  
|                                                 |  |              |       |      |   |      
|                                                 |  |              | 1,727 |      |   | 1,809
|                                                 |  |              |       |      |   |      
|Accumulated amortization:                        |  |              |       |      |   |      
|Technology                                       |  |              | 874   |      |   | 1,173
|Database                                         |  |              | 21    |      |   | 21   
|Trademark and trade name                         |  |              | 66    |      |   | 94   
|Debt issuance costs related to convertible debts |  |              | 106   |      |   | 107  
|                                                 |  |              |       |      |   |      
|                                                 |  |              | 1,067 |      |   | 1,395
|                                                 |  |              |       |      |   |      
|Amortized cost                                   |  | $            | 660   |      | $ | 414  
|                                                 |  |              |       |      |   |      

See also Notes 1b, 1c.



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##### Table of Contents

VIRYANET LTD. AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in
thousands, except share and per share data



NOTE 5:- OTHER INTANGIBLE ASSETS AND DEBT ISSUANCE COSTS, NET (Cont.)



| | b. | Amortization expenses of other intangible assets and debt issuance costs amounted to $ 336, $ 417 and $ 303 for the years ended December 31, 2005, 2006 and 2007,
respectively.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | c. | Customer relationship acquired as part of the acquisitions of certain subsidiaries. Amortization expenses amounted to $ 204, $ 248 and $ 256 for the years ended
December 31, 2005, 2006 and 2007, respectively.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | d. | Following is the estimated amortization expenses with respect to identifiable intangible assets and debt issuance costs for the years ended:
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------



|     |  |              |    
|---- |  | ------------ | ---
|     |  | December 31,
|2008 |  | $            | 472
|2009 |  | $            | 456
|2010 |  | $            | 135
|2011 |  | $            | 4  

NOTE 6:- GOODWILL

The changes in the carrying amount of goodwill for the years ended December 31, 2006 and 2007 are as follows:



|                                         |  |   |      
|---------------------------------------- |  | - | -----
|Balance as of January 1, 2006            |  | $ | 7,048
|Foreign currency translation adjustments |  |   | 40   
|                                         |  |   |      
|Balance as of December 31, 2006          |  |   | 7,088
|Foreign currency translation adjustments |  |   | 64   
|                                         |  |   |      
|Balance as of December 31, 2007          |  | $ | 7,152
|                                         |  |   |      

NOTE 7:- SHORT-TERM BANK CREDIT

As of December 31, 2004, the Company had a credit line facility with Bank Hapoalim (the Bank) of up to $ 137, of which the Company
used $ 13, and a short-term loan in the amount of $ 1,500. The weighted-average interest on the credit line and the short-term loan was approximately 4% and 5%, respectively.

On December 22, 2005, the Company refinanced its debt arrangement with the Bank by converting $ 1,800 of the outstanding balance of short-term
borrowings and line of credit to long-term debt and established a revolving line of credit for approximately $ 415 with the Bank, of which the Company used $ 264 as of December 31, 2005 (see Note 10). The weighted-average interest on
the credit line was approximately 7%.

During 2006, the Company increased its credit line facility to $ 1,187 with the Bank and as of
December 31, 2006, the Company had an outstanding balance of short-term borrowings under the credit line with the Bank in the amount of $ 728 and a short-term loan in the amount of $ 459. The weighted-average interest on the credit
line and the short-term loan ranged from 7.6% to 9%.



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##### Table of Contents

VIRYANET LTD. AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in
thousands, except share and per share data



NOTE 7:- SHORT-TERM BANK CREDIT (Cont.)

During 2007, the Company increased its credit line facility with the Bank to $ 1,719 and as of December 31, 2007, the Company had an outstanding
balance of short-term borrowings under the credit line with the Bank in the amount of $ 130 and a short-term loan in the amount of $ 1,589. The weighted-average interest on the credit line and the short-term loan ranged from 7% to 10%.

In August, 2007, Bank Hapoalim agreed to modify the Companys bank covenant requirements as part of its overall bank financing
arrangement such that on a quarterly basis starting August 1, 2007 (i) the Companys shareholders equity shall be at least the higher of (a) 13% of its total assets, or (b) $ 1,500, and (ii) its cash balance shall
not be less than $ 500. In addition, Bank Hapoalim provided the Company with a waiver of these new bank covenant requirements for the remainder of 2007. In connection with these changes, the Company recorded fees expenses in the amount of $ 10
and issued 10,000 Ordinary shares to the bank at no consideration.

The fair value of the Ordinary shares issued to the Bank
(Banks Shares) was determined using the market price of the Companys Ordinary shares at the measurement date. This resulted in an amount of $ 26. The Company recorded the Banks Shares based on their fair value as
additional paid-in capital.

In addition, as of December 31, 2007, Company had sold an amount of $ 130 of its accounts receivable to a
financial institution, relating to an annual renewal of support and maintenance transactions for which the revenue has not been recognized and, therefore, was accounted for as a financing transaction pursuant to EITF 88-18.

NOTE 8:- OTHER ACCOUNTS PAYABLE AND ACCRUED EXPENSES



|                               |  |              |       |      |   |      
|------------------------------ |  | ------------ | ----- | ---- | - | -----
|                               |  | December 31,
|                               |  | 2006         |       | 2007
|Employees and payroll accruals |  | $            | 1,257 |      | $ | 1,287
|Accrued expenses               |  |              | 627   |      |   | 783  
|                               |  |              |       |      |   |      
|                               |  | $            | 1,884 |      | $ | 2,070
|                               |  |              |       |      |   |      

NOTE 9:- PAYMENT ON ACCOUNT OF CONVERTIBLE NOTE

On December 19, 2007, the Company signed a financing transaction with a group of new financial investors. The transaction included an equity
investment of $ 600 at a price of $ 1.65 per Ordinary share and a convertible note of $ 600 (the Convertible Note) at a conversion price of $ 1.65 per Ordinary share. In addition, as part of the transaction, the
investors received warrants to purchase an aggregate of up to 600,000 Ordinary shares at an exercise price of $ 2.00 per Ordinary share (see also Note 13). The Convertible Note does not bear interest, does not have any maturity, is not
subject to a repayment in any event including liquidation and can only be converted into Ordinary shares. The Note Holder shall be entitled to convert any or all of the outstanding principal amount into Ordinary shares of the Company at a fixed
conversion price of $1.65 per Ordinary share, as may be adjusted to reflect stock splits, reconsolidation or similar technical adjustments to the Companys share capital. The Note Holder may convert the Principle Amount at any time at its
discretion.

All of the warrants and an amount of $ 439 of the Convertible Note are subject to the Companys shareholders approval
which was granted on January 31, 2008.



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##### Table of Contents

VIRYANET LTD. AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in
thousands, except share and per share data



NOTE 9:- PAYMENT ON ACCOUNT OF CONVERTIBLE NOTE (Cont.)

As of December 31, 2007, the Company received from the investors $ 600 of the equity investment and $ 161 of the Convertible Note, which both
were not subject to shareholders approval. The Company also received an additional amount of $ 239 as payment on account of the Convertible Note and warrants which was subject to shareholders approval.

The amount of Convertible Note of $ 161 which was not subject to shareholders approval, was classified as equity in accordance with SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities and SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.

The amount of $ 239 of Convertible Note and warrants which was received in 2007 and was subject to shareholders approval, is classified as current
liabilities as of December 31, 2007 as payment on account of convertible note.

The remaining balance of the Convertible Note and
warrants in the amount of $ 200 was received after December 31, 2007.

NOTE 10:- LONG-TERM BANK LOAN



| | a. | Composed as follows:
| | -- | --------------------



|                          |  |          |      |              |            |              |   |       |  |   |    
|------------------------- |  | -------- | ---- | ------------ | ---------- | ------------ | - | ----- |  | - | ---
|                          |  | Currency |      | Interestrate |            | December 31,
|                          |  |          | 2006 |              | 2007      
|Loan from a bank          |  | U.S. $   |      |              | LIBOR+2.25 |              | $ | 1,292 |  | $ | 738
|                          |  |          |      |              |            |              |   |       |  |   |    
|Less - current maturities |  |          |      |              |            |              |   | 574   |  |   | 589
|                          |  |          |      |              |            |              |   |       |  |   |    
|                          |  |          |      |              |            |              | $ | 718   |  | $ | 149
|                          |  |          |      |              |            |              |   |       |  |   |    

On December 22, 2005, and effective as of January 1, 2006, the Company refinanced its
debt arrangement with the Bank by converting $ 1,800 of its outstanding balance of short-term borrowings to long-term debt payable in twelve quarterly installments of $ 150, with the first payment due on April 1, 2006, and interest
payable quarterly at a rate of LIBOR + 2.25%. In addition, the Banks covenant requiring that the Company maintain a $ 2,000 quarterly cash balance in the Companys accounts beginning January 1, 2006, has been modified such that
(i) the Companys cash balance on January 1, 2006 shall not be less than $ 1,000, and (ii) the Companys cash balance on a quarterly basis beginning July 1, 2006, shall not be less than $ 1,000.

During 2006 and 2007, the Company did not comply with the covenants set forth under the long-term loan agreement. However, the Company received written
waivers from the Bank for each period in which it was in default under which the Bank agreed not to act upon its contractual rights on the Companys default.

In connection with this debt refinancing, the Company issued to the Bank 6,000 Ordinary shares in consideration of the par value of these Ordinary shares.



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##### Table of Contents

VIRYANET LTD. AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in
thousands, except share and per share data



NOTE 10:- LONG-TERM BANK LOAN (Cont.)

The fair value of the Ordinary shares issued to the Bank (Banks Shares) was determined using the market price of the Companys
Ordinary shares at December 22, 2005. This resulted in an amount of $ 50. In accordance with APB 14, the Company allocated a portion of the proceeds to the Banks Shares, based on their applicable fair value. Amounts allocated to
the Banks Shares were recorded as additional paid-in capital against a discount on the loan. The discount related to this loan will be amortized as financial expenses over the term of the loan of three years.

In August 2007, In connection with changes in bank arrangements including bank covenants, the Company issued 10,000 Ordinary shares to the bank at no
consideration (see also Note 7).



| | b. | The aggregate annual maturities of the long-term loans are as follows:
| | -- | ----------------------------------------------------------------------



|     |  |              |    
|---- |  | ------------ | ---
|     |  | December 31,
|2008 |  | $            | 589
|2009 |  |              | 149
|     |  |              |    
|     |  | $            | 738
|     |  |              |    

An amount of $ 12 as of December 31, 2007, which relates to the discount, was deducted
from the principal amount of the loan.



| | c. | As for charges, see Note 12c(1).
| | -- | --------------------------------

NOTE 11:- LONG TERM CONVERTIBLE DEBT

Composed as follows:



|                          |  |              |      |  |              |     |  |   |    
|------------------------- |  | ------------ | ---- |  | ------------ | --- |  | - | ---
|                          |  | Interestrate |      |  | December 31,
|                          |  |              | 2006 |  | 2007        
|Convertible debt          |  | 7.5          | %    |  | $            | 568 |  | $ | 556
|                          |  |              |      |  |              |     |  |   |    
|Less - current maturities |  |              |      |  |              |    |  |   |   
|                          |  |              |      |  |              |     |  |   |    
|                          |  |              |      |  | $            | 568 |  | $ | 556
|                          |  |              |      |  |              |     |  |   |    



| | a. | On July 28, 2004, the Company issued to LibertyView Special Opportunities Fund, L.P. (LibertyView) $ 2,500 aggregate principal amount of 7.5% Convertible debt
(the Debt) due July 28, 2014. The Company is obligated to pay interest on the Debt on a quarterly basis commencing October 15, 2004, with interest to be paid either in cash or in Ordinary shares of the Company, at the
discretion of the Company.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

VIRYANET LTD. AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in
thousands, except share and per share data



NOTE 11:- LONG TERM CONVERTIBLE DEBT (CONT.):

The Debt is convertible, at the option of LibertyView at any time before the maturity date, into Ordinary shares of the Company at a fixed conversion
price of $ 21.498 per Ordinary share. LibertyView also has an option to obligate the Company to purchase the Debt for an amount equal to 100% of the principal amount plus accrued and unpaid interest, on July 15, 2008, July 15,
2009 and July 15, 2011. If LibertyView elects to obligate the Company to purchase the Debt, the Company can elect to pay the repurchase price in cash, Ordinary shares or a combination thereof.

The Debt is also subject to repurchase for cash, at LibertyViews option and at a repurchase price equal to 100% of the principal amount plus accrued
and unpaid interest, on the occurrence of certain events, including the following:

(i) an acquisition of the Company for cash only,
(ii) an acquisition of the Company by another company whose market value is less than $ 25,000, (iii) if the Ordinary shares are neither listed for trading on a U.S. national securities exchange nor approved for trading on the Nasdaq
Stock Market or any similar system of automated dissemination of quotations of securities prices, and (iv) if the Company is subject to bankruptcy or similar proceedings.

In accordance with Emerging Issues Task Force No. 98-5, Accounting for Convertible Securities with Beneficial Conversion Features or
Contingently Adjustable Conversion Ratios (EITF No. 98-5) and Emerging Issues Task Force No. 00-27, Application of Issue No. 98-5 to Certain Convertible Instruments (EITF No. 00-27), no beneficial
conversion features were recognized or recorded.

In connection with the Debt, the Company agreed to file an F-3 Registration Statement
covering the Ordinary shares which may be issued upon conversion of the Debt within the earlier of (i) 60 days from the date of the Debt, and (ii) 5 business days after the registration statement that was filed with the SEC prior to the
date the Debt is declared effective by the SEC. In that respect, the Company has also agreed that in the event that the F-3 is not filed on time or not declared effective by the SEC within 90 days after it is filed, the Company shall pay LibertyView
a cash compensation equal to 1% of the loan under the Debt for each month of delay (on a pro-rated basis).



| | b. | On May 27, 2005, the Company entered into a letter agreement with LibertyView under which the Company agreed to issue to LibertyView 10,000 Ordinary shares at an estimated fair
value of $ 140 (as determined by applying EITF No. 96-18) and pay a cash amount of $ 40 as sole and complete remedy for the Companys inability to meet such registration deadlines.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | c. | On June 29, 2005, the Company issued to LibertyView 2,000 Ordinary shares at an estimated fair value of $ 23 (as determined by applying EITF No. 96-18) as sole and
complete remedy for the Companys inability to meet certain share listing conditions.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | d. | On August 5, 2005, the Company completed another financing transaction with LibertyView. The transaction included an equity investment of $ 700 at a price of
$ 10.50 per Ordinary share with warrants to purchase up to 23,334 Ordinary shares at an exercise price of $ 10.50 per Ordinary share (see also Note 13), and an increase in the amount of the existing $ 2,500 convertible Debt
with LibertyView to $ 2,980 (New Convertible Debt). The fixed conversion price for the entire value of the New Convertible Debt has been adjusted to $ 11.025 per Ordinary share, and may be converted to Ordinary shares at
the discretion of LibertyView at any time during the term of the loan. The New Convertible Debt bears interest of 7.5%, payable quarterly in cash, and is due on August 3, 2013. LibertyView has the option to request earlier repayment during
fixed time periods - beginning on July 15, 2008, July 15, 2009 and July 15, 2011.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

VIRYANET LTD. AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in
thousands, except share and per share data



NOTE 11:- LONG-TERM CONVERTIBLE DEBT (CONT.)

The Company has agreed to file a registration statement with the SEC covering the Ordinary shares from the equity investment and related warrants and the
resale of the Ordinary shares, which may be issued upon conversion of the New Convertible Loan in accordance with the fixed conversion price explained above, subject to certain terms and conditions.

The Company filed a registration statement on Form F-3 with the SEC on December 22, 2005 covering the Ordinary shares from the equity investment and
related warrants and the resale of the Ordinary shares which may be issued upon conversion of the Convertible Loan in accordance with the fixed conversion price explained above, subject to certain terms and conditions. The registration statement was
declared effective by the SEC on January 26, 2006.

This transaction was accounted for according to APB 14. The fair value of the
warrants and the conversion option was determined using the Black-Scholes pricing model, assuming a risk-free interest rate of 4.25%, a volatility factor 80%, dividend yields of 0% and a contractual life of eight years for the convertible Debt and
five years for the warrant.

In connection with the New Convertible Debt, the Company recorded a deferred debt premium of $ 645 with
respect to the premium arising from fair value allocation of the various elements of the transaction according to APB 14, which is being amortized from the date of issuance to the stated redemption date, August, 3, 2013. No beneficial conversion
features were recorded. In the event that the debt instrument is converted to equity, the carrying amount of the debt, as well as any interest accrued through the date of conversion, as prescribed in EITF No. 85-17, Accrued Interest upon
Conversion of Convertible Debt, would be credited to the capital accounts. Upon conversion, any un-amortized premium will be converted to equity.

In accordance with EITF Issue No. 96-19, Debtors Accounting for a Modification or Exchange of Debt Instruments (EITF 96-19), the Company concluded that the adjustment of the
conversion price of the LibertyView Debt on August 5, 2005, is considered a modification of a debt instrument which is substantial, and therefore, results in a debt extinguishment of the existing Debt. As a result, the Company
recorded a loss in the amount of $ 787 in financial expenses representing the change in the present value of the cash flows of the debt component.

According to the Debts terms, the holders were granted two Put options (i) the option to request earlier repayment during fixed time periods - beginning on July 15, 2008, July 15, 2009 and
July 15, 2011; (ii) If a designated event occurs, as defined in the Debts terms, the Debt shall be purchased by the Company, at the option of the holder thereof, at a cash purchase price equal to 101% of the principal amount of those
securities, plus accrued and unpaid interest. The Company applied the guidance of Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS No. 133), and
determined that SFAS No. 133 does require the bifurcation of the embedded Put options and to account for them separately. Based on a fair value valuation, these Put options have nominal value and their fair market value is immaterial as of
December 31, 2006. The Company will monitor the value of these options on an on-going basis and when the fair value becomes material, mark the bifurcated derivatives to market through earnings.



| | e. | On June 2, 2006, the Company and LibertyView amended the agreement described in d. above, and according to the amended agreement LibertyView converted $ 2,000 of the
Companys 7.5% convertible Debt to 261,438 Preferred A shares of the Company, at a conversion price of $ 7.65 per Preferred A share. The remaining $ 980 principal balance of LibertyViews convertible Debt with the Company
remained in effect under the existing terms of the Debt.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

VIRYANET LTD. AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in
thousands, except share and per share data



NOTE 11:- LONG-TERM CONVERTIBLE DEBT (CONT.)

Since the conversion involved the issuance of a new class of shares, Preferred A shares, which is not pursuant to the conversion rights provided in the
Convertible Debt terms at issuance, the Company accounted for this transaction as an early extinguishment of the Convertible Debt under the guidance of APB No. 26, Early Extinguishment of Debt (APB 26). Accordingly, the
difference between the fair value of the issued Preferred A shares and the net carrying amount of the extinguished debt in the amount of $ 743 was recognized as financial income in the period of extinguishment. The Company also considered the issued
Preferred A shares as permanent equity in accordance with EITF 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Companys Own Stock and recorded the fair value of the Preferred A
shares that were issued as equity.



| | f. | On November 30, 2006, LibertyView sold $ 500 of its Convertible Debt to Jerusalem High-tech Founders, Ltd. (JHTF), a company controlled by Samuel HaCohen, the
Companys Chairman of the Board of Directors, and in which Vladimir Morgenstern, a member of the Companys Board of Directors, has an economic interest. Upon the sale of the Debt, the Company signed an agreement with JHTF, which was
approved by the Companys shareholders, and consummated on December 29, 2006, to convert the $ 500 Convertible Debt to Preferred A shares at $ 7.65 per Preferred A share, which may be converted at the discretion of JHTF on a
one-to-one basis to Ordinary shares at any time. The Company issued 65,360 Preferred A shares to JHTF in exchange for the conversion of $ 500 of JHTF debt to the Company.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Since the conversion involved the issuance of a new class of shares, Preferred A shares, which is not pursuant to the conversion rights provided in the
Convertible Debt terms at issuance, the Company accounted for this transaction as an early extinguishment of the Convertible Debt under the guidance of APB No. 26, Early Extinguishment of Debt (APB 26). Accordingly, the
difference between the fair value of the issued Preferred A shares and the net carrying amount of the extinguished debt in the amount of $ 231 was recognized as financial income in the period of extinguishment. The Company also considered the issued
Preferred A shares as permanent equity in accordance with EITF 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Companys Own Stock and recorded the fair value of the of Preferred A
shares that were issued as equity.



| | g. | As of December 31, 2007 the balance of the convertible Debt in the amount of $ 556 was classified as a long-term convertible Debt in accordance with FAS 78,
Classification of Obligations That Are Callable by the Creditor an Amendment of ARB No. 43, Chapter 3A since LibertyView, the convertible debt holder, did not exercise its right to call for repayment of the debt on July 15,
2008 and as such the debt can be called for repayment only on the next exit date, which is July 15, 2009.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

VIRYANET LTD. AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in
thousands, except share and per share data



NOTE 12:- COMMITMENTS AND CONTINGENT LIABILITIES



| | a. | Royalty commitments:
| | -- | --------------------

The Company participated in programs
sponsored by the Israeli Government for the support of research and development activities, through the Office of the Chief Scientist of the Israels Ministry of Industry, Trade and Labor (the OCS). Through December 31, 2007,
the Company had obtained aggregate grants from the OCS of $ 372.

Under the Companys research and development agreement with the
OCS, and pursuant to applicable laws, the Company is required to pay royalties at the rate of between 3% to 5% on revenues derived from products developed with royalty-bearing grants provided by the OCS, in an amount of up to 100% of the grants
received from the OCS. The obligation to pay these royalties is contingent on actual sales of the products. 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.

Through December 31, 2007, the Company has paid or accrued royalties to the OCS in the
amount of $ 18. As of December 31, 2007, the total contingent liability to the OCS amounted to $ 387.



| | b. | Lease commitments:
| | -- | ------------------

The Companys facilities, its
subsidiaries facilities and its motor vehicles are leased under various operating lease agreements, which expire on various dates, the latest of which is in 2011.

Future minimum rental payments under non-cancelable operating leases are as follows:



|                        |  |            |    
|----------------------- |  | ---------- | ---
|Year ended December 31, |  | Facilities
|2008                    |  | $          | 384
|2009                    |  |            | 188
|2010                    |  |            | 190
|2011                    |  |            | 95 
|                        |  |            |    
|Total                   |  | $          | 857
|                        |  |            |    

Lease expenses in respect of facilities for the years ended December 31, 2005, 2006 and 2007
were approximately $ 661, $ 598 and $ 524, respectively.

Lease expenses in respect of motor vehicles for the years ended
December 31, 2005, 2006 and 2007 were approximately $ 211, $ 276 and $ 289, respectively. In addition, as of December 31, 2007 future minimum rental payments in connection with motor vehicles leased for the years 2008, 2009 and
2010 are $ 252, $ 134 and $ 99, respectively.



| | c. | Charges and guarantees:
| | -- | -----------------------



| | 1. | The Company has a floating charge on all of its assets in favor of the Bank.
| | -- | ----------------------------------------------------------------------------



| | 2. | The Company obtained bank guarantees in the amount of $ 82, in order to secure an office lease agreement.
| | -- | ---------------------------------------------------------------------------------------------------------



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##### Table of Contents

VIRYANET LTD. AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in
thousands, except share and per share data



NOTE 13:- SHAREHOLDERS EQUITY

The Ordinary shares of the Company were traded until June 11, 2007 on the Nasdaq Capital Market and were delisted from trading on that date. On
June 12, 2007, the Companys Ordinary shares became eligible for quotation and trading on the Pink Sheets. On November 14, 2007, the Companys Ordinary shares became eligible for quotation and trading on the OTC Bulletin Board
(OTCBB). On September 3, 2008 the Companys Ordinary shares ceased to be eligible for quotation and trading on the OTCBB and became eligible for quotation and trading on the Pink Sheets.

The Preferred A shares are not publicly traded.

On December 29, 2006, the Companys shareholders approved in the annual general shareholders meeting a one (1) for five (5) reverse split of the Companys Ordinary shares and Preferred A shares, which became
effective on of January 17, 2007.

Upon the effectiveness of the reverse share split, five Ordinary shares of NIS 1.0 par value per
Ordinary share were converted and reclassified as one Ordinary share of NIS 5.0 par value per Ordinary share. In addition, five Preferred A shares of NIS 1.0 par value per Preferred A share were converted and reclassified as one Preferred A
share of NIS 5.0 par value per Preferred A share on a post-split basis. All share data in this report are reported after the effect of the 1 for 5 reverse split that occurred on January 17, 2007.

General:



| | a. | The Ordinary shares and the Preferred A shares confer upon the holders the right to receive notice to participate and vote in general meetings of the Company, the right to receive
dividends, if declared, and the right to receive any remaining assets of the Company upon liquidation, if any, after full payment is made to any creditors.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The Preferred A shares have all rights and privileges as the Companys Ordinary shares, including, without limitation, voting rights on an as-converted basis, and have preference over the Ordinary shares in any
distribution to the Companys shareholders. The Preferred A shares may be converted into Ordinary shares at any time on a one-to-one basis at any time.



| | b. | In November 2005, the Companys shareholders approved in the annual general meeting an increase in the Companys authorized share capital by 1,000,000 Ordinary shares.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | c. | In June 2006, the Companys shareholders approved in a special meeting an increase in the Companys authorized share capital by 1,538,562 Ordinary shares, and by 261,438
Preferred A shares.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | d. | In December 2006, the Companys shareholders approved in the annual general meeting to increase the authorized number of Preferred A shares by 138,562 by decreasing the
authorized number of Ordinary shares by 138,562.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | e. | In February 2005, the Company issued to Telvent Investments S.L., an existing shareholder of the Company, in a private placement, 116,332 Ordinary shares at a price per share of
$ 11.435, for the total consideration of $ 1,332.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | f. | In May 2005, the Company issued to LibertyView 10,000 Ordinary shares at an estimated fair value of $ 140 (as determined by applying EITF No. 96-18) and paid a cash amount
of $ 40 as sole and complete remedy for the Companys inability to meet certain registration deadlines (see also Note 11).
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

VIRYANET LTD. AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in
thousands, except share and per share data



NOTE 13:- SHAREHOLDERS EQUITY (CONT.)



| | g. | In June 2005, the Company issued to LibertyView 2,000 Ordinary shares at an estimated fair value of $ 23 (as determined by applying EITF No. 96-18) as sole and complete
remedy for the Companys inability to meet certain share listing conditions (see also Note 11).
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | h. | In June 2005 and August 2005, the Company issued a total of 111,156 Ordinary shares related to the acquisition of e-Wise at an estimated fair value of $ 1,268 (see also Note
1b).
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | i. | In August 2005, the Company issued to LibertyView in a private placement 66,667 Ordinary shares at a price per share of $ 10.50 and warrants to purchase up to 23,334 Ordinary
shares at an exercise price of $ 10.50 per Ordinary share, for the total consideration of $ 700 (see also Note 11). The warrants are exercisable through August 2010. As of December 31, 2007, the warrants are outstanding.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | j. | In September 2005, the Company issued to a group of new financial investors, in a private placement, 47,619 Ordinary shares at a price per share of $ 10.50 and warrants to
purchase an aggregate of up to 32,540 Ordinary shares at an exercise price of $ 10.50 per Ordinary share, for the total consideration of $ 500. The warrants are exercisable through September 2010. As of December 31, 2007, the
warrants are outstanding.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | k. | In September 2005, the Company issued to a financial investor 6,508 Ordinary shares for no consideration at an estimated fair value of $ 68, as a finders fees related to the
September 2005 transaction in item j, above.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | l. | In December 2005, in connection with the refinancing of short-term to long-term debt, the Company issued to the Bank 6,000 Ordinary shares in consideration of the par value at an
estimated fair value of $ 50 (see also Note 10).
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | m. | During 2005, the Company issued to LibertyView a total of 20,384 Ordinary shares for interest expenses due on the convertible Debts at an estimated fair value of $ 231.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | n. | In January and May 2006, a warrant holder exercised a total of 23,867 warrants into 10,612 Ordinary shares in a cashless exercise.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------



| | o. | In January 2006, the Company issued 4,000 Ordinary shares to a service provider in consideration of consulting services.
| | -- | ------------------------------------------------------------------------------------------------------------------------



| | p. | In June 2006, the Company issued to a group of investors, including three existing shareholders and another institutional investor, 287,540 Ordinary shares at a price of
$ 4.695 per share for a total consideration of $ 1,350. The investors received warrants to purchase 57,510 Ordinary shares of the Company at an exercise price of $ 5.635 per Ordinary share and 2,693 Ordinary shares of the Company at
an exercise price of $ 4.693 per Ordinary share
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | q. | In June 2006, LibertyView, a convertible debt holder, converted $ 2,000 of the Companys 7.5% convertible debt to 261,438 Preferred A shares of the Company, at a
conversion price of $ 7.65 per Preferred A share (see also Note 11).
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | r. | In September 2006, the Company converted its short-term convertible debt (including accrued interest) to 114,301 Ordinary shares of the Company, at a conversion price of
$ 4.7025 per Ordinary share.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

VIRYANET LTD. AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in
thousands, except share and per share data



NOTE 13:- SHAREHOLDERS EQUITY (Cont.)



| | s. | In December 2006, Jerusalem High-tech Founders Ltd., a convertible debt holder, converted $ 500 of the Companys 7.5% convertible debt to 65,360 Preferred A shares of the
Company, at a conversion price of $ 7.65 per Preferred A share (see also Note 11f).
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | t. | In December 19, 2007, the Company issued to a group of new financial investors 363,636 Ordinary shares at a price of $ 1.65 per share for a total consideration of
$ 600. The transaction included also a non interest bearing convertible note of $ 600 at a conversion price of $ 1.65 per Ordinary share and warrants to purchase an aggregate of up to 600,000 Ordinary shares at an exercise price
of $ 2.00 per Ordinary share (see also Note 9). The Convertible note does not have any maturity, does not bear any interest and can only be converted into Ordinary shares. 50% of the warrants are callable by the Company when all shares
issued in connection with the new investment are registered with the SEC.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

All of the warrants and an amount of $ 439 of the
Convertible Note are subject to the Companys shareholders approval which was granted on January 31, 2008 (see also Note 9) and, therefore, the amounts received as of December 31, 2007 on account of the Convertible Note was recorded
in liabilities as payments on account of convertible note and warrants.



| | u. | Following the December 19, 2007 financing described in t. above, the Company had issued 211,457 Ordinary shares to a group of existing shareholders at no consideration which
exercised its anti-dilution protection right, granted under the September 2006 conversion terms of the short-term convertible debt (see also r above).
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | v. | In November 2007 and December 2007, the Company issued 28,500 Ordinary shares under the 2005 Share Options Plans to service providers in consideration of consulting services.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Stock options and Restricted shares:



| | a. | Under the Companys 1996, 1997, 1998 and 1999 Stock Option Plans (the Plans), the Company reserved for issuance 28,000, 10,000, 30,000 and 60,000 Ordinary shares,
respectively. The options may be granted to officers, directors, employees and consultants of the Company or its subsidiaries. Pursuant to the Plans
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

In 2001, 2003, 2004 and 2005, the Company increased the number of shares reserved for issuance under the 1999 Stock Option Plan by additional 60,000, 40,000, 70,000 and 30,000 shares, respectively.

Each option granted under the Plans is exercisable until the earlier of seven years from the date of the grant of the option or the expiration dates of
the respective option plans. The Companys 1999 option plan will expire on December 31, 2008, The exercise price of the options granted under the Plan may not be less than the nominal value of the shares into which such options are
exercised. The options vest primarily over periods of two to four years. Any options which are canceled or forfeited before expiration become available for future grants.

In November 2005, the Company adopted a new Israeli share option and restricted share plan and a new international share option and restricted share plan (the 2005 Share Option Plans) which superseded and
replaced all previous plans and provide the Company with the ability to grant restricted shares in addition to options under various tax regimes.



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##### Table of Contents

VIRYANET LTD. AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in
thousands, except share and per share data



NOTE 13:- SHAREHOLDERS EQUITY (Cont.)

Under the 2005 Share Option Plans, options, restricted shares and other share-based awards may be granted to employees, directors, office holders, service
providers, consultants and any other person or entity whose services the Companys board of directors shall determine to be valuable to the Company and/or its affiliated companies. The exercise price of the option granted under the 2005 Share
Option Plans are to be determined by the directors at the time of grant. The options granted expire no later than ten years from the date of grant. The 2005 Share Option Plans expire in 2015. Any options which are canceled or forfeited before
expiration become available for future grants. The options vest ratably over a period of two to four years, with the first portion vesting not earlier the one year after the grant of the options.

Any options that remain available for grants under any of the Companys stock option plans shall be available for subsequent grants of awards
under the 2005 Share Option Plans. In addition, if any outstanding award under the Companys existing option plans should, for any reason, expire, be canceled or be forfeited without having been exercised in full, the shares
subject to the unexercised, canceled or terminated portion of such award shall become available for subsequent grants of awards under the 2005 Share Option Plans.

As of December 31, 2007, an aggregate of 27,023 Ordinary shares of the Company were available for future grant.



| | b. | In November 2005, the Company issued to the Companys directors 14,000 restricted Ordinary shares for no consideration (the Restricted Shares). The Restricted
Shares shall be released ratably on an annual basis over a two-year period (release period), starting from the date of grant, and are subject to acceleration provisions upon certain events such as merger or acquisition. The Company has
accounted for this award in accordance with FIN 44 and is amortizing the deferred stock compensation in the amount of $ 139, reflecting the quoted market price of the Companys Ordinary shares as of the date of grant over the exercise
price at the grant date of the award ($ 0) as compensation expense ratably over the release period of the Restricted Shares. Compensation expenses of approximately $ 6, $ 65 and $ 49 were recognized during the years ended
December 31, 2005, 2006 and 2007, respectively.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | c. | On December 30, 2005, the Company decided to accelerate the vesting of 27,975 unvested stock options outstanding with an exercise price equal to or greater than $ 8.20 per
share, which were held by the Companys employees, including officers. As a result, these unvested stock options became fully exercisable effective as of December 30, 2005, rather than becoming exercisable at the later dates when such
options would have otherwise vested in the normal course. The Companys stock options have generally vested over a period of two to four years.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The decision to accelerate the vesting of these stock options was made primarily to reduce compensation expense that otherwise would be recorded in future periods following the Companys adoption in the first
quarter of 2006 of Statement of Financial Accounting Standards No. 123(R), Share-Based Payment (SFAS No. 123(R)) (see also Note 2). The acceleration was accounted for in accordance with FIN 44, which resulted in no
additional compensation expenses.



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##### Table of Contents

VIRYANET LTD. AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in
thousands, except share and per share data



NOTE 13:- SHAREHOLDERS EQUITY (Cont.)



| | d. | In April 2006 and in December 2006, the Company issued to the Companys employees and directors 26,270 and 10,000 restricted Ordinary shares, respectively, for no
consideration (the Restricted Shares). The Restricted Shares shall be released ratably on an annual basis over a two-year period (release period), starting from the date of grant, and some of them are subject to acceleration
provisions upon certain events such as merger or acquisition. The Company has accounted for this award in accordance with FAS123(R). The total grant date fair value was $ 151, reflecting the quoted market price of the Companys Ordinary
shares as of the date of grant over the purchase price of $ 0 as compensation expense, ratably over the release period of the Restricted Shares. Compensation expenses of approximately $34 and $ 37 were recognized during the years ended
December 31, 2006 and 2007, respectively.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | e. | In March 2007, the Company issued to the Companys employees and consultants 61,160 and 6,000 restricted Ordinary shares, respectively, at no consideration (the
Restricted Shares). The Restricted Shares shall be released ratably on an annual basis over a two or three-year period (release period), starting from the date of grant, and some of them are subject to acceleration provisions
upon certain events such as merger or acquisition. The Company has accounted for this award in accordance with FAS123(R) and for the awards granted to consultants in accordance with FAS123(R) and EITF 96-18. The total grant date fair value was
$ 224, reflecting the quoted market price of the Companys Ordinary shares as of the date of grant over the purchase price of $ 0 as compensation expense, ratably over the release period of the Restricted Shares. Compensation expenses
of approximately $ 110 were recognized during the year ended December 31, 2007.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | f. | The following is a summary of the Companys employees and directors stock option activity under the Plans and related information:
| | -- | ------------------------------------------------------------------------------------------------------------------------------------



|                                    |  |                              |   |  |                                                 |  |                         |  |                              |      
|----------------------------------- |  | ---------------------------- | - |  | ----------------------------------------------- |  | ----------------------- |  | ---------------------------- | -----
|                                    |  | Year ended December 31, 2007
|                                    |  | Numberofoptions              |   |  | Weightedaverageremainingcontractualterm (years) |  | Aggregateintrinsicvalue |  | Weightedaverageexerciseprice
|Outstanding - beginning of the year |  | 123,805                      |   |  |                                                 |  |                         |  | $                            | 10.92
|Canceled                            |  | (16,085                      | ) |  |                                                 |  |                         |  | $                            | 16.62
|                                    |  |                              |   |  |                                                 |  |                         |  |                              |      
|Outstanding - end of the year       |  | 107,720                      |   |  | 3.91                                            |  |                        |  | $                            | 10.06
|                                    |  |                              |   |  |                                                 |  |                         |  |                              |      
|Vested and expected to vest         |  | 107,720                      |   |  | 3.91                                            |  |                        |  | $                            | 10.06
|                                    |  |                              |   |  |                                                 |  |                         |  |                              |      
|Options exercisable                 |  | 107,720                      |   |  | 3.91                                            |  |                        |  | $                            | 10.06
|                                    |  |                              |   |  |                                                 |  |                         |  |                              |      

The total intrinsic value of options exercised during the years ended December 31, 2005, and
2006, was $ 6, and $ 2, respectively. No options were exercised in 2007.



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VIRYANET LTD. AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in
thousands, except share and per share data



NOTE 13:- SHAREHOLDERS EQUITY (Cont.)

The options outstanding as of December 31, 2007, under the Plans, have been separated into ranges of exercise price, as follows:



|                        |  |                                                        |  |                                                 |  |                              |      
|----------------------- |  | ------------------------------------------------------ |  | ----------------------------------------------- |  | ---------------------------- | -----
|Range of exercise price |  | Optionsoutstandingand exercisableas ofDecember 31,2007 |  | Weightedaverageremainingcontractuallife (years) |  | Weightedaverageexerciseprice
|$ 7.95-8.20             |  | 61,943                                                 |  | 2.51                                            |  | $                            | 7.99 
|$ 10.00-11.65           |  | 39,700                                                 |  | 3.81                                            |  | $                            | 10.78
|$ 20.50-28.00           |  | 6,077                                                  |  | 1.12                                            |  | $                            | 25.92
|                        |  |                                                        |  |                                                 |  |                              |      
|                        |  | 107,720                                                |  |                                                 |  | $                            | 10.06
|                        |  |                                                        |  |                                                 |  |                              |      

Compensation expenses related to options of approximately $ 115, $ 59 and $ 0 were
recognized during the years ended December 31, 2005, 2006 and 2007, respectively.

As of December 31, 2007, there was no
unrecognized compensation cost related to options to employees compensation arrangements granted under the plan, as a result of the acceleration of all unvested stock options outstanding as of December 30, 2005.



| | g. | A summary of the status of the Companys restricted shares as of December 31, 2007, and changes during the year ended December 31, 2007, is presented below:
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------



|                                |  |         |   |  |                                       |     
|------------------------------- |  | ------- | - |  | ------------------------------------- | ----
|Restricted shares               |  | Shares  |   |  | Weightedaverage grant-date fair value
|Restricted at January 1, 2007   |  | 39,470  |   |  | $                                     | 5.01
|Granted                         |  | 67,160  |   |  | $                                     | 3.34
|Vested                          |  | (19,390 | ) |  | $                                     | 5.93
|Forfeited                       |  | (6,525  | ) |  | $                                     | 3.75
|                                |  |         |   |  |                                       |     
|Restricted at December 31, 2007 |  | 80,715  |   |  | $                                     | 3.50
|                                |  |         |   |  |                                       |     

As of December 31, 2007, there was $160 of total unrecognized compensation cost related to
restricted shares compensation arrangements granted under the plan. That cost is expected to be recognized over a weighted-average period of 1.5 years. The total fair value of restricted shares released during the year ended December 31, 2007
was 43.

The weighted average grant date fair value of shares granted during 2005, 2006 and 2007 were $9.95, $4.15 and $3.34, respectively.



| | h. | The following table sets forth the total stock-based compensation expense for each of the two years ended December 31 2006 and 2007, resulting from awards granted to employees,
directors and consultants, included in the Companys consolidated statement of operations (no stock options were granted during 2006 and 2007):
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

VIRYANET LTD. AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in
thousands, except share and per share data



NOTE 13:- SHAREHOLDERS EQUITY (Cont.)



|                                       |  |                            |     |                            |   |    
|-------------------------------------- |  | -------------------------- | --- | -------------------------- | - | ---
|                                       |  | Year endedDecember 31,2006 |     | Year endedDecember 31,2007
|Cost of revenues                       |  | $                          | 6   |                            | $ | 23 
|Research and development cost          |  |                            | 3   |                            |   | 9  
|Selling and marketing expenses         |  |                            | 3   |                            |   | 24 
|General and administrative expenses    |  |                            | 99  |                            |   | 152
|                                       |  |                            |     |                            |   |    
|Total stock-based compensation expense |  | $                          | 111 |                            | $ | 208
|                                       |  |                            |     |                            |   |    

The fair value for restricted shares granted is amortized over their vesting period.



| | g. | Options issued to consultants:
| | -- | ------------------------------



| | 1. | The Companys outstanding options to consultants as of December 31, 2007, are as follows:
| | -- | -----------------------------------------------------------------------------------------



|               |  |                           |  |                        |       |                    |        |                    |               
|-------------- |  | ------------------------- |  | ---------------------- | ----- | ------------------ | ------ | ------------------ | --------------
|Issuance date  |  | Options forOrdinaryshares |  | Exerciseprice pershare |       | Optionsexercisable |        | Exercisablethrough
|January 2002   |  | 1,000                     |  | $                      | 20.50 |                    | 1,000  |                    | January 2009  
|September 2002 |  | 3,812                     |  | $                      | 8.20  |                    | 3,812  |                    | September 2009
|August 2003    |  | 4,900                     |  | $                      | 7.95  |                    | 4,900  |                    | August 2010   
|August 2004    |  | 500                       |  | $                      | 10.00 |                    | 500    |                    | August 2011   
|March 2005     |  | 7,000                     |  | $                      | 10.30 |                    | 7,000  |                    | March 2012    
|               |  |                           |  |                        |       |                    |        |                    |               
|Total          |  | 17,212                    |  |                        |       |                    | 17,212 |                    |               
|               |  |                           |  |                        |       |                    |        |                    |               

Compensation expenses of approximately $ 36, $ 25 and $ 3 were recognized during the
years ended December 31, 2005, 2006 and 2007, respectively as sales and marketing expenses. Compensation expenses of approximately $ 12, $ 0 and $ 0 were recognized during the years ended December 31, 2005, 2006 and 2007,
respectively as general and administrative expenses.



| | 2. | In January 2006, the Company issued 4,000 Ordinary shares under the 2005 Share Options Plans to a service provider in consideration of consulting services.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------

In March 2007, the Company granted 6,000 restricted shares under the 2005 Share Options Plans to service providers in consideration of consulting
services.



| | 4. | In November 2007 and December 2007, the Company issued 28,500 Ordinary shares under the 2005 Share Options Plans to service providers in consideration of consulting services.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

VIRYANET LTD. AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in
thousands, except share and per share data



NOTE 13:- SHAREHOLDERS EQUITY (Cont.)

Warrants:



| | a. | Warrants issued for financing transactions:
| | -- | -------------------------------------------



| | 1. | In connection with an additional credit line received in March 2005 (see Note 10), the Company issued to a subsidiary of Bank Hapoalim a warrant to purchase an additional 10,000
Ordinary shares of the Company for an aggregate exercise price of $ 10.30 per share. The warrant is exercisable during a period of two years from the date of grant.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

During 2005, 2006 and 2007, the Company recorded a compensation of approximately $ 24, $ 12 and $ 12, respectively, which was included in the
financial expenses. This transaction was accounted for according to APB 14.

The fair value of this warrant was determined using the
Black-Scholes pricing model, assuming a risk free interest rate of 3%, a volatility factor of 113%, dividend yield of 0% and an expected term of two years.

As of December 31, 2007, all of the above warrants are outstanding.



| | 2. | The Companys outstanding warrants to investors and consultants as of December 31, 2007, are as follows:
| | -- | --------------------------------------------------------------------------------------------------------



|               |  |                            |  |                        |       |                     |         |                     |                   
|-------------- |  | -------------------------- |  | ---------------------- | ----- | ------------------- | ------- | ------------------- | ------------------
|Issuance date  |  | Warrants forOrdinaryshares |  | Exerciseprice pershare |       | Warrantsexercisable |         | Exercisable through
|April 1998     |  | 578                        |  | $                      | 1.25  |                     | 578     |                     | No expiration date
|August 2005    |  | 23,334                     |  | $                      | 10.50 |                     | 23,334  |                     | August 2010       
|September 2005 |  | 32,540                     |  | $                      | 10.50 |                     | 32,540  |                     | September 2010    
|May 2006       |  | 57,510                     |  | $                      | 5.63  |                     | 57,510  |                     | May 2008          
|May 2006       |  | 2,663                      |  | $                      | 4.69  |                     | 2,663   |                     | May 2008          
|               |  |                            |  |                        |       |                     |         |                     |                   
|Total          |  | 116,625                    |  |                        |       |                     | 116,625 |                     |                   
|               |  |                            |  |                        |       |                     |         |                     |                   



| | 3. | See also Notes 9 and 11.
| | -- | ------------------------

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. Dividends paid to shareholders in non-Israeli currency may be converted into dollars, on the basis of the exchange rate prevailing at the time of payment. The Company does not intend to pay cash dividends in the foreseeable future. The
Company has decided not to declare dividends out of tax-exempt earnings.



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##### Table of Contents

VIRYANET LTD. AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in
thousands, except share and per share data



NOTE 14:- TAXES ON INCOME

FIN-48:

The Company adopted the provisions of FASB Interpretation No. 48, Accounting for
Uncertainty in Income Taxes (FIN 48), on January 1, 2007. As a result of the implementation of Interpretation 48, the Company recognized an increase of approximately $ 55 in the liability for unrecognized tax benefits,
which was accounted for as an increase to the January 1, 2007 balance of the accumulated deficit and an amount of $ 13 related to interest and penalties on tax positions for the year ended December 31, 2007 which was recorded in
financial expenses. The interest liability related to uncertain tax positions in the amounts of $ 13, is included within the income tax provision on the Companys consolidated balance sheet as of December 31, 2007.

The reconciliation of the beginning and ending balances of the total amounts of gross unrecognized tax benefits was not provided due to immateriality.

In accordance with the Companys accounting policy, both before and after adoption of FIN 48, interest expense and potential penalties
related to income taxes are included in the financial expenses, net line of the Companys consolidated statements of operations.

The
Company and its subsidiaries file federal and state income tax returns in the U.S., Israel, Australia and the U.K. ViryaNet Ltd. may be subject to examination by the Israel tax authorities for fiscal years 2003 through 2007. ViryaNet Inc.s
(the U.S. subsidiary) tax returns through 2006 were audited by the U.S. Internal Revenue Service (IRS) which resulted with no incremental tax liability. ViryaNet Inc. may be subject to examination by the IRS for fiscal year 2007.
ViryaNet PTY (the Australian subsidiary) may be subject to examination by the Australian tax authorities for fiscal years 2005 through 2007.

The Company believes that it has adequately provided for any reasonably foreseeable outcome related to tax audits and settlement. The final tax outcome of the Companys tax audits could be different from what is reflected in the
Companys income tax provisions and accruals. Such differences could have a material effect on the Companys income tax provision and net loss in the period in which such determination is made.

Reduction in Israeli tax rates:

For
tax year 2007, Israeli companies are subject to Corporate Tax on their taxable income at the rate of 29%. Following an amendment to the Israeli Income Tax Ordinance, 1961 (the Israeli Tax Ordinance), which came into effect on
January 1, 2006, the corporate tax rate is scheduled to decrease as follows: 27% for the 2008 tax year, 26% for the 2009 tax year and 25% for the 2010 tax year and thereafter.

Israeli companies are generally 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.

Tax benefits under the Law for the Encouragement of Capital Investments, 1959 (the
Law):

The Companys production facilities have been granted an approved enterprise status under the law,
for three separate investment programs, which were approved in February 1989, March 1995 and April 1998.

The status of approved
enterprise granted for the February 1989 investment program has expired.

The status of approved enterprise granted for
the March 1995 investment program will expire in 2008.



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VIRYANET LTD. AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in
thousands, except share and per share data



NOTE 14:- TAXES ON INCOME (CONT.):

The tax benefits period for the April 1998 program has not yet begun. Income derived from this alternative benefits track program is exempted from tax for
a period of ten years, starting in the first year in which the Company generates taxable income from the approved enterprise, subject to a condition that the Company will have a certain minimum number of professional employees. The Company has not
yet met this condition; however it has applied for relief, and adjustment of this requirement. There can be no assurance that the relief will be granted to the Company, and if the relief is not granted the Company will lose its entitlement to future
benefits under Law. Generally, Approved Enterprise tax benefits are limited to 12 years from commencement of production or 14 years from the date of approval, whichever is earlier.

Pursuant to the Law, the Company has elected for its two other investment programs the alternative benefits track and has waived Government
grants in return for a tax exemption. The Companys offices and its research and development center are located in Jerusalem, in a region defined as a Priority A Development Region. Therefore, income derived from these programs will
be tax-exempt for a period of ten years commencing with the year in which it first earns taxable income, subject to certain conditions.

As
the Company currently has no taxable income, the benefits from all these programs have not been yet utilized.

The entitlement to the above
benefits is conditional upon the Company fulfilling the conditions stipulated by the Law, regulations published thereunder and the letters of approval for the specific investments in approved enterprises. In the event of failure to
comply with these conditions, the benefits may be canceled and the Company may be required to refund the amount of the benefits, in whole or in part, including interest and the Israeli Consumer Price Index (the CPI).

If the retained tax-exempt income were distributed, it would be taxed at the corporate tax rate applicable to such profits as if the Company had not
chosen the alternative tax benefits (rate of 10% - 25% based on the percentage of foreign ownership in the Companys shares) on the gross amount distributed. In addition, these dividends will be subject to a 15% withholding tax. The
Companys board of directors has determined that such tax-exempt income will not be distributed as dividends.

The Law also grants
entitlement to accelerated depreciation claim on buildings and equipment used by the approved enterprise during the first five tax years of using the assets.

Income from sources other than the approved enterprise during the benefit period will be subject to tax at the regular Israeli corporate tax rate, as describe above.

On April 1, 2005, an amendment to the Capital Investments Law came into effect (the Amendment) and has significantly changed the
provisions of the Capital Investments Law. The Amendment limits the scope of enterprises which may be approved by the Investment Center by setting criteria for the approval of a facility as a Beneficiary Enterprise, such as provisions generally
requiring that at least 25% of the Beneficiary Enterprises income will be derived from export. Additionally, the Amendment enacted major changes in the manner in which tax benefits are awarded under the Capital Investments Law so that
companies who choose the alternative benefits track no longer require Investment Center approval in order to qualify for tax benefits.



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VIRYANET LTD. AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in
thousands, except share and per share data



NOTE 14:- TAXES ON INCOME (CONT.):

However, the Capital Investments Law provides that terms and benefits included in any letter of approval already granted will remain subject to the
provisions of the law as they were on the date of such approval. Therefore the Companys existing approved enterprise will generally not be subject to the provisions of the Amendment. As a result of the Amendment, tax-exempt income
generated under the provisions of the new Law, will subject the Company to taxes upon distribution or liquidation and the Company may be required to record deferred tax liability with respect to such tax-exempt income. As of December 31, 2007,
the Company did not generate income under the provision of the new Law.

Tax benefits under Israels Law for the Encouragement of
Industry (Taxation), 1969:

The Company currently qualifies as an industrial company under the above law and, as such, is
entitled to certain tax benefits, mainly accelerated depreciation of machinery and equipment, and the right to claim public issuance expenses and amortization of patents and other intangible property rights over eight years as a deduction for tax
purposes.

The Company is an industrial company, as defined by this law and, as such, is entitled to certain tax benefits,
mainly amortization of costs relating to know-how and patents over eight years, the right to claim public issuance expenses and accelerated depreciation.

Taxable income under the Inflationary Income Tax (Inflationary Adjustments) Law, 1985:

Results of
the Company for tax purposes are measured and reflected in real terms in accordance with the changes in the CPI. As explained in Note 2, the financial statements are presented in U.S. dollars. The difference between the rate of change in Israeli CPI
and the rate of change in the NIS/U.S. dollar exchange rate causes a difference between taxable income or loss and the income or loss before taxes reflected in the financial statements. In accordance with paragraph 9(f) of SFAS No. 109, the
Company has not provided deferred income taxes on this difference between the reporting currency and the tax bases of assets and liabilities.

On February 26, 2008, the Israeli Parliament (the Knesset) enacted the Income Tax Law (Inflationary Adjustments) (Amendment No. 20) (Restriction of Effective Period), 2008, which the Company refers to as the Inflationary
Adjustments Amendment. In accordance with the Inflationary Adjustments Amendment, the effective period of the Inflationary Adjustments Law will cease at the end of the 2007 tax year and as of the 2008 tax year the provisions of the law shall no
longer apply, other than the transitional provisions intended at preventing distortions in the tax calculations. In accordance with the Inflationary Adjustments Amendment, commencing with the 2008 tax year, income for tax purposes will no longer be
adjusted to a real (net of inflation) measurement basis. Furthermore, the depreciation of inflation immune assets and carried forward tax losses will no longer be linked to the Israeli Consumer Price Index.

Net operating losses carryforward:

The Company has accumulated losses for tax purposes as of December 31, 2007, in the amount of approximately $ 30,302, which may be carried forward and offset against taxable income and capital gain in the future for an indefinite
period.

Through December 31, 2007, ViryaNet U.K. had accumulated losses for income tax purposes of approximately $ 18,224, which
can be carried forward and offset against taxable income in the future for an indefinite period.

In April 2007, the Company dissolved
ViryaNet Japan, and the accumulated loss for income tax purposes of $ 1,197 was extinguished as part of the dissolution.



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VIRYANET LTD. AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in
thousands, except share and per share data



NOTE 14:- TAXES ON INCOME (CONT.):

As of December 31, 2007, the U.S. subsidiary had U.S. federal net operating loss carryforward for income tax purposes in the amount of approximately
$ 7,218. Net operating loss carryforward arising in taxable years beginning before August 6, 1997, can be carried forward and offset against taxable income for 15 years and expiring between 2010 and 2012. Net operating loss carryforwards
arising in taxable years beginning after August 6, 1997 can be carried forward and offset against taxable income for 20 years, expiring between 2017 and 2026.

Utilization of U.S. net operating losses may be subject to substantial annual limitations due to the change in ownership provisions of the Internal Revenue Code of 1986 and similar state provisions. The
annual limitation may result in the expiration of net operating losses before utilization.

Through December 31, 2007, ViryaNet
Australia had accumulated losses for income tax purposes of approximately $ 262, which can be carried forward and offset against taxable income in the future for an indefinite period.

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s
deferred tax assets are as follows:



|                                                     |  |              |         |   |      |   |         |  
|---------------------------------------------------- |  | ------------ | ------- | - | ---- | - | ------- | -
|                                                     |  | December 31, |        
|                                                     |  | 2006         |         |   | 2007 |  
|Deferred tax assets:                                 |  |              |         |   |      |   |         |  
|U.S. net operating loss carryforward                 |  | $            | 2,470   |   |      | $ | 2,815   |  
|Israeli net operating loss carryforward              |  |              | 6,337   |   |      |   | 7,573   |  
|U.K. net operating loss carryforward                 |  |              | 5,384   |   |      |   | 5,467   |  
|Japan net operating loss carryforward                |  |              | 359     |   |      |   |        |  
|Australia net operating loss carryforward            |  |              | 52      |   |      |   | 79      |  
|Allowances and reserves                              |  |              | 198     |   |      |   | 257     |  
|                                                     |  |              |         |   |      |   |         |  
|Total deferred tax assets before valuation allowance |  |              | 14,800  |   |      |   | 16,191  |  
|Valuation allowance                                  |  |              | (14,800 | ) |      |   | (16,191 | )
|                                                     |  |              |         |   |      |   |         |  
|Net deferred tax asset                               |  | $            |        |   |      | $ |        |  
|                                                     |  |              |         |   |      |   |         |  

As of December 31, 2007, the Company and its subsidiaries have provided valuation allowances
in respect of deferred tax assets resulting from tax loss carryforward and other temporary differences, since they have a history of operating losses and current uncertainty concerning its ability to realize these deferred tax assets in the future.
Management currently believes that it is more likely than not that the deferred tax regarding the loss carryforward and other temporary differences will not be realized in the foreseeable future.



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##### Table of Contents

VIRYANET LTD. AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in
thousands, except share and per share data



NOTE 14:- TAXES ON INCOME (CONT.):

Net loss consists of the following:



|         |  |                         |       |      |   |       |  |   |      
|-------- |  | ----------------------- | ----- | ---- | - | ----- |  | - | -----
|         |  | Year ended December 31,
|         |  | 2005                    |       | 2006 |   | 2007 
|Domestic |  | $                       | 3,133 |      | $ | 1,800 |  | $ | 2,660
|Foreign  |  |                         | 2,925 |      |   | 119   |  |   | 1,150
|         |  |                         |       |      |   |       |  |   |      
|         |  | $                       | 6,058 |      | $ | 1,919 |  | $ | 3,810
|         |  |                         |       |      |   |       |  |   |      

Reconciliation of the theoretical tax expense (benefit) to the actual tax expense (benefit):

In 2005, 2006 and 2007, the main reconciling item of the statutory tax rate of the Company (34% - in 2005, 31% in 2006 and 29% in 2007)
to the effective tax rate (0%) is tax loss carryforwards and other deferred tax assets for which a full valuation allowance was provided.

NOTE 15:-
SEGMENTS, CUSTOMERS AND GEOGRAPHIC INFORMATION



| | a. | Summary information about geographical 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 a single reportable segment, the Field Service
business segment (see Note 1 for a brief description of the Companys business). The total revenues are attributable to geographic areas based on the location of the end customer.

The following table presents total revenues for the years ended December 31, 2005, 2006 and 2007 and long-lived assets as of December 31, 2005,
2006 and 2007:



|                           |  |               |        |                  |   |               |  |                  |        |               |   |                  |  |   |        |  |   |      
|-------------------------- |  | ------------- | ------ | ---------------- | - | ------------- |  | ---------------- | ------ | ------------- | - | ---------------- |  | - | ------ |  | - | -----
|                           |  | 2005          |        | 2006             |   | 2007         
|                           |  | Totalrevenues |        | Long-livedassets |   | Totalrevenues |  | Long-livedassets |        | Totalrevenues |   | Long-livedassets
|United States              |  | $             | 11,249 |                  | $ | 1,226         |  | $                | 9,917  |               | $ | 793              |  | $ | 8,809  |  | $ | 611  
|Europe and the Middle East |  |               | 1,052  |                  |   | 151           |  |                  | 1,021  |               |   | 81               |  |   | 1,001  |  |   | 43   
|Asia Pacific               |  |               | 1,906  |                  |   | 996           |  |                  | 2,922  |               |   | 816              |  |   | 1,349  |  |   | 644  
|                           |  |               |        |                  |   |               |  |                  |        |               |   |                  |  |   |        |  |   |      
|                           |  | $             | 14,207 |                  | $ | 2,373         |  | $                | 13,860 |               | $ | 1,690            |  | $ | 11,159 |  | $ | 1,298
|                           |  |               |        |                  |   |               |  |                  |        |               |   |                  |  |   |        |  |   |      



| | b. | Major customers data as a percentage of total revenues:
| | -- | -------------------------------------------------------

There were no major customers representing 10% of more of revenues in 2007 and 2006. One customer accounted for approximately 15% of revenues in 2005.



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VIRYANET LTD. AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in
thousands, except share and per share data



NOTE 16:- FINANCIAL EXPENSES, NET



|                                                                                                |  |                         |       |      |   |       |  |   |    
|----------------------------------------------------------------------------------------------- |  | ----------------------- | ----- | ---- | - | ----- |  | - | ---
|                                                                                                |  | Year ended December 31,
|                                                                                                |  | 2005                    |       | 2006 |   | 2007 
|Income:                                                                                         |  |                         |       |      |   |       |  |   |    
|Interest income                                                                                 |  | $                       | 9     |      | $ |      |  | $ |   
|Foreign currency translation adjustments                                                        |  |                         | 34    |      |   |      |  |   |   
|Income from conversion of convertible debt                                                      |  |                         |      |      |   | 975   |  |   |   
|Other income                                                                                    |  |                         | 114   |      |   |      |  |   |   
|                                                                                                |  |                         |       |      |   |       |  |   |    
|Total income                                                                                    |  |                         | 157   |      |   | 975   |  |   |   
|                                                                                                |  |                         |       |      |   |       |  |   |    
|Expenses:                                                                                       |  |                         |       |      |   |       |  |   |    
|Interest and bank charges                                                                       |  |                         | 394   |      |   | 604   |  |   | 286
|Foreign currency translation adjustments                                                        |  |                         |      |      |   | 188   |  |   | 113
|Loss from extinguishment of convertible note and other expenses related to convertible note     |  |                         | 920   |      |   |      |  |   |   
|Bank fees and stock based compensation expenses related to options and shares granted to a Bank |  |                         | 173   |      |   | 227   |  |   | 136
|                                                                                                |  |                         |       |      |   |       |  |   |    
|Total expenses                                                                                  |  |                         | 1,487 |      |   | 1,019 |  |   | 535
|                                                                                                |  |                         |       |      |   |       |  |   |    
|Financial expenses, net                                                                         |  | $                       | 1,330 |      | $ | 44    |  | $ | 535
|                                                                                                |  |                         |       |      |   |       |  |   |    

NOTE 17:- RELATED PARTIES TRANSACTIONS



| | a. | In June 1999, the board of directors approved the issuance of 3,478 Series C-2 Preferred shares to its Chairman in consideration of $ 100, which the Company loaned to him. The
loan was approved by the shareholders in June 2000 and bears annual interest at the rate of 6.5%. Repayment of the loan is due when the Chairman sells or otherwise disposes of the shares, subject to the loan. In addition, the Company, at its sole
discretion, may call for immediate repayment of the loan and the interest thereon in the event that (i) the Chairman becomes bankrupt or files a motion for bankruptcy, or (ii) the Chairman ceases to remain in the employment of the Company
for any reason.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | b. | On July 21, 2003, the board of directors and audit committee approved an agreement with a director of the Company, to provide project management services to the Company in
connection with its engagements with customers and prospects. The compensation provided under the terms of this agreement is based on the average compensation provided to employees providing similar services to the Company. During 2005, the director
was paid $ 8 for these services. No payments were made to the director in 2006 and 2007.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | c. | Insurances policies with Clal Credit Insurance and Clal Insurance:
| | -- | ------------------------------------------------------------------

During the period from 2005 through 2007, the Company purchased several insurance policies from Clal Credit Insurance and Clal Insurance, both of which are affiliated with the Clal Group, which is the Companys shareholder.



| | d. | Transactions with Telvent Interactive S.A. (Telvent), a shareholder in the Company, an affiliate of which serves on the Companys board of directors:
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------

On June 30, 2004, the Company entered into a value added reseller agreement with Telvent, under which Telvent became a
non-exclusive reseller of the Companys products at normal reseller terms.



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VIRYANET LTD. AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in
thousands, except share and per share data



NOTE 17:- RELATED PARTIES TRANSACTIONS (CONT.):

On December 1, 2004, the Company entered into an agreement with Telvent, under which, Telvent provides the Company with certain technical consulting
services relating to one of the Companys customers.

The following is a summary of the transactions with Telvent:



|                         |  |                         |     |      |   |      |  |   |    
|------------------------ |  | ----------------------- | --- | ---- | - | ---- |  | - | ---
|                         |  | Year ended December 31,
|                         |  | 2005                    |     | 2006 |   | 2007
|Revenues:                |  |                         |     |      |   |      |  |   |    
|Software license         |  | $                       |    |      | $ |     |  | $ |   
|Maintenance and services |  |                         | 140 |      |   | 137  |  |   | 105
|                         |  |                         |     |      |   |      |  |   |    
|Total                    |  | $                       | 140 |      | $ | 137  |  | $ | 105
|                         |  |                         |     |      |   |      |  |   |    
|Cost of revenues:        |  |                         |     |      |   |      |  |   |    
|Maintenance and services |  | $                       | 163 |      | $ |     |  | $ |   
|                         |  |                         |     |      |   |      |  |   |    

There were no trade payables with Telvent as of December 31, 2006 and 2007.



| | e. | As part of the e-Wise acquisition (see also Note 1(a)), the Company assumed an amount of approximately $ 285 in unsecured debt. The unsecured debt is payable to e-Wises
major shareholder, Mark Hosking, who became a shareholder and an officer of the Company as a result of the acquisition.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

On
August 28, 2007, the Company and Mark Hosking, agreed to a revision in the payment terms for the $ 115 balance of the Companys unsecured debt arrangement with Mr. Hosking. Accordingly, the Company paid $ 25 on October 1, 2007
and the balance will be paid by the Company in eight equal monthly installments beginning January 1, 2008. As part of this arrangement, the Company reserves the right to make early payment of the outstanding debt in full at any time in advance
of the payment conditions set forth above, without penalty.

As of December 31, 2007, the outstanding amount of the debt is $ 90.



| | f. | On November 30, 2006, LibertyView sold $ 500 of its Convertible Debt to Jerusalem High-tech Founders, Ltd. (JHTF), a company controlled by Samuel HaCohen, the
Companys Chairman of the Board of Directors, and in which Vladimir Morgenstern, a member of the Companys board of directors, has an economic interest. Upon the sale of the debt, the Company signed an agreement with JHTF, which was
approved by the Companys shareholders and consummated on December 29, 2006, to convert the $ 500 Convertible Debt to Preferred A shares at $ 7.65 per Preferred A share, which may be converted at the discretion of JHTF on a one-to-one
basis to Ordinary shares at any time. The Company issued 65,360 Preferred A shares to JHTF in exchange for the conversion of $ 500 of JHTF debt to the Company. See also Note 11.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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VIRYANET LTD. AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in
thousands, except share and per share data



NOTE 18:- SUBSEQUENT EVENTS



| | a. | On January 31, 2008, the Companys shareholders approved the additional issuance of convertible note in the amount of $ 439 and warrants in the amount of $ 1,200
in accordance with the agreement with the new financial investors from December 19, 2007 (see also Note 13t)
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | b. | On January 31, 2008, the Companys shareholders approved an increase of the authorized share capital of the Company by NIS 10,000,000 (consisting of 2,000,000
Ordinary shares of NIS 5.0 per share) and increase the number of restricted shares and shares options reserved in the Companys 2005 Share Option Plans by 200,000.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | c. | On January 2, 2008, the Companys short-term bank loan in the amount of $ 1,589 was extended for an additional year. On September 29 Bank Hapoalim agreed to convert
the short term loan that was due on January 2, 2009 to a long-term loan, such that $100 will be paid on July 2, 2009 an additional $100 will be paid on August 15, 2009 and the balance of $1,389 million will be paid over 14 quarterly
payments starting October 2, 2009
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | d. | On September 28, 2008, the Company received from Bank Hapoalim a waiver of its bank covenants for the balance of 2008 and for the first quarter of 2009. In connection with the
waiver and the conversion of the short-term loan to Long term loan (see also Note 18c above), the Company agreed to pay $ 30 of fees to the bank.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | e. | On July 31, 2008, in connection with the December 19, 2007 financing transaction (see Note 13t), the new financial investors signed an exercise letter in which they
exercise warrants to purchase 300,000 Ordinary shares at an exercise price of $ 2.00 per Ordinary share and further undertook to transfer the exercise price no later than October 30, 2008.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------







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