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# UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549

# FORM 20-F

|o | REGISTRATION
STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------------

# OR

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

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2008

# OR

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

# OR

|o | SHELL
COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | -------------------------------------------------------------------------------------------

DATE OF EVENT REQUIRING THIS SHELL COMPANY REPORT __________

COMMISSION FILE NO.
005-60609

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Compugen Ltd.(Exact name of registrant as specified in its charter and translation of registrants name into English)

---

Israel(Jurisdiction of
incorporation or organization)

72 Pinchas Rosen
Street, Tel Aviv, 69512 Israel (Address of principal
executive offices)

---

# Dikla Czaczkes
Axselbrad, Chief Financial OfficerPhone: 972-3-765-8585,
Fax: 972-3-765-855572 Pinchas Rosen
Street, Tel Aviv, 69512 Israel(Name, Telephone, E-mail
and/or Facsimile number and Address of Company Contact Person)

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Securities registered or to be registered pursuant to Section 12(b) of the Act:Ordinary Shares, par value New Israeli Shekels 0.01 per share(Class of Securities)



---

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NASDAQGlobal Market(Name of Exchange)

Securities registered or to be registered pursuant to Section 12(g) of the Act:None(Title of Class)

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:None

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

28,512,440 Ordinary
Shares

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

o Yes     x No

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

o Yes     x No

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:

x Yes     o No

Indicate by check mark whether the
registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.
See definition of accelerated filer and large accelerated filer in Rule 12b-2
of the Exchange Act. (Check one):

Large accelerated filer  o                    Accelerated filer  o                 Non-accelerated filer x

Indicate by check mark which basis of
accounting the registrant has used to prepare the financial statements included in this
filing:

U.S. GAAP x

International Financial Reporting Standards as issued by the International Accounting Standards Board o

Other o

If Other has been checked
in response to the previous question, indicate by check mark which financial statement
item the registrant has elected to follow.

Item 17  o               Item 18  o

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).

o Yes    x No

2

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# TABLE OF CONTENTS

|          |                                                                              |   
|--------- | ---------------------------------------------------------------------------- | --
|
|
|
|
|PART I.   |                                                                              | 5 
|         
|ITEM 1.   | IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS                        | 5 
|ITEM 2.   | OFFER STATISTICS AND EXPECTED TIMETABLE                                      | 5 
|ITEM 3.   | KEY INFORMATION                                                              | 5 
|ITEM 4.   | INFORMATION ON THE COMPANY                                                   | 18
|ITEM 4A.  | UNRESOLVED STAFF COMMENTS                                                    | 33
|ITEM 5.   | OPERATING AND FINANCIAL REVIEW AND PROSPECTS                                 | 33
|ITEM 6.   | DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES                                   | 45
|ITEM 7.   | MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS                            | 54
|ITEM 8.   | FINANCIAL INFORMATION                                                        | 56
|ITEM 9.   | THE OFFER AND LISTING                                                        | 56
|ITEM 10.  | ADDITIONAL INFORMATION                                                       | 57
|ITEM 11.  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                   | 70
|ITEM 12.  | DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES                       | 70
|         
|PART II   |                                                                              | 71
|         
|ITEM 13.  | DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES                              | 71
|ITEM 14.  | MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS | 71
|ITEM 15T. | CONTROLS AND PROCEDURES                                                      | 71
|ITEM 16.  | RESERVED                                                                     | 72
|ITEM 16A. | AUDIT COMMITTEE FINANCIAL EXPERT                                             | 72
|ITEM 16B. | CODE OF ETHICS                                                               | 72
|ITEM 16C. | PRINCIPAL ACCOUNTANT FEES AND SERVICES                                       | 72
|ITEM 16D. | EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES                   | 72
|ITEM 16E. | PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS       | 72
|ITEM 16F. | CHANGES IN REGISTRANT'S CERTIFYING ACCOUNTANT                                | 72
|ITEM 16G. | CORPORATE GOVERNANCE                                                         | 72
|         
|PART III  |                                                                              | 73
|         
|ITEM 17.  | FINANCIAL STATEMENTS                                                         | 73
|ITEM 18.  | FINANCIAL STATEMENTS                                                         | 73
|ITEM 19.  | EXHIBITS                                                                     | 73

3

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# CAUTIONARY STATEMENT
REGARDINGFORWARD-LOOKING
STATEMENTS

This
annual report on Form 20-F includes forward-looking statements within the
meaning of Section 21E of the Securities Exchange Act of 1934. These statements include
words such as may, expect, could, project,
estimate, believe, and intend, and describe opinions
about future events. We have based these forward-looking statements on information
available to us on the date hereof, and on our current intentions, beliefs, expectations
and projections about future events. We assume no obligation to update any such
forward-looking statements. These forward-looking statements are not guarantees of future
performance and are subject to risks, uncertainties and assumptions that could cause our
actual results to differ materially from our expectations or projections. Factors that
could cause our actual results to differ materially from those projected in the
forward-looking statements include, without limitation, the risk factors set forth under
Item 3. Key Information. Risk Factors, the information about us set forth
under Item 4. Information about the Company, and information related to our
financial condition under Item 5. Operating and Financial Review and
Prospects.

Compugen
Ltd. is referred to in this annual report as "Compugen",  "we",  "our",  "our company",
 "the Company" or "us".

---

We
have prepared our consolidated financial statements in United States dollars and in
accordance with accounting principles generally accepted in the United States. All
references herein to dollars or $ are to United States dollars,
and all references to Shekels or NIS are to New Israeli Shekels.

4

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# PART I.

|ITEM 1. |  | IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
|------- |  | -----------------------------------------------------

Not
applicable.

|ITEM 2. |  | OFFER STATISTICS AND EXPECTED TIMETABLE
|------- |  | ---------------------------------------

Not
applicable.

|ITEM 3. |  | KEY INFORMATION
|------- |  | ---------------

The
following selected consolidated financial data for and as of the five years ended December
31, 2008, are derived from our audited consolidated financial statements which have been
prepared in accordance with U.S. GAAP. The selected consolidated financial data as of
December 31, 2008 and 2007 and for the years ended December 31, 2008, 2007 and 2006 have
been derived from our audited consolidated financial statements and notes thereto included
elsewhere in this annual report. The selected consolidated financial data as of December
31, 2006, 2005 and 2004 and for the years ended December 31, 2005 and 2004 have been
derived from audited consolidated financial statements not included in this annual report.
The selected consolidated financial data set forth below should be read in conjunction
with and are qualified by reference to Item 5, Operating and Financial Review and
Prospects and our consolidated financial statements and notes thereto included
elsewhere in this annual report.

# Selected Financial Data

|                                | Year ended December 31,
|------------------------------- | -----------------------
|
|
|
|
|Consolidated Statement of       |                        
|Operations Data                 |                        
|Revenues                        |                        
|                                |                        
|Total operating expenses (1)    |                        
|                                |                        
|Operating loss                  |                        
|Financial and other income, net |                        
|Net loss from continuing        |                        
|operations                      |                        
|Net loss from discontinued      |                        
|operations                      |                        
|Net loss available to ordinary  |                        
|shares                          |                        
|Basic and diluted net loss per  |                        
|ordinary share from continuing  |                        
|operations                      |                        
|                                |                        
|Basic and diluted net loss per  |                        
|ordinary share                  |                        
|                                |                        
|Weighted average number of      |                        
|ordinary shares used in         |                        
|computing basic and diluted     |                        
|net loss per share              |                        
|                                |                        

|                                |  |  |   |          |  
|------------------------------- |  |  | - | -------- | -
|
|
|
|
|Consolidated Balance Sheet Data |  |  |   |          |  
|Cash and cash equivalents,      |  | 
|short-term deposits,            |  | 
|marketable securities and       |  | 
|cash held in favor of           |  | 
|consortium partners (2)         |  |  | $ | 19,519   |  
|Investment in Evogene           |  |  |   | -        |  
|Long-term deposits and          |  | 
|marketable securities           |  |  |   | 27,854   |  
|Total assets                    |  |  |   | 55,353   |  
|Accumulated deficit             |  |  |   | (105,756 | )
|Total shareholders' equity      |  |  | $ | 49,566   |  

|(1) | Includes
stock based compensation  see Note 10 of our 2008 consolidated           financial
statements.
|--- | --------------------------------------------------------------------------------------------------------

|(2) | The
amounts set forth for 2004, 2005 and 2006 have been reclassified.
|--- | ---------------------------------------------------------------------

For
additional financial information, please see Item 5. Operating and Financial Review
and Prospects  Results of Operations.

5

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# Risk Factors

Many
factors could affect our financial condition, cash flows and results of operations. We are
subject to various risks resulting from changing economic, political, social, industry,
business and financial conditions. If we do not successfully address the risks to which we
are subject, we could experience a material adverse effect on our business, results of
operations and financial condition and our share price may decline. We can give no
assurance that we will successfully address any of these risks. Theprincipal risks
are described below.

Factors Related to our
Financial Results and Financing Needs

We cannot provide assurance that
our business model will succeed in generating revenues.

Our
business model is primarily based on receiving revenues in the form of fees, milestones
and royalties, and other revenue sharing payments from licensees and co-development
partners of drug and diagnostic products based on product candidate discoveries (i) made
by us independently and/or (ii) made pursuant to various forms of collaborations with
partner companies whereby our discovery platforms or other discovery capabilities are
targeted to areas of interest of such partner companies (discovery on demand
collaborations). To date we have received only minimal revenues from the licensing of our
initial product candidates, recognizing $10,000, $180,000 and $40,000 of such revenue in
2006, 2007 and 2008 respectively. We cannot be certain this business model will generate a
stable or significant revenue stream. The inability to derive adequate revenues from our
business model would significantly impede improvement in our operating results and
liquidity.

We have a history of losses, we
expect to incur future losses and we may never achieve or sustain profitability

As
of December 31, 2008, we had an accumulated deficit of approximately $157 million
resulting in large part from our primary focus from 1997 to 2004 on research and
infrastructure building activities. These activities were focused on obtaining deeper
understandings of selected biological phenomena at the molecular level and creating
algorithms and other computational biology tools that would allow the building of
predictive models of such phenomena. During this period, the costs of such research and
discovery activities were partially offset by limited revenues obtained by providing
certain of these capabilities to third parties in the form of services and software
products. In late 2004, we began to focus a portion of our research and discovery efforts
on the creation of field specific discovery platforms intended to identify novel drug and
diagnostic product candidates and discontinued commercialization of computational biology
tools and services, as reflected by the resulting decrease in revenues. We incurred net
losses of approximately $13 million in 2006, approximately $12 million in 2007 and
approximately $13 million in 2008. We expect to continue to incur net losses in the future
due in part to the costs and expenses associated with our research and discovery
activities, including the building and validation of additional discovery platforms as
well as the nature of our business model. To date, we have received only minimal revenues
from our initial licensing activities and we cannot be certain that we will ever achieve
profitability. Even if we do achieve profitability, we may not be able to sustain or
increase profitability.

6

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We may be required to allocate
substantial additional funds in the future to our discovery and validation activities, and
we may never be able to achieve profitability.

Our
discovery efforts primarily consist of developing and validating discovery platforms on a
field by field basis, and then utilizing these platforms on our own or pursuant to
collaborations with others to discover therapeutic and diagnostic product candidate
molecules that appear to have potential applications. In 2008, as in previous years, we
allocated a substantial portion of our cash and other resources to such research,
validation and discovery activities and we intend to continue to do so. To date, these
activities have generated only negligible revenues. These activities may never generate
significant revenues and we may never achieve profitability.

We will need to raise additional
funds. If we are unable to raise additional funds in the future, we may need to curtail or
cease operations, and if we do raise additional funds, to the extent such funding is based
on the sale of equity, our existing shareholders are likely to experience dilution of
their shareholdings.

As
of December 31, 2008, we had cash and cash equivalents, short-term deposits, long-term
deposits and marketable securities of approximately $7.2 million, compared with
approximately $17.2 million as of December 31, 2007, in both cases, not including the
market value of the 2,150,000 shares of Evogene ordinary shares owned by the Company. We
do not anticipate that we will achieve profitability in the near future and believe that
we will need additional funds to continue financing our discovery, validation, development
and commercialization activities. Potential sources of additional funds include milestones
and fees under current and/or new specific product based agreements, fees and other
payments under discovery or demand or other broader collaborations, sale of
all or a portion of our Evogene shares, a rights offering of Compugen securities to our
shareholders or various other equity based arrangements.

We
cannot provide any assurance that additional funding will be available from any of these
potential sources on terms that are favorable to us, if at all. Our ability to obtain
additional funding will be subject to a number of factors, including market conditions,
our operating performance and investor sentiment. In particular, the recent downturn in
the credit and liquidity markets may restrict our ability to borrow funds or raise capital
on favorable terms or at all. If we raise additional funds by issuing equity securities or
any other convertible securities, we expect that our shareholders will experience dilution
of their shareholdings. If we are unable to obtain the required additional financing on
commercially reasonable terms, we may have to curtail or cease our discovery and
validation activities, or restrict or cease operations. Therefore, the Board of Directors
of the Company has adopted a contingency plan that includes various cost reduction
measures which, in the absence of obtaining the required additional funding (including but
not limited to, from the sale of Evogene shares or otherwise) would enable the Company to
continue to support its operations through December 31, 2009.   For more
information, see Note 1e of our 2008 consolidated financial statements.

If we are unable to continue to
successfully apply for research and development grants, our financial results may be
materially harmed.

We
have received research and development grants from the Office of the Chief Scientist of
the Israeli Ministry of Industry, Trade and Labor, from the Israel-U.S. Bi-national
Industrial Research and Development Foundation and from the European Community, under the
European Unions 6th Framework Program. In 2008, the grants we received
totaled approximately $544,000, compared with approximately $1.4 million in 2007, and
approximately $1.7 million in 2006. Our entitlement to receive these grants is dependent
on, among other things, our compliance with the various grants respective terms and
conditions. In addition, the total value of grants that the Office of the Chief Scientist
makes available generally, and to each individual grantee, has gradually decreased in
recent years and the Office of the Chief Scientist may reduce or eliminate these benefits
in the future. Our contingent liability to repay these grants out of future revenues
totaled approximately $6.0 million at December 31, 2008.

If
we do not comply with the terms and conditions of the grants or if we do not succeed in
obtaining these or similar grants in the future, or if we will be able to obtain only a
reduced amount of grants, we may have to restrict certain research activities.

7

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The current world-wide financial
crisis and its impact on capital, which may continue indefinitely or intensify, could
adversely affect our results of operations, cash flows and financial condition and may
affect our ability to access certain sources of funding.

The
global economy is currently undergoing a period of rapid decline. This has led, and could
further lead, to reduced consumer spending in the foreseeable future, which may include
reduced spending on healthcare and materially impact the earnings and financial health of
our collaborators and potential collaborators. As a consequence, our current customers and
other prospective customers may postpone, reduce or even forego research and development
activities, including acquiring licenses for therapeutic and diagnostic product
candidates, which could further adversely affect our potential revenues and profitability.
We cannot predict when these conditions will improve. If we attempted to obtain long term
credit to finance our operations, we may not be able to do so. In the past, we accessed
the capital markets to support our business activities. In the future, we may not be able
to obtain capital market financing on favorable terms, or at all, which could have a
material adverse effect on our ability to grow or even to continue our business
operations.

Factors Related to our
Discovery and Development Activities and to the Commercialization of our Discoveries

Our approach to discovering novel
therapeutic and diagnostic product candidates is itself novel and has not yet been fully
proven or validated in the form of marketed products and may never lead to marketed
products. If this approach does not prove to be successful, our business will be
significantly harmed.

Our
method of discovering novel product candidates primarily involves first utilizing our
computational biology capabilities and predictive models to generate in silico(ie.
computers) a large number of potential product candidates in the field of interest. Next
we utilize proprietary algorithms and tools and other methodologies to select from this
large number of potential product candidates a smaller number of novel molecules that we
believe have the highest probability of being product candidates for such field of
interest. Some or all of these selected molecules are then synthesized and undergo in
vitro and/or in vivo validation testing. By using this approach, we have
successfully validated the predictive capabilities of a number of discovery platforms, and
in addition have discovered numerous product candidates in a number of diagnostic and
therapeutic areas that were first predicted in silicoand then initially validated
in the laboratory. However, our approach in general has not yet been proven or validated
beyond this initial validation and we cannot predict whether any of such discoveries will
be suitable for development into therapeutic or diagnostic products or that our discovery
method will continue to yield product candidates.

If
we or our licensees and collaborators are not able to find any beneficial biological
activity for the therapeutic and diagnostic product candidates that we discover, or
potential licensees or collaborators do not believe that this is an effective discovery
methodology, or our approach is ultimately proven to be ineffective or non-competitive for
discovering candidates suitable for development into therapeutic and diagnostic products,
or we or our licensees or collaborators fail to commercialize our discoveries, our
business will likely be significantly harmed.

The success of our business
largely depends on our discovery platforms and related technologies. The predictive
capabilities of our discovery platforms with respect to yielding marketable products
remains largely unproven and may never lead to marketable products. If we fail to continue
to develop and enhance our discovery platforms, or we or our partners fail to make novel
discoveries, or focus on the most promising discoveries, our business will likely be
materially harmed.

Our
proprietary discovery platforms are designed to predict, select and validate potential
product candidates in each selected field of interest. These discovery platforms
essentially model biological processes, whether physiological or pathological. This
modeling is partial and might not be sufficient to result in true predictions to the
biological processes as they occur naturally. Even if we make true or partially true
predictions, we might be able only to repeat discoveries already made by others and not be
able to make novel discoveries. This may result either from feeding our discovery
platforms with data already used by others or by developing discovery platforms already
developed, wholly or partially by others, or from inherent incapacity of the prediction
capabilities of our discovery platforms. In addition, since our research and discovery
resources are limited we might be able to progress with only a fraction of our
discoveries. We currently assess which discoveries to validate based on various criteria.
If we or our partners fail to select the right candidates to progress with, either due to
lack of experience or applying the wrong criteria, the selected candidates may never
result in a marketable product. Additionally, we may not be able to make the necessary new
developments and enhancements to our discovery platforms and related technologies in order
to compete successfully within the pharmaceutical and biotechnology industries.

8

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We rely on access to public and
commercial databases to feed our discovery platforms and on the quality of the data
available from those databases, and if we are denied access to these databases for any
reason or if the quality of available information is poor, or if the quantity of the
available information is insufficient, our operations and business may be harmed.

In
the development and validation of our discovery platforms and of the resulting therapeutic
and diagnostic product candidates, we rely on our ability to access and use public and
commercially available databases. The quality of our platforms and discoveries is in part
dependent on the quality and quantity of the data in these databases. If we are denied
access to these databases, or if we are granted access to such databases on terms, which
are not commercially reasonable, or if the quality of data available from those databases
is poor, or if the quantity of the available information is insufficient, our business and
our results of operation may be materially harmed.

We
rely on access to high-quality biological samples supported by detailed clinical records
to conduct parts of our discovery activities and to perform experimental analysis and
initial clinical validation. If we will fail to identify and purchase or otherwise obtain
such samples for any reason or if the quality of available biological samples is poor, or
if the quantity of the available biological samples is insufficient, our discovery and
validation capabilities may be harmed.

In
carrying out our discovery and development of therapeutic and diagnostic product
candidates, we rely on our ability to access and use commercially available biological
samples. The quality of our discoveries is in part dependent on the quality and quantity
of available biological samples. If we will fail to identify and purchase or otherwise
obtain such samples for any reason or if the quality of available biological samples is
poor, or if the quantity of the available biological samples is insufficient, our
discovery and validation capabilities may be harmed.

There are risks that are inherent
in the development and commercialization of therapeutic and diagnostic products, and if
these risks materialize, our business and financial results may be materially harmed.

We
face a number of risks of failure that are inherent in the process of developing and
commercializing therapeutic and diagnostic products. These risks include, among other
risks, the possibility that:

| |  | our
therapeutic  product  candidates will be found to be  pharmacologically  ineffective or
toxic          or to have other detrimental side effects;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------

| |  | our
diagnostic product candidates will prove to be ineffective in distinguishing between
healthy and disease samples or in providing information relating to a patients
response to a drug;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | our
collaborators will not fully develop or commercialize to the full extent our product
candidates for economic reasons, including competition with other product candidates;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | our
collaborators will fail to receive applicable regulatory approvals;
| | - | -----------------------------------------------------------------------

| |  | our
 collaborators  will fail to manufacture  these products on a large scale in a cost
effective          manner;
| | - | ------------------------------------------------------------------------------------------------------------------

| |  | our
collaborators will fail to develop and market products based on our discoveries prior to
the successful marketing of competing products by others or prior to expiry of the
patents protecting such products;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the
development, marketing or sale of our product candidates will fail because they may
infringe third party intellectual property rights;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------

| |  | the
development, marketing or sale of our product candidates will fail because of our
inability or failure to protect or maintain our own intellectual property rights; and/or
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | once
a product is launched in the market, there will be little or no demand for it as a result
of its exclusion from health funds reimbursement schemes or as a result of there
being alternative products available for sale.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

If
one or more of these risks or any similar risks materialize, our business and financial
results may be materially harmed.

We have limited experience in, and
limited resources for, the discovery and development of therapeutic and diagnostic product
candidates, and if we fail to maintain and/or acquire the appropriate experience, our
business may be materially harmed.

Our
experience in the discovery and development of therapeutic and diagnostic product
candidates is limited. In order to successfully develop and commercialize therapeutic and
diagnostic product candidates, we must either access such expertise via collaborations or
improve our internal expertise, capabilities and facilities. We may not be able to
maintain and/or engage any or all of the experts that we need in order to do so.

9

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If
we fail to have available at the appropriate times all of the required experience and
expertise in the discovery and development of therapeutic and diagnostic product
candidates, we may be unsuccessful in our discovery and development activities, and as a
result our business may be materially harmed.

We or our licensees or
collaborators may be unable to obtain regulatory approval of any of our therapeutic or
diagnostic candidates, and if we or our collaborators fail to obtain such regulatory
approval, our business will be materially harmed.

The
clinical development and marketing of therapeutic and diagnostic products based on our
discoveries requires obtaining regulatory approvals to such effect. The process of
obtaining regulatory approvals for therapeutic or diagnostic products based on our
discoveries in the United States, Israel and in other countries can be lengthy and
complex. Changes in legislation and in guidelines and policies made pursuant to such
legislation could increase the complexity and the length of the process of obtaining such
regulatory approvals. The time required to obtain Food and Drug Administration and other
approvals for therapeutic and diagnostic products is unpredictable but may exceed several
years following the commencement of clinical trials. Neither we, nor our licensees or
collaborators, have yet applied for or received any regulatory approvals for the marketing
of any therapeutic or diagnostic products based on our discoveries. It is possible that
none of the product candidates we or our licensees or collaborators develop will obtain
the appropriate regulatory approvals necessary to begin selling them. Even if and once we
or our collaborators or licensees obtain regulatory approval for products based on our
discoveries, these products may be subject to continuous regulatory review. Products based
on our discoveries that are found to be unsuitable for human consumption, for example due
to the causation of unwanted side effects, may result in the withdrawal of such products
from the market.

Furthermore,
because some of the therapeutic products we are intending to develop may represent a newly
discovered class of therapeutic products or a new indication or new use for an existing
drug, without clear FDA guidelines for development, the FDA may not have established
definitive policies, practices or guidelines in relation to these products or uses. The
lack of such policies, practices or guidelines may hinder or slow review by the FDA of any
regulatory filings that we or our licensees or collaborators may submit. Moreover, the FDA
may respond to these submissions by defining requirements we may not have anticipated.
Such responses could lead to significant delays in the development of our product
candidates. Any delay or failure in obtaining required approvals could have a material
adverse effect on our ability to generate revenues from a particular product candidate.
Furthermore, any regulatory approval to market a product may be subject to limitations on
the indicated uses for which we may market the product. These limitations may limit the
size of the market for the product. We or our licensees or collaborators are also subject
to numerous regulatory requirements outside the United States governing the conduct of
clinical trials, manufacturing and marketing authorization, pricing and third-party
reimbursement. The regulatory approval process outside the United States includes all of
the risks associated with FDA approval described above as well as risks attributable to
the satisfaction of local regulations in these jurisdictions. Therefore, approval by the
FDA does not assure approval by regulatory authorities outside the United States.

If
we or our collaborators or licensees fail to obtain required regulatory approvals, our
collaborators or licensees may be prevented from marketing therapeutic or diagnostic
products based on our discoveries. This will in turn reduce our chances of receiving
payment from our collaborators and as a result, our business may be materially harmed.

We have no experience in
conducting and managing human trials. If we fail in the conducting of such trials, our
business will be materially harmed.

We
have no experience in conducting and managing the clinical trials which will be necessary
to obtain regulatory approvals for our therapeutic or diagnostic product candidates. To
the extent that we or our licensees or collaborators choose to rely on third parties for
clinical development, our control over these critically important activities will be
reduced. Third-party contractors may not complete activities on schedule, or may not
conduct clinical trials in accordance with regulatory requirements or our trial design. If
these third parties do not successfully carry out their contractual duties or meet
expected deadlines, clinical trials could be delayed and our business materially harmed.

10

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The biotechnology and
pharmaceutical industries are highly competitive, and we may be unable to compete
effectively.

The
biotechnology and pharmaceutical industries are highly competitive. Numerous entities in
the United States, Europe and elsewhere compete with our efforts to discover, validate and
partner with licensees and/or collaborators tocommercialize therapeutic and
diagnostic products or product candidates. Our competitors include pharmaceutical,
biotechnology and diagnostic companies, academic and research institutions and
governmental and other publicly funded agencies. We face, and expect to continue to face,
competition from these entities to the extent that they develop products that have a
function similar or identical to the function of our therapeutic and diagnostic product
candidates. We also face, and expect to continue to face, competition from entities that
seek to develop technologies that enable the discovery of novel therapeutic and diagnostic
product candidates.

Many
of our competitors benefit from greater market recognition, and have substantially greater
financial, technical, human, research and development, and marketing resources than we do.
Since we are a small company with limited human resources, we are not able to work with a
large number of collaborators in parallel. Our competitors may discover and develop
product candidates or market and sell products based on their discoveries, in advance of
us or of our collaborators or licensees. They may also obtain patents and other
intellectual property rights before us and thereby prevent us from pursuing the
development and commercialization of our discoveries. For information about the specific
competitors with whom we compete, see Competition under Item 4.
Information on the Company.

If
we are unable to compete successfully against existing or potential competitors, our
financial results and business may be materially harmed.

The trend towards consolidation in
the pharmaceutical, diagnostic and biotechnology industries may adversely affect us.

There
is a trend towards consolidation in the pharmaceutical, diagnostic and biotechnology
industries. This consolidation trend may result in the remaining companies having greater
financial resources and discovery technological capabilities, thus intensifying
competition in these industries. This trend may also result in fewer potential
collaborators or licensees for our therapeutic and diagnostic product candidates. Also, if
a consolidating company is already doing business with our competitors, we may lose
existing licensees or collaborators as a result of such consolidation.

This
trend may adversely affect our ability to enter into agreements for the development and
commercialization of our product candidates, and as a result may harm our business.

We depend significantly on
collaborators and licensees for the development and commercialization of our therapeutic
and diagnostic product candidates, and if we are unable to maintain our existing
agreements or to enter into additional agreements with collaborators and licensees in the
future, our business will likely be materially harmed.

Our
strategy for the development and commercialization of therapeutic and diagnostic product
candidates depends on the formation of collaborations or licensing relationships with
third parties that have complementary capabilities. We depend significantly on our
collaborators and licensees to carry out and/or finance product development and
commercialization of our therapeutic and diagnostic product candidates. Potential
collaborators and licensees include pharmaceutical, biotechnology and diagnostic companies
and academic institutions

To
date, we have granted a small number of licenses and entered into collaborations covering
development and commercialization rights with respect to certain of our product
candidates. As of December 31, 2008, we had entered into eleven such agreements for a
multiple number of our product candidates.

We
cannot assure you that any of these agreements will result in the successful development
or commercialization of any products based on our discoveries. Further, we cannot assure
you that we will succeed in identifying suitable collaborators or licensees or entering
into any other agreements with collaborators or licensees for the development and
commercialization of our therapeutic and diagnostic product candidates. If we are unable
to identify suitable collaborators or licensees or enter into new collaborations or
license agreements, our business will likely be materially harmed.

We may not be able to find
collaborators or licensees that will agree to license our discoveries at an early stage,
and if we do not find these collaborators or licensees, our business will likely be
materially harmed.

Our
strategy for the development and commercialization of therapeutic and diagnostic product
candidates is based on our discovery and early stage validation and in some cases,
pre-clinical development of those product candidates. We consider early stage development
of diagnostic product candidates to be a stage at which their existence is validated. At
this stage we may demonstrate that the product candidate is differentially expressed in
different physiological conditions, but in any case with no clinical proof. We consider
early stage development of therapeutic product candidate to be a stage at which we show
biological activity of that candidate in animal models. We either carry out such early
stage validation work ourselves or we engage third parties to provide such validation work
but we ordinarily seek to rely on our collaborators and licensees to carry out further
product development.

11

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Pharmaceutical
and diagnostic companies may be reluctant or refuse to in-license our therapeutic and
diagnostic product candidates at these early stages of discovery or validation. One
potential barrier to our success in obtaining collaborators and licensees is the existence
of skepticism in the industry about the value of in silico predictive modeling in
life science discovery due to largely unsuccessful past attempts by others. Even if we are
successful in commercializing our product candidates at an early stage of development, our
licensees may propose terms that we may not consider commercially desirable and the
consideration that we may receive for each individual product may be relatively low. The
consideration that we would expect to receive for commercializing our products candidates
increases commensurately with the number of such products commercialized and the stage of
development that we attain for them.

If
we are unable to out-license our discoveries at an early stage, we may need to validate
and develop our discoveries ourselves until the candidates attain a more mature stage of
development. Such development activities may require us to expend substantial additional
financial and other resources. If we are unable to raise or spend these additional
resources, we may have to curtail or cease our discovery and development activities, and
as a result our business will likely be materially harmed.

Our dependence on licensing and
collaboration agreements with third parties presents a number of risks, and if one or more
of these risks materialize, our business may be materially harmed.

The
risks that we face in connection with our existing collaborations, licenses and other
business alliances as well as those that we may enter into the future include, among other
things, the following:

| |  | we
may be unable to comply or fully comply with our obligations under license or
collaboration agreements into which we enter, and as a result, we may not generate
royalties or milestone payments from such agreements, and our ability to enter into
additional agreements may be harmed;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | our
collaborators may have significant discretion in electing whether to pursue any of the
planned activities and the manner in which this will be done;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | we
may not be able to control our collaborators or licensees willingness to
pursue development of our product candidates, or the amount of resources that our
collaborators will devote to the collaboration;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | changes
 in a  collaborator's  or a  licensee's  business  strategy  may  negatively  affect  its
         willingness or ability to complete its obligations under its arrangement with us;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | ownership
of the intellectual property generated under our collaborations may be disputed;
| | - | ------------------------------------------------------------------------------------------

| |  | our
ownership of rights in any intellectual property or products that may result from our
collaborations may depend on additional investment of money that we may not be able nor
willing to make;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | prospective
collaborators may pursue alternative products or technologies, by internally developing
them or by preferring those of our competitors;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------

| |  | disagreements
 between us and our  collaborators  may lead to delays in, or  termination  of, the
         collaboration; and
| | - | -----------------------------------------------------------------------------------------------------------------------------

| |  | our
collaborators may fail to develop or commercialize successfully any products based on
product candidates to which they have obtained rights from us.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------

If
any of these risks materialize, our business, financial condition and results of
operations may be materially harmed.

Factors Related to our
Operations

The licensing cycle for our
commercial offerings is complex and lengthy and as a result, we may expend substantial
funds and management resources with no assurance of success.

We
are required to negotiate agreements containing terms unique to each licensee and
collaborator and which suit each licensees or collaborators specific
discovery, development and business strategies. The accommodation of these requirements
mandates a thorough consideration of both the scientific and business aspects of each
transaction. As a result, the process of preparing and negotiating our licensing and other
agreements is complex, and may take 12 months or longer. These business development and
related commercial activities require the input and substantial time and efforts of our
key management personnel.

12

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As
a result we believe that we will need to continue to expend substantial funds and
substantial management time and effort into these business development activities with no
assurance of successfully entering into agreements with potential collaborators and
licensees.

We may be unable to hire or retain
key personnel or sufficiently qualified employees, in which case our business may be
harmed.

Our
business is highly dependent upon the continued services of our senior management and key
scientific and technical personnel. While members of our senior management and other key
personnel have entered into employment or consulting agreements and non-competition and
non-disclosure agreements, we cannot assure you that these key personnel and others will
not leave us or compete with us, which could harm our business activities and operations.
Within our geographic location, it is difficult to find suitable and highly qualified
personnel in certain aspects of our industry.

Furthermore,
we do not carry key person life insurance on any member of our senior management.

In
December 2008, following a restructuring intended to reduce our costs and cash burn, the
Company reduced its headcount to 57, from 72 as of December 31, 2007. While we believe
that this headcount reduction will not impact any of the Companys discovery
capabilities or its ability to develop new platforms, we cannot be certain of this and
such reduction may have a material adverse effect on our employee retention ability.

Our
business may be harmed if we are unable to retain our key personnel, or to attract,
integrate or retain other highly qualified personnel in the future.

Revenues that we may generate from
commercialization of our technologies or discoveries may be reduced because of obligations
to pay back Israeli governmental grants or other grants that we receive.

The
development of some of our technologies and of the discoveries that we make have been and
may in the future be partially funded by governmental grants that we received or will
receive from the Israel-U.S. Bi-national Industrial Research and Development Foundation
and the Office of the Chief Scientist of the Israeli Ministry of Industry, Trade and
Labor. According to Israeli law, certain restrictions and obligations may be imposed on us
in relation to the development and commercialization of discoveries that are financed by
these grants. These obligations and restrictions may be imposed if we were to seek to
manufacture the technologies or the discoveries outside of Israel or transfer certain of
our know-how within or outside of Israel.

We
believe that these obligations and restrictions do not apply to us for a number of
reasons, including our strategy to license the candidates discovered using our platform
technology and not to transfer the know-how subsisting in our platform technologies and
discovery platforms. We also believe that these restrictions do not apply to the sale or
to the export of product candidates that we develop using or based on our Office of the
Chief Scientist-funded platform technologies or discoveries.

Nevertheless,
if the Office of the Chief Scientist of the Israel Ministry of Industry, Trade and Labor
adopts a view contrary to our own or if restrictive statutory changes are legislated in
the future, our flexibility in commercializing some of our technologies or discoveries may
be reduced.

We may be unable to safeguard the
integrity, security and confidentiality of our data or third parties data, and if we
are unable to do so, our business may be harmed.

We
rely heavily on the use and manipulation of large amounts of data and on the secure and
continuous use of our internal computers, communication networks and software and hardware
systems. We have implemented and maintain physical and software security measures to
preserve and protect our computers, communication, and hardware and software systems as
well as our data and third parties data. However, these methods may not protect us
against fire, storm, flood, power loss, earthquakes, telecommunications failures, physical
or software break-ins or similar events. In addition, these measures may not be sufficient
to prevent unauthorized access, use or publication of such proprietary data. A party who
is able to circumvent our security measures could misappropriate or destroy proprietary
information or cause interruptions in our operations. A party who has access to our
proprietary data could misappropriate such data, make unauthorized use of or
unintentionally destroy all or part of such proprietary data. In addition, a party,
including an employee, who obtains unauthorized access to our proprietary data or breaches
a confidentiality agreement with us could publish or transfer large portions or all of our
proprietary data. Such publication of proprietary data could materially harm our
intellectual property position, thereby seriously harming our financial condition. These
security breaches, if significant, could harm our operations and even cause our business
to cease.

13

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We may be subject to claims
related to hazardous chemicals and biological materials that we use, and these claims may
harm our business.

Our
research and development activities in some cases may involve the controlled use of
biological and chemical materials, a small amount of which could be hazardous. We cannot
eliminate the risk of accidental contamination or discharge of any of these materials. If
hazardous biological or chemical materials in our possession were to be improperly used,
this could result in harm to persons or property and we could be subject to both civil
damages and criminal penalties. In such event, our liability may exceed our insurance
coverage.

Factors Related to
Intellectual Property

We may not be able to protect our
non-patented proprietary data, technologies or discoveries, and this may materially harm
our business.

We
rely heavily on our proprietary know-how and trade secrets that we develop and that are
not protectable or protected by patents. The protective measures that we employ may not
provide adequate protection for our trade secrets and know-how. Our business
collaborators, licensees, employees, advisers and consultants may disclose our proprietary
know-how or trade secrets in violation of their obligations to us. We may not be able to
meaningfully protect our rights in our proprietary know-how or trade secrets against such
unauthorized disclosure and any consequent unauthorized publication.

If
we are not able to adequately protect our proprietary know-how and trade secrets,
competitors may be able to develop technologies and resulting discoveries and inventions
that are the same or similar to our own discoveries and inventions. This could erode our
competitive advantageand materially harm our business.

We may not be able to obtain or
maintain patent protection for our inventions and if we fail to do so, our business will
likely be materially harmed.

The
success of our business depends, to a large extent, on our ability to obtain and maintain
patents that cover our therapeutic and diagnostic product candidates. We have applied for
patents covering our therapeutic and diagnostic product candidates as well as aspects of
some of our technologies. We have a total of 12 issued patents, of which 11 are U.S.
patents and one is an Australian patent. We also have 137 pending patent applications
which include 48 patent applications that have been filed in the United States (four of
which have, to date, been allowed for issuance) and seven applications that have been
filed under the Patent Cooperation Treaty for which we have not yet designated the
countries of filing. We plan to continue to apply for patents as we deem appropriate, but
we cannot assure you that any of our patent applications will be accepted, or that they
will be accepted to the extent that we seek.

The
process of obtaining patents for inventions that cover our products is uncertain for a
number of reasons, including but not limited to:

| |  | the
patenting of our inventions  involves  complex legal issues,  many of which have not yet
been          settled;
| | - | -------------------------------------------------------------------------------------------------------------------

| |  | legislative
 and judicial  changes,  or changes in the  examination  guidelines  of  governmental
         patent offices may negatively affect our ability to obtain gene-based patents;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | in
view of the finite number of human genes, we face intense competition from other
biotechnology and pharmaceutical companies who have already sought patent protection
relating to gene-based discoveries that we may intend to develop and commercialize;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | publication
of large amounts of genomic data by non-commercial and commercial entities may hinder our
ability to obtain sufficiently broad patent claims for our inventions;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | even
if we succeed in obtaining  patent  protection,  such  protection  may not be  sufficient
to          prevent third parties from using our patented inventions; and
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | even
if we succeed in obtaining patent protection, our patents could be partially or wholly
invalidated, including by our competitors.
| | - | --------------------------------------------------------------------------------------------------------------------------------------

If
we do not succeed in obtaining patent protection for our inventions to the fullest extent
for which we seek protection, our business and financial results will likely be materially
harmed.

14

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The existence of third party
intellectual property rights may prevent us from developing our discoveries or require us
to expend financial and other resources to be able to continue to do so.

In
selecting a therapeutic or diagnostic product candidate for development, we take into
account, among other considerations, the existence of third party intellectual property
rights that may hinder our right to develop and commercialize that product candidate. The
human genomic pool is finite. To our knowledge, third parties, including our competitors,
have been filing wide patent applications covering an increasing portion of the human
genomic pool and the proteins expressed therefrom.

As
a result of the existence of such third party intellectual property rights, we have been
and may be required further to:

| |  | forgo
the research, development and commercialization of therapeutic and diagnostic products
candidates that we discover, notwithstanding their promising scientific and commercial
merits; or
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | invest
substantial management and financial resources to either challenge or in-license such
third party intellectual property, and we cannot assure you that we will succeed in doing
so on commercially reasonable terms, if at all.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

We
do not always have available to us, in a timely manner, information of the existence of
third party intellectual property rights related to our own discoveries. The content of
U.S. and other patent applications remain unavailable to the public for a period of
approximately 18 months from their filing date. In some instances, the content of U.S.
patent applications remain unavailable to the public until the patents are issued. As a
result, we can never be certain that development projects that we commence will be free of
third party intellectual property rights. If we become aware of the existence of third
party intellectual property rights only after we have commenced a particular development
project, we may have to forgo such project after having invested in it substantial
resources.

We may infringe third party rights
and may become involved in litigation, which may materially harm our business.

If
a third party accuses us of infringing its intellectual property rights or if a third
party commences litigation against us for the infringement of patent or other intellectual
property rights, we may incur significant costs in defending such action, whether or not
we ultimately prevail. Typically, patent litigation in the pharmaceutical and
biotechnology industry is expensive and prolonged. Costs that we incur in defending third
party infringement actions would also include diversion of managements and technical
personnels time, the effect of which may be even more adverse then in the past due
to the recent reduction in force. In addition, parties making claims against us may be
able to obtain injunctive or other equitable relief that could prevent us or our
collaborators and licensees from further developing our discoveries or commercializing our
products. In the event of a successful claim of infringement against us, we may be
required to pay damages and obtain one or more licenses from the prevailing third party.
If we are not able to obtain these licenses at a reasonable cost, if at all, we could
encounter delays in product introductions and loss of substantial resources while we
attempt to develop alternative products. Defense of any lawsuit or failure to obtain any
of these licenses could prevent us or our partners from commercializing available products
and could cause us to incur substantial expenditures.

Factors Related to our
Ordinary Shares

Holders of our ordinary shares who
are U.S. residents may be required to pay additional U.S. federal income taxes.

There
is a risk that we may be classified as a passive foreign investment company, or PFIC. Our
treatment as a PFIC could result in a reduction in the after-tax return to the U.S.
holders of our ordinary shares and may cause a reduction in the value of our shares. For
U.S. federal income tax purposes, we will generally be classified as a PFIC for any
taxable year in which either: (i) 75% or more of our gross income is passive income or
(ii) at least 50% of the average value of our assets for the taxable year produce or are
held for the production of passive income. If we were determined to be a PFIC for U.S.
federal income tax purposes, highly complex rules would apply to U.S. holders owning our
ordinary shares and such U.S. holders could suffer adverse U.S. tax consequences. Based on
our income, assets, activities, market capitalization and other considerations, we do not
believe that we were a PFIC for the taxable year ended December 31, 2008. However there
are no assurances that the Unites States Internal Revenue Service (IRS) will
not challenge this conclusion. Furthermore, if the current price of our ordinary shares
does not increase during 2009, there is a risk that we could be classified as a PFIC for
2009.

For
a discussion of the rules relating to PFICs and related tax consequences, please see
Taxation, United States Federal Income Tax Considerations under Item 10.
Additional Information.

15

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We
have a very limited operating history with respect to the commercialization aspects of our
business model, upon which to base an investment decision or upon which to predict our
revenues.

Our
business model depends on our ability to generate revenues primarily in the form of fees,
milestones, and revenue sharing payments from the licensing and commercialization of
current and future product candidate discoveries, and our ability to do so remains
untested. To date we have received only minimal revenues from the licensing of our initial
product candidates, recognizing $180,000 of such revenue in 2007 and $40,000 of such
revenue in 2008. We cannot be certain that this business model will ever generate a stable
or significant revenue stream. Our operating history with respect to the commercialization
aspects of our business model provides an extremely limited basis for you to assess our
ability to generate significant fee, milestone, and revenue sharing revenues from the
licensing and commercialization of our product candidate discoveries, or from
discovery on demand collaborations, and therefore on the advisability of
investing in our securities.

Our share price and trading volume
have been volatile and may be volatile in the future and this could limit investors
ability to sell stock at a profit and could limit our ability to successfully raise funds.

During
the last two fiscal years, our stock price on the Nasdaq Global Market has traded at a low
of $0.34 to a high of $3.40 and trading volume has been very volatile. The volatile price
of our stock and the changing trading volume may make it difficult for investors to
predict the value of their investment, to sell shares at a profit at any given time, or to
plan purchases and sales in advance. A variety of factors may affect the market price of
our ordinary shares including:

| |  | negative
global macroeconomic developments
| | - | ------------------------------------------

| |  | successfully
reaching certain developmental milestones;
| | - | -------------------------------------------------------

| |  | failure
to raise capital on the capital markets;
| | - | ------------------------------------------------

| |  | achievement
or rejection of regulatory approvals by our competitors or us;
| | - | --------------------------------------------------------------------------

| |  | announcements
of technological innovations or new commercial products by our competitors;
| | - | -----------------------------------------------------------------------------------------

| |  | developments
concerning proprietary rights, including patents;
| | - | --------------------------------------------------------------

| |  | developments
concerning our existing or new collaborations;
| | - | -----------------------------------------------------------

| |  | regulatory
developments in the United States, Israel and other countries;
| | - | -------------------------------------------------------------------------

| |  | economic
or other crises and other external factors;
| | - | ----------------------------------------------------

| |  | delay
or failure by us or our partners in  initiating,  completing or analyzing  pre-clinical
 or          clinical trials or the unsatisfactory design or results of these trials;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | period
to period fluctuations in our revenues and other results of operations;
| | - | ------------------------------------------------------------------------------

| |  | changes
in financial estimates by securities analysts;
| | - | ------------------------------------------------------

| |  | our
need and ability to raise additional funds;
| | - | -----------------------------------------------

| |  | our
inability to disclose the commercial terms of, or progress under, our collaborations;
| | - | -----------------------------------------------------------------------------------------

| |  | our
inability to show and accurately predict revenues; and
| | - | ----------------------------------------------------------

| |  | sales
of our ordinary shares.
| | - | -----------------------------

We
are not and will not be able to control many of these factors, and we believe that
period-to-period comparisons of our financial results will not necessarily be indicative
of our future performance.

In
addition, the stock market in general, and the market for biotechnology companies in
particular, has experienced extreme price and volume fluctuations that may have been
unrelated or disproportionate to the operating performance of individual companies. These
broad market and industry factors may seriously harm the market price of our ordinary
shares, regardless of our operating performance.

In
addition, the market prices of equity securities of companies that have a significant
presence in Israel may also be affected by the changing security situation in the Middle
East and particularly in Israel. As a result, these companies may experience difficulties
in raising additional financing required to effectively operate and grow their businesses.
Such failure and the volatility of the securities market in general, and our share price
in particular, may affect our ability to raise additional financing in the future. Market
and industry fluctuations may adversely affect the trading price of our ordinary shares,
regardless of our actual operating performance.

16

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Provisions of Israeli law may
delay, prevent or affect a potential acquisition of all or a significant portion of our
shares or assets and therefore depress the price of our shares.

Israeli
corporate law regulates mergers, requires tender offers for acquisitions of shares above
specified thresholds, requires special approvals for transactions involving directors,
officers or significant shareholders and regulates other matters that may be relevant to
these types of transactions. The provisions of Israeli law may delay or prevent an
acquisition, or make it less desirable to a potential acquirer, even if such an
acquisition would be considered beneficial by a majority of our shareholders, and
therefore depress the price of our shares. For information about these limitations, see
Anti-Takeover Provisions under Israeli Law Under Item 10. Additional
Information. Furthermore, Israeli tax considerations may make potential transactions
undesirable to us or to some of our shareholders.

Our ordinary shares may be
delisted from the Nasdaq Global Market, and as a result the liquidity and price of our
ordinary shares would likely decline.

Our
ordinary shares are currently listed on the Nasdaq Global Market. Nasdaqs continued
listing requirements include that (i) the minimum bid price of a listed security must be
at least $1 and (ii) listed companies maintain, among other things, a minimum of $10.0
million in shareholders equity, as reported on the issuers balance sheet. Our
ordinary shares have traded below $1 per share since November 4, 2008. Our
shareholders equity was $10.0 million as of December 31, 2008, and we expect our
shareholders equity to decline for the next reporting period. The delisting of our
ordinary shares would likely have an adverse impact on the liquidity of our ordinary
shares and, as a result, the market price for our ordinary shares would likely become more
volatile and could decline significantly. Additionally, if we were delisted from the
Nasdaq Global Market, the benefits of dual-listing reporting requirements would no longer
be relevant and we would be required to make all our disclosures pursuant to Israeli law
and Tel Aviv stock exchange rules and regulations. Alternatively, we might choose to or be
required to delist from the Tel Aviv stock exchange as well.

Risks Relating to
Operations in Israel

Conditions in the Middle East and
in Israel may harm our operations.

Our
principal offices and research and development facilities are located in Israel.
Accordingly, political, economic and military conditions in Israel may directly affect our
operations. Since the establishment of the State of Israel in 1948, a number of armed
conflicts have taken place between Israel and its Arab neighbors, as well as incidents of
civil unrest, military conflicts and terrorist actions. In addition, Israel and companies
doing business with Israel have, in the past, been the subject of an economic boycott. Any
future armed conflicts or political instability in the region may negatively affect
business conditions and adversely affect our results of operations. Parties with whom we
do business have sometimes declined to travel to Israel during periods of heightened
unrest or tension, forcing us to make alternative arrangements when necessary. In
addition, the political and security situation in Israel may result in parties with whom
we have agreements involving performance in Israel claiming that they are not obligated to
perform their commitments under those agreements pursuant to force majeure provisions in
the agreements. We cannot give you any assurance that this will continue to be the case.
Additionally, if there were to be emergency conditions, some of our key employees may be
called to active army duty for extended periods of time and this could adversely affect
our operations.

Our
insurance does not cover losses that may occur as a result of events associated with the
security situation in the Middle East. Although the Israeli government currently covers
the reinstatement value of direct damages that are caused by terrorist attacks or acts of
war, we cannot assure you that this government coverage will be maintained. Any losses or
damages incurred by us could have a material adverse effect on our business. Any armed
conflicts or political instability in the region would likely negatively affect business
conditions and could harm our results of operations.

Our results of operations may be
adversely affected by devaluation of the Dollar against the New Israeli Shekel.

We
hold most of our cash, cash equivalents deposits and marketable securities in U.S. dollars
but incur a significant portion of our expenses, principally salaries and related
personnel expenses and administrative expenses, in New Israeli Shekels. As a result, we
are exposed to the risk that the U.S. dollar will be devalued against the New Israeli
Shekel. Depreciation of the US dollar could have a material adverse effect on our results
of operation and financial condition. The Company entered into derivative instrument
arrangements to hedge a portion of its anticipated New Israeli Shekel (NIS)
payroll and certain operation expenses. For more information, see Note 2q of our 2008
consolidated financial statements.

# We may not continue to
be entitled to certain tax benefits.

We
are entitled to certain tax benefits under Israeli government programs.

17

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The
tax benefits are a function of the Approved Enterprise status of our existing
facilities in Israel. For more information, see Item 5. Operating and Financial
Review and Prospects; Operating Results; Governmental Economic, Fiscal, Monetary or
Political Policies that Materially Affected or Could Materially Affect our
Operations. To date we have not received any such tax benefits because we have not
yet generated any taxable income. To maintain our eligibility for these tax benefits, we
must continue to meet certain conditions, including making specified investments in fixed
assets and financing a percentage of investments with share capital.

If
we cease to become entitled to these tax benefits, we may be required to pay increased
taxes on the taxable income that we may generate in the future.

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

Service
of process upon us, since we are incorporated in Israel, and upon our directors and
officers and our Israeli auditors, almost all of whom reside outside the United States,
may be difficult to obtain within the United States. In addition, because substantially
all of our assets and almost all of our directors and officers are located outside the
United States, any judgment obtained in the United States against us or any of our
directors and officers may not be collectible within the United States.

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

# History and Development
of the Company

Our
legal and commercial name is Compugen Ltd. We were established as a corporation and have
operated under the laws of the State of Israel since 1993. Our principal offices are
located at 72 Pinchas Rosen Street, Tel Aviv 69512, Israel, and our telephone number is
+972-3-765-8585. The mailing address of Compugen USA, Inc. (formerly known as Compugen,
Inc.), our wholly-owned U.S. subsidiary and our agent in the United States, is Compugen
c/o Adjuvant Global Advisors, 7101Wisconsin Avenue, Suite 1001, Bethesda MD 20814.Our primary Internet address is www.cgen.com. None of the information on our website
is incorporated by reference into this annual report.

Our
initial business beginning in 1994 was to develop and commercialize a computer hardware
system and software applications to accelerate homology searches of biological sequences
under the name Bioccelerator in order to facilitate an understanding of the
human genome and proteins. Thereafter, we began to develop better algorithms to increase
the speed of processing and to cope with the high level of complexity of life at the
molecular level. The initial result of this effort was an early understanding that the
majority of human genes can express multiple transcripts (i.e. alternative splicing) and
therefore multiple proteins.

Beginning
with this understanding of alternative splicing, our research efforts were then largely
directed to obtaining additional predictive understandings of selected biological
phenomena at the molecular level, including how genes express transcripts, how transcripts
become proteins, and more recently, how proteins are cleaved to create peptides. These
efforts, over more than 10 years, have created a core infrastructure of multidisciplinary
and experienced researchers, computational biology systems, tools and algorithms and
proprietary understandings and predictive models of key aspects of life at the molecular
level. During this period we obtained revenues by providing certain of these capabilities
to third parties (including multi-million dollar collaborations with Abbott Laboratories,
Human Genome Sciences Inc., Novartis Pharma AG and Warner-Lambert Company, and the United
States Patent and Trademark Office in the form of services and software products).

In
2004, having achieved what we believed to be the required infrastructure in terms of
experienced scientists, computational tools and models, and scientific understandings, we
began to focus a portion of our research and development efforts on the creation of field
specific discovery platforms intended to provide drug and diagnostic product candidates.
Consistent with this new focus, we discontinued commercialization of computational biology
tools and services.

From
late 2004 to date, a series of discovery platforms were successfully developed and
validated. In addition, a number of initial product candidate discoveries were made, and
the Company began to enter into various types of agreements with pharmaceutical and
diagnostic companies for the further evaluation, development and commercialization of
products based on these discoveries.

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The
Company sees its competitive advantage as having the ability to utilize computational
biology based prediction and selection methodologies to systematically
discover, through the use of its discovery platforms, multiple product candidates of
interest in an increasing number of important drug and diagnostic fields. During late
2008, in order to more fully leverage this capability, the Company increased its focus on
the next stage of its commercial development in the form of seeking broader, more
strategic types of collaborations whereby our discovery platforms or other discovery
capabilities are targeted to areas of interest of our partner. Such discovery on
demand collaborations based on our existing and to be developed
platforms are a high priority for our company and we expect that these types of
collaborations will provide the majority of our milestone and royalty opportunities in the
future. However, we cannot be certain this business model will generate a stable or
significant revenue stream. The inability to derive adequate revenues from our business
model would significantly impede improvement in our operating results and liquidity.

In
2009, we intend to focus our internal R&D activities primarily on therapeutic peptides
and monoclonal antibody drug targets. In our biomarker and other programs, particularly in
view of our current financial situation, we intend to give priority to those activities
pursued in collaboration with other companies. The net impact of these and related
decisions resulted in a staff reduction in December 2008, and an approximate 30% reduction
in planned expenditures for 2009 compared to 2008.

In
1997, we incorporated our wholly-owned U.S. subsidiary, Compugen USA, Inc. and in 2008,
our wholly-owned UK subsidiary, Compugen UK Ltd. However, neither of these subsidiaries is
anticipated to have any significant operations during 2009. Our research and discovery,
business development and commercial operations are all carried out primarily from our Tel
Aviv offices.

In
August 2000, we sold 5,000,000 of our ordinary shares in an initial public offering of our
shares on the Nasdaq Global Market at $10.00 per share. In September 2000, we sold an
additional 750,000 ordinary shares upon the exercise by our underwriters of their
over-allotment option. In January 2002, we listed our shares for trading on the Tel Aviv
Stock Exchange (TASE).

In
1999, we established a chemistry division to carry out a research program in which we
integrated the disciplines of organic chemistry with physics and advanced computational
technologies for the development of a method to substantially increase the predictability
and success rates of small molecule drug discovery. On August 1, 2004, we transferred all
of the assets and liabilities of this division to Keddem Bioscience, a wholly-owned
subsidiary. In August 2007, we announced the suspension of Keddems operations. In
2008, in order to continue to seek to maximize the value of Keddems intellectual
property, Compugen entered into a term sheet agreement with Mada Ltd., a newly formed
company owned and managed by the former two Co-CEOs of Keddem, under which Compugen will
license the Keddem intellectual property to Mada in exchange for royalties on any future
revenues and certain access rights to any developed technology. Mada intends to seek third
party funding for the development of this intellectual property, but we can give no
assurances that it will be successful in doing so.

In
1999, we established a division to utilize our in silico predictive discovery
capabilities in the agricultural biotechnology field. On January 1, 2002, we transferred
this business to Evogene Ltd., a newly formed corporation in exchange for
1,640,000 ordinary shares of Evogene, representing 82% of the companys initial
capital. The remaining 360,000 Evogene shares were issued to the two founding scientists,
who had previously directed the agbio division at Compugen. In August 2008, Evogene
entered into a multi-year research and development collaboration with Monsanto Company
focused on identifying key plant genes related to yield, environmental stress and
fertilizer utilization. At such time, Monsanto purchased an $18 million equity stake in
Evogene and agreed to purchase an additional $12 million in the future, subject to certain
Evogene diligence requirements. We currently hold 2,150,000 Evogene ordinary shares
representing approximately 9.0% of the outstanding ordinary shares. For more information
about these transactions and our holdings in Evogene, see below Significant
Investment; Evogene Ltd. and Organizational Structure in this Item 4.
See also Note 1b and Note 2e to our consolidated financial statements.

On
November 12, 2008, we announced the appointment of Mr. Martin Gerstel as Compugens
president and chief executive officer, effective January 1, 2009. Mr. Gerstel, who served
as chairman of Compugen since 1997, succeeded then president and chief executive officer
Mr. Alex Kotzer, who informed the Board of his interest to retire from his full time
executive responsibilities. Mr. Kotzer continues as a director of the Company. In
addition, on February 9, 2009, we announced the appointment of Dov Hershberg as chairman
of the board, succeeding Martin Gerstel.

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# Recent Operating
Developments

In
February 2007, we announced the development of our G-protein coupled receptor (GPCR)
Therapeutic Peptide Ligand discovery platform and eight novel peptides that activate GPCRs
discovered through the use of this new platform.

In
July 2007, we announced the development of a new discovery platform for the identification
of existing drug molecules that are predicted to have important therapeutic indications
that are currently not known (New Indications), and the selection at such time, of nine
product candidates from the initial use of this platform, three of which successfully
completed in vitro screening and advanced to in vivostudies.

In
January 2008, we announced results from initial in vivo validation studies of
CGEN-855A and CGEN-855B, two novel peptide agonists of the FPRL1 GPCR, which may serve as
anti-inflammatory and cardio-protective drug candidates, discovered using the
Companys GPCR ligand discovery platform.

In
February 2008, we announced positive in vivo results for two novel peptide agonists
of the MAS GPCR, indicating cardio-protective effects and therapeutic potential for the
treatment of various cardiovascular and other pathologies. The two peptides 
CGEN-856 and CGEN-857  were identified using Compugens GPCR ligand discovery
platform.

In
March 2008, we announced the development and validation of our Blockers of
Disease-Associated Conformation (DAC Blockers) platform, a discovery platform for the
identification of peptides that block proteins from adopting their disease-associated
conformations. Two of the predicted therapeutic peptide candidates from the pilot
validation run of the platform showed initial experimental verification, one with
anti-inflammatory and the other with anti-cancer activities.

In
April 2008, we announced the discovery and experimental verification of CGEN-438, a
potential blood based biomarker for lung cancer, which could potentially serve as both a
serum biomarker for the diagnosis of small cell lung cancer and as a component in a
biomarker combination for the diagnosis of non-small cell lung cancer patients. CGEN-438
is one of a group of putative cancer and cardiovascular biomarkers which was initially
predicted in silico using Compugens Protein disease markers discovery
platform, and then further validated experimentally.

In
May 2008, we presented experimental results for three Compugen discovered Relaxin related
molecules that could have therapeutic activity in various clinical indications, including
labor complications, infertility, inflammation, congestive heart failure and fibrotic
diseases. These three novel peptides were predicted in silico through the use of
Compugens GPCR Peptide Discovery Platform.

In
June 2008, we announced the discovery of more than ten novel targets of antibody therapy
for various types of solid and hematopoietic cancer. The newly identified targets were
initially predicted and selected in silico using Compugens Monoclonal
Antibody Therapeutic Targets Platform. Further experimental validation of the therapeutic
potential has been initiated for five of these targets.

In
June 2008 we announced the discovery and experimental confirmation of a novel combination
of four biomarkers for early detection of drug-induced nephrotoxicity. Data demonstrate
that the biomarker signature may enable a much earlier prediction of drug-induced kidney
toxicity during pre-clinical trials in rats in comparison to traditional diagnostic
methods such as histopathology or clinical chemistry. The biomarkers were discovered
through the use of Compugens Nucleic Acid Testing (NAT) Discovery Platform and a key
component of the discovery effort was the integration of proprietary expression and
clinical data derived from biological samplers provided by Teva Pharmaceutical Industries
Ltd.

In
July 2008, we announced positive results from an in vivo study of CGEN-25007, a
novel peptide antagonist of the gp96 protein. The data indicate that CGEN-25007 has
immunosuppressive effects and therapeutic potential for the treatment of various
inflammatory diseases and other immune related pathologies. CGEN-25007 was initially
predicted using Compugens DAC blockers platform, which was designed to predict
peptides that block proteins of interest from achieving certain disease-associated
conformations.

In
July 2008, we announced the discovery of the potential use of CGEN-50001, a known central
nervous system (CNS) drug, for breast cancer therapy. In in vitro and
in vivo validations studies, co-administration of CGEN 50001 was shown to
significantly increase the effect of Tamoxifen, a frequently used drug for the treatment
of estrogen receptor (ER) positive breast cancer. This previously unknown action of CGEN
50001 was initially predicted in silico by Compugens New Indications
Discovery Platform. At such time, we also announced plans to conduct a proof of concept
human trial for such use during 2009. Subsequently, and as part of the reduction in
expenditures for 2009, planning for such trial was placed on hold and is expected to move
forward only in the event of a third party collaboration.

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In
September 2008, we announced that our proprietary DAC Blockers Discovery Platform had led
to the discovery of CGEN-25008, a novel peptide antagonist of the Clusterin protein. We
also announced that recently analyzed in vitro and initial in vivo results
from cell-based assays and a lung cancer mouse model indicate that CGEN-25008 reduces the
growth rate of several cancer cell lines and specifically enhances the anti-cancer
activity of TaxolTM, a frequently used cancer chemotherapeutic drug.

In
October 2008 we announced the development and validation of a new Viral Peptides Discovery
Platform designed to identify peptides from viral genomes for potential human therapeutic
use against inflammatory and immune related diseases. The Viral Peptides Discovery
Platform has led to the discovery of two novel viral peptides demonstrating in in
vitro studies, the ability to suppress inflammatory responses.

# Principal Capital
Expenditures

In
the years ended December 31, 2008, 2007 and 2006, our capital expenditures were $120,000,
$205,000 and $157,000, respectively, and were spent primarily on laboratory equipment,
computer software and hardware and leasehold improvements. We have no current commitments
for capital expenditures.

# Business Overview

We
are a company that engages in drug and diagnostic product candidate discovery and the
commercialization of such candidates largely through early stage licensing and
co-development agreements. Our business is focused on developing and using our growing
inventory of field-focused discovery platforms to predict, select and validate therapeutic
drug candidates and diagnostic biomarker candidates. Our initial discovery platforms have
focused mainly on cancer, cardiovascular and immune-related diseases. Prediction and
selection of product candidates is largely computer based utilizing one or more of our
discovery platforms, while validation of the resulting candidates is accomplished through
the use of various in vitro and in vivo experimental techniques. Product
candidate discoveries are pursued either (i) by us independently and/or (ii) under various
forms of collaborations with partner companies whereby our discovery platforms or other
discovery capabilities are targeted to areas of interest of such partner companies. In
general, we seek to license out our discoveries at an early stage with the goal of
maximizing the number of our product candidates in development by our licensing and
co-development partners under various types of milestone and revenue sharing agreements.

We
are focused on and are structured along the lines of our three principal  activities:
 (i) research and                        discovery;                        (ii)
therapeutics;                        and (iii) diagnostics.

Research
and Discovery: Our research and discovery activities consist of two primary and
overlapping components. The first is our continuing effort to obtain deeper predictive
understandings of important biological phenomena at the molecular level through the
analysis of biological data of various types such as DNA or RNA sequences, gene expression
data, protein network data, data related to drugs in development and drugs already being
commercialized. The second utilizes these understandings, along with field specific
information, to develop field-focused discovery platforms. Both components require the use
of our extensive base of proprietary algorithms and other computational biology systems
and tools.

Therapeutics
and Diagnostics: In each field, we seek to discover novel candidates that answer unmet
medical needs and that may be suitable for further development as therapeutic or
diagnostic products. Although each of our platforms is field- or disease-specific, our
underlying capabilities and general approach are not, and can be utilized for numerous
applications, both therapeutic and/or diagnostic. At any given time, our discovery efforts
may span a number of candidates which may become diagnostic or therapeutic products. Our
therapeutic candidates include either novel peptides or proteins that are themselves drug
candidates, targets to potential drugs, like specific receptors of cancer cells, or known
small molecules with new indications. Our diagnostic biomarkers indicate, among others,
the presence or absence of a condition, such as a disease, or a persons
predisposition to either acquire a disease or to respond to a therapeutic treatment.

Our
business model is based on entering into commercial collaborations with leading
diagnostic, biotechnology and pharmaceutical companies, as well as academic and medical
institutions, which have the ability to support and fund discovery activities as well as
commercial development of our early-stage discoveries and candidates from early
pre-clinical stages for therapeutics or from initial clinical validation for diagnostics.
These collaborations can be based on either product candidates previously discovered by
Compugen, or product candidate discovery on demand in areas of interest to our
partner, or combinations of the two. We intend to generate revenues through milestone and
royalty based license agreements and joint development agreements with these
collaborators. We have entered into several such agreements, but we have not yet
recognized significant revenues from these agreements.

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Research
and Discovery

We
develop predictive biological computer based models and platforms that better enable us to
discover potential therapeutic or diagnostic product candidates by analyzing biological
data of various types such as DNA or RNA sequences, gene expression data, protein network
data and data related to drugs in development and to drugs already being commercialized.

In
general, each Compugen discovery platform targets a specific field and consists of three
modules: Prediction, Selection and Validation. The first two modules are largely in
silico (i.e. performed by computer) with the third, being laboratory based
in-vitro and in vivo experimental validation of selected candidates. The
Prediction module utilizes our computational biology capabilities and predictive models
with field specific information to generate in silico a large number of putative
product candidates for the specific purpose or field of interest. Next, the Selection
module utilizes proprietary algorithms and tools and other methodologies to select from
this large number of putative product candidates a smaller number of molecules (typically
in the low hundreds) that we believe have the highest probability of being product
candidates for that specific purpose or field of interest. Some or all of these selected
molecules are then synthesized and undergo experimental screening and therafter in
vitro and/or in vivo validation testing in the third module. By using this
systematic approach, we have successfully validated the predictive capabilities of a
number of discovery platforms, and in addition have discovered numerous product candidates
in a number of diagnostic and therapeutic areas that were first predicted in silicoand then initially validated in the laboratory. In addition, this procedure provides
additional data for the continued improvement of the predictive capabilities incorporated
in the discovery platforms.

Current
Validated Discovery Platforms

| |  | Splice
Variant based Therapeutic Proteins: Alternative Splicing is a biological phenomenon
that enables multiple protein products from a single gene. Our historical platform, the
LEADS infrastructure platform models this phenomenon by analyzing databases
of sequence data, mainly ESTs (Expressed Sequence Tags  short sub-sequences of a
transcribed spliced nucleotide sequence) and predicts the collection of human proteins
(proteome), among them many potential novel splice variants. In some cases, splice
variants could be drug candidates. The LEADS infrastructure platform is used in other
discovery platforms as well.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Nucleic-Acid
Disease Markers: Using the LEADS infrastructure platform in combination with a gene
expression database, we can identify RNA sequences found in different levels in
pathological as opposed to healthy conditions. These RNA sequences can be used as
biomarkers for the diagnosis of specific pathological conditions, such as cancer.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Protein
Disease Markers: Using the same capabilities as above, we can identify RNA sequences
that are translated to proteins secreted to the blood stream under various pathological
conditions. Such protein sequences, identified in the bloodstream, can serve as
biomarkers for the diagnosis of various diseases. This platform serves as the basis of
our collaborations with Siemens Healthcare Diagnostics Inc., Ortho-Clinical Diagnostics
(a Johnson & Johnson company) and Iverness Medical (formerly Biosite).
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Monoclonal
Antibody Targets: This platform predicts the existence of proteins that can serve as
targets for antibody therapeutics. It combines several information sources such as the
LEADS infrastructure platform, gene expression profiles and protein domains predictions.
We have recently begun to experimentally validate drug target candidates which are novel
membrane proteins which we believe may serve as targets for antibody therapeutics and may
play a role in the treatment of various cancer and autoimmune diseases. This platform is
the basis for the drug target discovery program that enables our collaboration with
Medarex.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Nucleic-Acid Preclinical
Toxicity Markers: Using the LEADS infrastructure platform in combination with gene
expression experiments designed to identify drug-induced toxicity biomarkers, we can
identify high levels of RNA sequences in tissues that were exposed to toxic drug agents.
Such RNA sequences can be used as biomarkers for the early detection of toxicity in
preclinical trials. To date, in a collaborative program with Teva Pharmaceutical
Industries, we have successfully identified and validated such biomarkers for kidney
toxicity.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | Non-SNP
Drug Response Markers: This platform (also called our GeneVa platform)
predicts non-SNP variations in the human genome that could be potential drug response and
disease predisposition markers. This platform consists of three components: a component
constituting an atlas with over 200,000 predicted non-SNP variations, a component that
associates variations from this atlas with a certain conditions of interest (eg. response
to a drug), and an experimental genotyping component that allows testing of variations on
human DNA samples. This platform forms the base of our collaboration with Roche for the
identification of drug response markers to anti rheumatoid arthritis drugs.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | GPCR Therapeutic
Peptide Ligands: G-protein coupled receptors (GPCRs) are desirable drugs targets
 with at least 40% of drugs currently in the market thought to act on GPCRs. This
platform aims at finding novel peptide ligand agonists to GPCRs that could become drug
candidates and is based on a predicted peptidome and our capability to extract from it,
GPCR related peptides. Our peptidome is a collection of thousands of novel human peptide
sequences which are expected to correspond to natural peptides, and was created by
predicting novel cleavage sites in precursor proteins. Using this proprietary platform,
to date, we have identified many novel peptides that activate GPCRs and progressed with
multiple peptides into in vivo studies. In addition, we signed a collaboration
agreement with Merck to use this platform to target and predict peptides likely to
activate selected GPCRs and to validate their agonistic activity.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | New
Indications: This platform predicts new indications for existing drugs through the
analysis of vast amounts of information and raw data from many different experimental and
drug and disease specific sources, including gene expression, known or predicted protein
networks, gene regulation data, known or predicted associations between genes and
pathologies and other experimental results. A key component of the platform is the
Compugen developed MED (Mining of Expression Data) infrastructure technology, which is
also being utilized in other discovery platforms. The MED technology allows the
integration and subsequent querying of multiple types and sources of data, including,
gene expression results from tens of thousands DNA chips from around the world, covering
hundreds of biological conditions (e.g. disease states). A significant value in
discovering a new indication of an existing drug is found in the shortened development
time and decreased risk due to the existence of safety, toxicity and other data.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Disease-Associated
Conformation Blockers:  This discovery platform is designed to identify segments in
proteins of interest that, if introduced therapeutically as synthetic peptides, would
block specific conformational changes of such proteins, thereby preventing them from
adopting disease-associated conformations and related activities. A key capability of
this platform is that it enables a proteome wide search for conformational change
blocking peptides in human, viral and bacterial proteomes.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Viral
Peptides Discovery: This is our newest platform, targeted at the discovery of novel
therapeutic peptides from viral genomes for potential human therapeutic use against
inflammatory and immune related diseases. The rationale of the platform is based on the
concept of utilizing the virus gained knowledge on how to subvert the human immune
system. The initial run of this platform identified two viral peptides that were shown in
in vitro studies on activated immune cells to suppress secretion of various
cytokines and chemokines suggesting anti-inflammatory properties.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

THERAPEUTIC
ACTIVITIES

We
use our therapeutic discovery platforms to first predict, based on various computational
biology predictive models, a large number of potential candidates and then use algorithms,
machine learning systems and other tools to select from among the many predictions, likely
novel potential drug candidates. After this in-silico prediction and selection of
potential candidates, we perform an initial screening experiment that tests for the
predicted biological activity. We then identify potential candidates, and select some for
preliminary biological testing (usually in-vitro tests) which initially, also serves as
validation of the discovery platform itself. Using the in-vitro results, we make an
assessment based on an internal set of criteria, whether to proceed to more advanced tests
(usually in vivo tests) which may further demonstrate the potential of the
discovery platform and enable us to place those molecules with successful results, in our
therapeutic pipeline. We may perform these validation activities of our candidates
internally or outsource these activities to a third party.

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Our
initial therapeutic product candidates include the following molecules that are either
being actively pursued by Compugen or are covered by an existing collaboration:

| |  | CGEN-241
is a splice variant of the MET receptor, a prominent therapeutic target for cancer, also
discovered using Compugens Splice Variant based Therapeutic Proteins discovery
platform. Compugens MET variant is a truncated soluble form of the MET receptor,
which has been shown to inhibit HGF-induced Met phosphorylation as well as cell
proliferation and survival, indicating anti-mitogenic activity. Furthermore, CGEN-241
displays a profound inhibitory effect on properties related to cell motility and
invasiveness demonstrated by inhibition of cell scattering, cell invasion and urokinase
activity induced by HGF. Compugens results demonstrate that in addition to the
inhibition of ligand-dependent activities, CGEN-241 can also affect ligand-independent
functions, illustrated by the induction of apoptosis in MKN45 cells and binding of
CGEN-241 to Met overexpressing cells, implying a direct interaction with the membranal
Met receptor. These different mechanisms of action may confer a therapeutic advantage
with the ability to inhibit the diverse modes of Met activation existing in human
malignancies.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | CGEN-855
is a peptide agonist of the FPRL1 GPCR receptor, predicted by Compugens GPCR
peptide ligand discovery platform. Using in vivo models of acute myocardial
ischemia-reperfusion injury, CGEN-855 and CGEN-855B (a shorter derivative of CGEN-855)
displayed significant dose-dependent inhibition of acute inflammation in mice.
Furthermore, these peptides provided cardioprotection against reperfusion injury, as
manifested by reduction in infarct size and troponin I plasma secretion. Taken together,
our results indicate that these novel FPRL1 agonists may be a useful therapeutic agent
for control of inflammatory diseases, and for the treatment of myocardial infarct and
subsequent heart failure. This protein is currently under a research and option for
license agreement with Merck Serono.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | CGEN-856
and CGEN-857 are MAS GPCR peptide agonists, predicted by Compugens GPCR peptide
ligand discovery platform. Sub-nanomolar concentrations of both peptides exhibit
vasodilation of aortic rings which is dependent on the presence of endothelium and NO
synthesis, and is mediated through the Mas receptor. In vivo studies using models
of cardiac remodeling, induced by isoproterenol or ischemia-reperfusion, indicate that
these peptides provide significant cardioprotection, as manifested by reduction in
cardiac fibrosis and cardiomyocytes hypertrophy.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | CGEN-25007
peptide was discovered using Compugens proprietary discovery platform, namely, the
DAC Blockers platform, which is designed for the prediction and selection of peptides
that block proteins from adopting their disease-associated conformations. CGEN-25007
corresponds to a segment of the gp96 protein, a heat shock protein which, triggers both
the innate and adaptive arms of the immune system and is involved in inflammatory
responses. gp96 is the unique and obligatory master chaperone for toll-like receptors
(TLRs). CGEN-25007 exhibited anti-inflammatory activity in human PBMCs and murine
splenocytes challenged with various inflammatory stimuli. Moreover, using an animal model
of endotoxemia CGEN-25007 exhibited anti-inflammatory activities. The above results
suggest that CGEN-25007 may be developed as an anti inflammatory drug.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | CGEN-25008
peptide is a Clusterin antagonist and was discovered using Compugens DAC Blockers
platform. In vitro,CGEN-25008 evoked growth inhibition of various tumor cell
lines such as non-small cell lung cancer (A549), colorectal adenocarcinoma (HT29), breast
cancer (MCF7) and prostate cancer (PC3). In a xenograft animal model of lung cancer,
CGEN-25008 was shown to induce up to 25% greater reduction in tumor size when given
together with Taxol, in comparison to mice treated with Taxol only. The peptide is
currently under assessment in additional cancer models.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | CGEN-25009-4
is an agonist peptide of the LGR7 receptor that was predicted by the GPCR peptide ligand
discovery platform. The LGR7 receptor is known to be activated by Relaxin and therefore
could potentially have therapeutic activity in various clinical indications including
fibrosis, labor complications, infertility and heart failure. In vitroCGEN 25009-4
peptide showed an apparent cAMP related effect on CHO-K1 cells transiently transfected
with LGR7. The peptide is currently under assessment in an animal model of lung fibrosis.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

In
addition to the above, Compugen has discovered and initially validated the following
therapeutic product candidates that, as of now, will be pursued only if and when a
collaboration partner is identified or currently on-going negotiations with a potential
partner are successfully concluded:

| |  | CGEN-54
is a splice variant of the MCP-1 chemokine- a possible drug candidate for inflammatory
conditions and cancer, discovered using Compugens Splice Variant based Therapeutic
Proteins discovery platform. Inhibition of CCR2, the receptor for MCP-1, has been shown
to have an anti-inflammatory effect. Compugens variant of MCP-1 is an inhibitor of
the CCR2 axis. This protein reduces thioglycollate-induced recruitment of macrophages to
the peritoneum in a dose dependent manner.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

24

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| |  | CGEN-34
is a splice variant of the peptide ANP, also discovered using Compugens Splice
Variant based Therapeutic Proteins discovery platform. This variant is a possible agonist
of ANP and is likely to share similar biological properties as ANP, and therefore it
could potentially affect the cardiovascular system.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | CGEN-50001
is a small molecule drug which has been used in the clinic for many years for CNS related
indications and has a well established safety profile. Using Compugens New
Indications Discovery Platform, it was predicted that CGEN-50001 would likely strengthen
the effect of anti-breast cancer drugs which target the estrogen receptor, such as
Tamoxifen. In vitro and invivo validation studies performed by
Compugen, supported this computational prediction and demonstrated that administration of
CGEN-50001 was shown to have certain anti-cancer effects. This suggests a new therapeutic
indication for a known drug for breast cancer patients.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

DIAGNOSTIC
ACTIVITIES

As
with our therapeutic discovery efforts, our diagnostic discovery platforms incorporate the
prediction of a large number of possible candidates for the area of interest and then
selection of those with apparent higher probabilities. After these steps, we make an
assessment, based on the set of criteria set forth below, which candidates to seek to
experimentally validate. A candidate is validated by testing it on a set of
clinical samples derived from healthy and diseased individuals. Validation may be
accomplished using molecular biology techniques and antibody development and
immunoassay-based detection assays. Our principal selection criteria to assess whether or
not to validate a candidate are:

| |  | Novelty
and freedom to operate. We select molecules that we predict to be novel and have found to
not be covered by third party patents or known patent applications.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Differentiation
between disease/pathological and healthy conditions. We select molecules that we predict
to be present in different quantities in diseased/pathological and healthy human tissues
that allow the development of a test having a diagnostic value.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Biological
characteristics. We select molecules that have biological features, which make them
suitable for diagnostic detection. For example, in the case of immunoassay-based
diagnostic biomarkers, we select molecules that are predicted to be secreted into the
blood stream and therefore possibly detectable in blood.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | The
specific interest of our collaboration partner. The selection of a candidate for
validation is often done together with our collaboration partner, based on their
diagnostic areas of interest and the specific candidate.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Our
initial diagnostic product candidates include:

| |  | CGEN-144
is a variant of the Troponin I biomarker for diagnosing acute myocardial infarction. The
Troponin I variant is one of a group of putative cancer and cardiovascular biomarkers
previously predicted by Compugens immunoassay biomarker computational discovery
platform. The molecule has subsequently been experimentally verified to be differentially
expressed as a serum protein in myocardial infarction patients compared to healthy
individuals. In accordance with a recently signed agreement with Compugen, Biosite will
develop and select antibodies that bind to CGEN-144 to determine assay sensitivity and
specificity in various disease states and as an addition to the current commercial
Troponin I test.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | CGEN-438
is a splice variant peptide of the delta-like protein 3 precursor (DLL3). Using a test
developed by Compugen to detect CGEN-438 in serum, the blood levels of the peptide were
measured in both lung cancer patients and healthy individuals. The CGEN-438
concentrations detected in serum samples of Small Cell Lung Cancer (SCLC) patients were
higher than those detected in the controls, demonstrating the potential of CGEN-438 to
become a diagnostic biomarker for SCLC. CGEN-438 was also found to be expressed, to a
large extent, in certain Non-SCLC serum samples. As such, CGEN-438 may too be used in a
biomarker combination test for the diagnosis of Non-SCLC.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

25

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| |  | CGEN-6
is a splice variant form of the Gastrin Releasing Peptide Precursor (GRP) gene. Today,
there are three known isoforms of the wild type GRP protein, all of which are secreted
proteins. CGEN-6 is a novel secreted splice variant protein with a unique combination of
amino acids derived from various known GRP isoforms. This protein is detectable at higher
protein concentrations in serum samples of SCLC patients as compared to control healthy
samples. The control samples showing positive CGEN-6 values were different than those
showing positive CGEN-438 values, implying that a combination test using both markers may
enhance assay specificity.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | CGEN-327
is splice variant of the HE4 (Human Epididymis Protein 4) gene, which is a known
biomarker for ovarian cancer. The computationally discovered transcript was found to
exist in human ovarian tissues and presented an over expression profile in ovarian cancer
tissues as compared to healthy and benign ovaries. These results suggest that this splice
variant may serve as a novel molecular biomarker candidate for the diagnosis of ovarian
cancer.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Our
diagnostic discovery platforms together with our related technologies and their
experimentally validated novel output have already formed the basis for discovery-based
collaborations with:

| |  | Siemens
Healthcare Diagnostics;
| | - | -------------------------------

| |  | Ortho-Clinical
Diagnostics, a Johnson & Johnson company;
| | - | --------------------------------------------------------

| |  | Iverness
Medical (formerly Biosite Inc.);
| | - | -----------------------------------------

| |  | Mayo
Clinic;
| | - | ------------

| |  | Teva
Pharmaceutical Industries Ltd.; and
| | - | ----------------------------------------

| |  | F.
Hoffmann-La Roche Ltd.
| | - | -------------------------

We
expect that in 2009 and 2010, as was the case in 2008, we will continue to validate and
develop products based on discoveries from our immunoassay based diagnostic discovery
platforms. We also intend, together with our licensees and collaborators, to continue our
discovery activities, which are currently targeted at cancer, cardiovascular and
inflammatory diseases, as well as drug-related toxicities, and also extend these
activities to other disease areas.

# Selected Existing
Customers and Collaborators

We
have to date entered into a number of agreements under which we have out-licensed novel
therapeutic and diagnostic product candidates. We intend to continue to license out our
novel therapeutic and diagnostic product candidates, to pharmaceutical, biotechnology and
diagnostics companies and in addition, to enter into broader discovery on
demand collaborations. We seek to generate revenues from these collaborations
primarily in the form of certain predetermined developmental stages and milestones, and
royalties from the sales of the drugs and/or diagnostics applications. Under all of the
agreements that we have entered to date, and as is customary in the industry, successful
outcomes with respect to such development or commercial milestones are not guaranteed nor
required of us or of our partner company.

In
November, 2008, we announced signing a collaboration agreement with Merck KGaA, covering
CGEN-855, a Compugen-discovered novel peptide targeting the FPRL1 G-protein coupled
receptor. The agreement covers additional research to be conducted by Compugen and
provides Merck Serono with an option to exclusively license the novel peptide for
worldwide development and commercialization.

On
April 1, 2008, we announced the discovery and experimental verification of CGEN-144, a
novel variant of Troponin I biomarker, and the signing of a research and license option
agreement with Biosite, Inc. We simultaneously announced that a patent for this biomarker
was granted by the U.S. Patent and Trademark Office.

In
January 2008, we announced our entry into a collaboration with Merck & Co., Inc.,
targeted at predicting peptides likely to activate selected G-protein coupled receptors
(GPCRs) and validating their agonistic activity. The agreement includes an option to Merck
for exclusive worldwide licenses for such peptides  on a peptide by peptide basis
 covering the development and commercialization of therapeutic products.

26

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---

In
December 2007, we announced our entry into a collaborative discovery and license agreement
with Roche for the identification and validation of genetic variations for the prediction
of response to drugs used for the treatment of rheumatoid arthritis. We plan to utilize
our proprietary GeneVa platform to analyze DNA samples and clinical data provided by Roche
in order to identify and validate non-SNP (single nucleotide polymorphism) genetic
variations that could serve as biomarkers for the predicted response or non-response to
selected drugs for treatment of rheumatoid arthritis.

In
August 2007, we announced the discovery of CGEN-54, a Compugen-discovered novel splice
variant of MCP-1 and our entry into a research and license option agreement with Teva
Pharmaceutical Industries, Ltd. relating to it. Teva has informed Compugen that it will
not be exercising its option and therefore we are seeking other collaboration partners for
this molecule.

In
April 2007, we announced our entry into an agreement with Mayo Clinic targeted at
discovering and validating novel biomarkers for diagnosing the presence of unstable
atherosclerotic plaques in coronary artery disease and cerebrovascular disease. Coronary
artery disease (CAD) is the leading cause of death in the developed world. Vulnerable
plaque is regarded as the most common cause of complications from CAD and can lead to
increased incidence of heart attack and stroke. We expect to utilize our unique discovery
platform approach to predict and validate biomarkers related to active atherosclerotic
disease, incorporating data derived from biological materials provided by Mayo Clinic, as
well as our own proprietary expression and clinical data.

In
March 2007, we announced our entry into an agreement with Biosite Inc. for the development
and commercialization of immunoassay diagnostic products. Entering into this agreement was
an expansion of our immunoassay diagnostic collaboration with Biosite, which we entered
into in June 2005. Under this agreement, Compugen and Biosite expanded the number of
potential diagnostic biomarkers that we made available to Biosite for selection.
Furthermore, our existing collaboration was expanded to cover additional diagnostic fields
such as cardiovascular and oncology. As with the initial agreement, we are entitled to
receive milestone payments and royalties from the sale of any products emerging from the
collaboration.

In
January 2007, we announced our entry into a collaborative agreement with Medarex, Inc. to
develop novel monoclonal antibody-based therapeutics for oncology and autoimmune diseases.
Under the terms of the agreement, we will share with Medarex discovery, development and
commercialization responsibilities on antibody-based therapeutics resulting from the
collaboration, and share revenues generated from the sale of such therapeutic products.
Under the collaboration, we are utilizing our proprietary antibody-target discovery
platform to identify novel drug targets. Medarex plans to develop fully human antibodies
against these targets using its proprietary system for developing human antibodies. The
collaboration also provides that we may independently pursue diagnostic applications
involving certain antibodies and targets.

In
January 2007, we also announced our entry into an agreement with Teva Pharmaceutical
Industries to collaborate on a project for the discovery of biomarkers for the detection
of drug toxicity in preclinical stages of the drug development process. The initial focus
of the collaboration was on biomarkers for the early detection of potential nephrotoxicity
(being toxicity to kidney cells). We granted Teva a license to use the discovered markers
for research and development activities while retaining commercialization rights for
licensing to other companies, as well as rights for internal use. Under the collaboration,
we utilized our proprietary computational tools, discovery platforms and nucleic acid
testing technologies for the purpose of predicting and validating toxicity biomarkers. Our
integrated analysis incorporated data derived from biological samples collected by Teva in
a preclinical study designed specifically for this project, as well as our proprietary
expression and clinical data.

We
currently coordinate a consortium funded by the European 6th Framework as part
of a three year collaborative project, which commenced on January 1, 2006 and which was
extended to June 30, 2009. In addition, we participate as a partner in an additional
research consortia under the European Unions 6thFramework Program. The
grants we receive from these projects do not bear any repayment provisions or royalties.
In our role as the coordinator of one of these projects, we receive the consortium funds
from the European Commission for distribution to the consortium members pursuant to the
agreement.

In
June 2005, we announced our entry into a collaboration with Ortho-Clinical Diagnostics,
Inc, a Johnson & Johnson company, or OCD, for the development and commercialization of
immunoassay based diagnostic products that are based on the output of our diagnostic
discovery platforms. The terms of this agreement allow OCD to select up to nine diagnostic
biomarkers which we will then collaborate on the initial clinical validation of the
selected biomarkers. Under the agreement, successfully validated biomarkers will be
developed into products and commercialized by OCD. In exchange, we will receive milestone
payments and license fees for each commercialized biomarker, in addition to revenue-based
royalties. We applied together with OCD for a grant from the Israel-U.S. Bi-national
Industrial Research and Development Foundation for contribution to our research and
development expenditures under our joint collaborative project. For more information about
this grant, see Item 5.Operating and Financial Review and Prospects;
Research and Development, Patents and Licenses.

27

---

---

In
June 2005, we also announced our entry into a collaboration with Biosite, for the
development and commercialization of immunoassay based diagnostic products based on the
output of our diagnostic discovery platforms. Under the terms of this agreement, we
granted to Biosite an exclusive license in the diagnostic field to use certain of our
targets for immunoassay based diagnostic applications. In return for this grant, we are
entitled to receive milestone payments and royalties from the sales of each diagnostic
product emerging from the collaboration.

In
August 2004, we entered into a broad pipeline discovery-based collaboration with
Diagnostic Product Corporation, a division of Siemens Healthcare Diagnostics (DPC) for the
development and commercialization of certain diagnostic products based on the output of
our diagnostic discovery platforms. The terms of this agreement allow DPC to develop and
commercialize immunoassay and nucleic-acid based diagnostic products that are based on
candidate biomarkers that we already discovered, as well as additional candidates that may
arise out of the collaboration. We are entitled to receive milestone payments and
royalties from the sales of each diagnostic product emerging from the collaboration. In
February 2006, we entered into an expansion agreement with DPC under which we agreed to
collaborate in relation to up to an additional five diagnostic product candidates. The
terms of the expansion agreement entitle DPC to acquire a license to candidates that
Compugen validates using serum samples to be supplied by DPC, in consideration for an
option and milestone payments that are in excess of the analogous payments under the
original agreement.

# Our Strategy

Our
mission is to be the world leader in the discovery and licensing of product candidates to
the drug and diagnostic industries under milestone and revenue sharing agreements. Our
increasing inventory of powerful and proprietary discovery platforms is enabling the
predictive discovery  field after field  of numerous therapeutic and
diagnostic product candidates. These discovery platforms are based on our decade-long
focus on the predictive understanding of important biological phenomena at the molecular
level.

To
date, we have commenced implementing this strategy through (i) the successful development
and validation of the predictive capabilities of our ten discovery platforms, (ii) the
discovery of numerous product candidates in several diagnostic and therapeutic areas that
were first predicted and selected in silicoand then initially validatedin
vitro and/or in vivo in the laboratory and (iii) the signing of collaboration
and license agreements with Roche, Siemens Healthcare Diagnostics, Inc., Ortho-Clinical
Diagnostics (a Johnson & Johnson company), Biosite, Teva Pharmacuetical Industries,
Merck & Co. and Medarex, Inc. for the development and commercialization of novel
diagnostic and therapeutic products.

Our
current inventory of validated discovery platforms is as follows:

| |  | Splice
Variant based Therapeutic Proteins
| | - | -----------------------------------------

| |  | Protein
Disease Markers
| | - | -----------------------

| |  | Nucleic-Acid
Disease Markers
| | - | ----------------------------

| |  | Monoclonal
Antibody Targets
| | - | ---------------------------

| |  | Nucleic-Acid Preclinical
Toxicity Markers
| | - | -----------------------------------------

| |  | Non-SNP
Drug Response Markers
| | - | -----------------------------

| |  | GPCR Therapeutic
Peptide Ligands
| | - | --------------------------------

| |  | New
Indications
| | - | ---------------

| |  | Disease-Associated
Conformation Blocker
| | - | ---------------------------------------

| |  | Viral
Peptides Discovery
| | - | ------------------------

# Subsidiary

Keddem
Bioscience Ltd.

In
1999, we established a chemistry division that focused on substantially increasing the
predictability and success rates of small molecule drug discovery. On August 1, 2004, we
transferred all of the assets and liabilities of this division to Keddem Bioscience
(Keddem), a wholly-owned subsidiary.

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Keddem
experienced recurring losses from operations and had accumulated a deficit of
approximately $2,917,000 at December 31, 2006. In August 2007, we announced the suspension
of Keddems operations and as such, it is reflected as a discontinued operation in
our consolidated financial statements. In 2008, in order to continue to seek to maximize
the value of Keddems intellectual property, Compugen entered into a term sheet
agreement with Mada Ltd., a newly formed company owned and managed by the former two
Co-CEOs of Keddem, under which Compugen will license the Keddem intellectual property to
Mada in exchange for royalties on any future revenues and certain access rights to any
developed technology. Mada intends to seek third party funding for the development of this
intellectual property, but we can give no assurances that it will be successful in doing
so.

For
more information on Keddem, see Item 7. Major Shareholders and Related Party
Transactions; Related Party Transactions; Keddem Bioscience Ltd..

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# Significant Investment

Evogene
Ltd.

In 1999,
we established a division to utilize our in silico predictive discovery
capabilities in the agricultural biotechnology field. On January 1, 2002, we transferred
this business, including a three year Computational Tools License to certain existing
Compugen computational biology knowhow, including LEADS, to Evogene Ltd, a newly formed
corporation in exchange for 1,640,000 ordinary shares of Evogene, representing 82% of the
companys initial capital. Evogene Ltd. issued 360,000 ordinary shares representing
18% of the companys initial capital to the two founding scientists, who previously
had directed the agbio division at Compugen.

On
August 1, 2004, the Computational Tools License was extended for two additional years,
until December 31, 2007, in consideration of the issuance to Compugen of 350,000 ordinary
shares of Evogene. During these two years we were obligated to provide to Evogene limited
support services for no additional consideration. In August 2006, we entered into a
Software License Agreement with Evogene, under which we agreed to grant Evogene a license
to certain software which supports the LEADS technology licensed under the Computational
Tools License Agreement. In consideration for the grant of the license, Evogene issued to
us 40,000 ordinary shares during 2006 and an additional 20,000 ordinary shares during
2008. In May 2007 we entered into a further extension, under which we agreed to grant
Evogene a license to certain software until December 31, 2014. In consideration, Evogene
paid us $150,000 and issued to us 100,000 Evogene ordinary shares.

In
February, 2006 Evogene entered into an equity investment agreement with certain investors
for $7 million of which approximately $2 million had originally been received by Evogene
as a bridge loan in January 2005 but was converted into equity pursuant to the terms of
the equity investment agreement. We did not participate in this financing round.

In
June, 2007, Evogene completed an initial public offering on the Tel Aviv Stock Exchange.
The company sold units consisting of ordinary shares, Series 1 warrants and Series 2
warrants. In total, 3,800,000 shares, 3,900,000 Series 1 warrants and 3,400,000 Series 2
warrants were sold in the offering. In addition, existing shareholders exercised warrants
for approximately 2,000,000 ordinary shares, bringing the total new capital raised to
approximately $8 million. We did not participate in this public offering. In August 2008,
Evogene entered into a five year research and development collaboration with Monsanto
Company focused on identifying key plant genes related to yield, environmental stress and
fertilizer utilization. At such time, Monsanto purchased an $18 million equity stake in
Evogene and agreed to purchase an additional $12 million in the future, subject to certain
Evogene diligence requirements.

In
August 2008, Evogene granted to us 30,000 options to purchase ordinary shares subject to
the terms of the Evogene Share Option Plan (2002)". Each of Evogenes
directors was entitled to such options in consideration for their service as a director.
Mr. Eli Zangvil, Compugens representative on Evogenes board of directors,
instructed that these options be issued directly to Compugen and not to him personally.

As
a result of the above financings and other transactions, as of December 31, 2008, we held
2,150,000 Evogene shares, with the ability to vote 9.0% of Evogenes share capital
and 30,000 options to purchase ordinary shares of Evogene.

The
investment in Evogene was historically accounted for in accordance with APB 18, The
Equity Method of Accounting for Investments in Common Stock. Through February 2006,
when Evogene completed a major finance round, we accounted for the investment under the
equity method. The finance round resulted in our holdings being diluted to below 20% of
Evogenes outstanding stock. We cannot exercise significant influence over operating
and financial policies of Evogene and the carrying amount of the investment is currently
classified and accounted for as available-for-sale marketable securities in accordance
with Statement of Financial Accounting Standard No. 115, Accounting for Certain
Investments in Debt and Equity Securities (SFAS 115). Securities available-for-sale
are carried at fair value, with the recognized gains and losses reported as a separate
component of stockholders equity under accumulated other comprehensive income in the
consolidated balance sheet.

For
more information on our holdings in Evogene, see below Organizational
Structure in this Item 4. See also Note 1b and Note 2e to our 2008 consolidated
financial statements.

30

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# Sales, Marketing and
Business Development

Since
our incorporation in 1993, we have devoted most of our capital and human resources to
obtaining deeper and predictive understandings of important life processes at the
molecular level and utilizing these understandings as well as our extensive and growing
base of proprietary computational biology systems, tools and platforms, to substantially
improve important aspects of drug and diagnostic product discovery. In recent years, these
efforts have focused on the development of field-specific discovery platforms and the
prediction, selection and initial validation of numerous drug and diagnostic candidates.
Therefore, our principal sales, marketing and business development efforts currently
involve licensing or other forms of collaborations with biotech, pharmaceutical and
diagnostic companies for the development and commercialization of our product candidates
and our discovery platforms. In earlier years we provided certain of our capabilities in
the form of services and software tools to third parties, but these activities were
largely discontinued by 2004.

Our
business model is primarily based on receiving revenues in the form of fees, milestones,
and royalties and other revenue sharing payments from licensees and co-development
partners. Therefore, current revenues remain insignificant. Revenues for the year ended
December 31, 2008 were $338,000, most of which were in Israel. The approximate
geographical breakdown of our revenues for the year ended December 31, 2008 was 12% in
North America and 88% in Israel. For the year ended December 31, 2007, all of our revenues
were in North America.

In
2008, in the United States, we had a business development presence in Rockville, Maryland,
which operations will be suspended in 2009.

# Raw Materials

We
use a large range of raw materials in our research. For our research and discovery
activities, we use biological databases such as databases of ESTs, which are short
nucleotide sequences that code for the expression of partial mRNA, databases on DNA
sequences gene expression databases, including from microarrays, databases which link
proteins to diseases, protein interaction pathway databases and databases that match drugs
with their respective targets. We also use a large range of biological reagents such as
cell growth media, enzymes, antibodies as well as human tissue samples and cell lines for
our therapeutics and diagnostic validation activities.

We
rely on the quality and integrity of the raw materials that we use. We have encountered
circumstances in which various biological reagents that we acquired were found to be of
poor quality. Such circumstances may delay and even interfere with our discovery and
development efforts.

# Intellectual Property
Rights

Our
intellectual property assets are our principal assets. These assets include the
intellectual property rights subsisting in our proprietary know-how and trade secrets, the
copyrights subsisting in our software and related documentation and in our patents and
patent applications. We seek to vigorously protect our rights and interests in our
intellectual property. We expect that our commercial success will depend on, among other
things, our ability to obtain commercially valuable patents especially for our therapeutic
and diagnostic product candidates, maintain the confidentiality of our proprietary
know-how and trade secrets and otherwise protect our intellectual property.

We
seek patent protection for inventions that relate to our therapeutic and diagnostic
potential product candidates as well as certain components of our technology platforms. We
currently have a total of 12 registered patents of which 11 are registered in the United
States and one is registered in Australia. We also have 137 pending patent applications,
which include 48 patent applications that have been filed in the United States (four of
which have to date been allowed for issuance) and seven applications that have been filed
under the Patent Cooperation Treaty for which we have not yet designated the countries of
filing. We intend to continue to apply for patent protection for our therapeutic and
diagnostic inventions, including for related inventions such as antibodies and peptides.

We
also seek protection for our proprietary know-how and trade secrets that are not
protectable or protected by patents, by way of safeguarding them against unauthorized
disclosure. This is done through the extensive use of confidentiality agreements and
assignment agreements with our employees, consultants and third parties as well as by
technological means. We use license agreements both to access third party technologies and
to grant licenses to third parties to exploit our intellectual property rights.

# Competition

The
biotechnology and pharmaceutical industries are highly competitive. Numerous entities in
the United States and elsewhere compete with our efforts to make discoveries and
commercialize them. Our competitors include pharmaceutical, biotechnology and diagnostic
companies, academic and research institutions and governmental and other publicly funded
agencies.

31

---

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We
face, and expect to continue to face, competition from entities that discover and develop
products that have a function similar or identical to the function of our therapeutic and
diagnostic product candidates. In respect of our diagnostic product candidates, we
potentially face competition from any company to the extent that it discovers or develops
diagnostic products, and especially, if its products are aimed at diagnosing cancers and
cardiovascular diseases as well as toxicity biomarkers. These companies include companies
such as Abbott and Bayer as well as diaDexus, Inc., and Celera Diagnostics. In respect of
our therapeutic product candidates, our potential competitors comprise companies that
develop or commercialize therapeutic protein or peptides such as Amgen, Inc., Wyeth
Pharmaceuticals, Inc., Genentech, Inc., Xencor, Inc. and Zymogenetics, Inc.

Our
discovery program depends, in large part, on our discovery platforms and other
technologies and our proprietary data to make inventions and establish intellectual
property rights in genes and gene-based products, including mRNAs, proteins and peptides.
There are a number of other means by which such inventions and intellectual property can
be generated. We believe that our computational technologies, and specifically our
discovery platforms, provide us with a competitive advantage in the field of predicting
gene-based products, and occasionally gain some information on their biological
importance. We believe that this advantage is made possible by the incorporation of ideas
and methods from mathematics and computer science into biology, and by the modeling of
significant biological phenomena and the resultant better research capabilities that we
have developed. Nevertheless, we may lose this advantage if our existing or future
competitors make scientific and technological progress. In addition, we may discover and
pursue the development of therapeutic or diagnostic product candidates that could conflict
with our collaborators discovery and development plans, including licensees or
collaborators to whom we granted in the past a license to use certain of our earlier
computational platforms.

# Government Regulation

Environmental
Regulation

Some
of our research and development activities involve the controlled use of biological and
chemical materials, a small amount of which could be considered to be hazardous. We also
have the facilities for safe use and handling of radioactive materials, although these
facilities are currently not in use. We are subject to Israeli laws and regulations
governing the use, storage, handling and disposal of all these materials and resulting
waste products. We store relatively small amounts of biological and chemical materials. To
our knowledge, we substantially comply with these laws and regulations. However, the risk
of accidental contamination or injury from these materials cannot be entirely eliminated.
In the event of an accident, we could be held liable for any resulting damages, and any
liability could exceed our resources.

Regulation
of Use of Human Tissue

We
need to access and use various human or other organisms tissue samples for the
purpose of development and or validation of some of our products. Our access and use of
these samples is subject to government regulation, in the United States, Israel and
elsewhere and may become subject to further regulation. United States and other
governmental agencies may also impose restrictions on the use of data derived from human
or other tissue samples. To our knowledge, we substantially comply with these regulatory
requirements.

Regulation
of Products Developed with the Support of Research and Development Grants

For
a discussion of regulations governing products developed with research and development
grants from the Government of Israel, see Item 5. Operating and Financial Review and
Prospects; Research and Development, Patents and Licenses; Israeli Government Research and
Development Programs.

# Organizational Structure

We
incorporated our wholly-owned U.S. subsidiary, Compugen USA, Inc., in 1997 and in January
2008, we established a wholly-owned UK Subsidiary, Compugen UK Ltd. However, neither of
these subsidiaries is anticipated to have any significant operations during 2009. Our
research and discovery, business development and commercial operations are all carried out
primarily from our Tel Aviv offices.

As
of December 31, 2008, we held 2,150,000 ordinary shares in Evogene, with the power to vote
approximately 9.0% of the outstanding share capital of Evogene Ltd. For more information
on Evogene, see Item 7. Major Shareholders and Related Party Transactions; Related
Party Transactions; Evogene Ltd. Evogene was not consolidated into our consolidated
financial statements for the years 2007 and 2008. For accounting treatment of our
investment in Evogene, see Note 1b and Note 2e to our 2008 consolidated financial
statements.

32

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# Property, Plant and
Equipment

We
lease an aggregate of approximately 28,200 square feet of office and biology laboratory
facilities in Tel Aviv, Israel. The lease in Tel Aviv expires in December 2009. We have
begun the process of negotiating the renewal of this lease. We sublease approximately
4,825 square feet of this space to another entity.

We
believe that the facilities that we currently lease are sufficient for at least the next
12 months, subject to renewal of the lease.

There
are no encumbrances on our rights in these leased properties or on any of the equipment
that we own.

To
our knowledge, there are no environmental issues that affect our use of the properties
that we lease.

|ITEM 4A. |  | UNRESOLVED STAFF COMMENTS
|-------- |  | -------------------------

Not
Applicable

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

The
following discussion of our critical accounting policies and our financial condition and
operating results should be read in conjunction with our consolidated financial
statements and related notes, prepared in accordance with U.S. GAAP for the years ended
December 31, 2008, 2007, and 2006 respectively, and with any other selected financial
data included elsewhere in this annual report.

Background

We
are a company that engages in drug and diagnostic product candidate discovery and
commercialization of such candidates largely through early stage licensing and
co-development agreements. Our business is focused on developing and using our growing
inventory of field-focused discovery platforms to predict, select and validate
therapeutic drug candidates and diagnostic biomarker candidates. Our initial discovery
platforms have focused mainly on cancer, cardiovascular and immune-related diseases.
Prediction and selection of product candidates is largely computer based utilizing one or
more of our discovery platforms, while validation of the resulting candidates is
accomplished through the use of various in vitro and in vivo experimental
techniques. Product candidate discoveries are pursued either (i) by us independently
and/or (ii) under various forms of collaborations with partner companies whereby our
discovery platforms or other discovery capabilities are targeted to areas of interest of
such partner companies (discovery on demand collaborations). In general, we
seek to license out our discoveries at an early stage with the goal of maximizing the
number of our product candidates in development by our licensing and co-development
partners under various types of milestone and revenue sharing agreements.

We
are focused on and are structured along the lines of our three principal activities: (i) research
and discovery; (ii) therapeutics; and (iii) diagnostics.

Research
and Discovery: Our research and discovery activities consist of two primary and
overlapping components. The first is our continuing effort to obtain deeper predictive
understandings of important biological phenomena at the molecular level through the
analysis of biological data of various types such as DNA or RNA sequences, gene
expression data, protein network data, data related to drugs in development and drugs
already being commercialized. The second utilizes these understandings, along with field
specific information, to develop field focused discovery platforms. Both components
require the use of our extensive base of proprietary algorithms and other computational
biology systems and tools.

33

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Therapeutics
and Diagnostics: In each field, we seek to discover novel candidates that answer
unmet medical needs and that may be suitable for further development as therapeutic or
diagnostic products. Although each of our platforms is field- or disease-specific, our
general approach is not, and can be utilized for numerous applications, both therapeutic
and/or diagnostic. At any given time, our discovery efforts may span a number of
candidates which may become diagnostic or therapeutic products. Our therapeutic
candidates include either novel peptides or proteins that are themselves drug candidates,
targets to potential drugs, like specific receptors of cancer cells, or known small
molecules with new indications. Our diagnostic biomarkers indicate, among others, the
presence or absence of a condition, such as a disease, or a persons predisposition
to either acquire a disease or to respond to a therapeutic treatment. Our business model
is based on entering into commercial collaborations with leading diagnostic,
biotechnology and pharmaceutical companies, as well as academic and medical institutions,
which have the ability to support and fund discovery activities as well as commercial
development of our early-stage discoveries and candidates from pre-clinical stages for
therapeutics or from initial clinical validation for diagnostics. These collaborations
can be based on either product candidates previously discovered by Compugen, or product
candidate discovery on demand in areas of interest to our partner, or
combinations of the two. We intend to generate revenues through milestone and royalty
based license agreements and joint development agreements with these collaborators. We
have entered into several such agreements, but we have not yet recognized significant
revenues from these agreements.

# OPERATING RESULTS

# Overview

We
have incurred losses and our revenues may not increase over the next few years.

Since
our inception, we have incurred significant losses and, as of December 31, 2008, we had
an accumulated deficit of $157 million. We expect to continue to incur net losses in the
foreseeable future.

In
late 2004, we began to focus a portion of our research and discovery efforts on the
creation of field specific discovery platforms intended to identify novel drug and
diagnostic product candidates and discontinued commercialization of our computational
biology software products, with a resulting decrease in revenues. We incurred net losses
of approximately $13 million in 2006, approximately $12 million in 2007 and approximately
$13 million in 2008. We expect to continue to incur net losses in the future due in part
to the costs and expenses associated with our research and discovery activities,
including the building and validation of additional discovery platforms. Our business
model is primarily based on receiving revenues in the form of fees, milestones and
royalties, and other revenue sharing payments from licensees and co-development partners
of drug and diagnostic products based on Compugen made or enabled product candidate
discoveries. To date, we have received only minimal such revenues.

Our
net research and development expenses are expected to account for more than 65% of our
totaloperating expenses.

Our
net research and development expenses are expected to be our major operating expense in
2009, accounting for more than 65% of our expected total 2009 operating expenses. Our
research and development expenses have always comprised a significant portion of our
expenses. In 2005, we increased the resources allocated to research and development in
order to advance our internal therapeutic and diagnostic biomarkers pipeline. In
2006, as a result of our December 2005 re-organization, our operating expenses and
research and development expenses decreased. In 2007 and 2008, these expenses continued
to be, and we expect will continue to be, our largest operating expense.

Liquidity
and Capital Resources.

For
a detailed description of our cash and cash equivalents position, see Liquidity and
Capital Resources in this Item 5.

Compensation expenses attributed to
option grants.

We
recorded compensation expenses of approximately $1.9 million in 2006, approximately $2.3
million in 2007, and approximately $1.7 million in 2008 in connection with the grant of
share options. These expenses are attributable to options that we granted to our
employees and directors and to those of our consultants to whom we granted stock options
at the fair market value known on the date of grant. These amounts are amortized over the
vesting periods of the individual share options. Based on options granted through
December 31, 2008 and on our ordinary share price on that date, we estimate that our
future amortization of compensation expenses will be approximately $1.6 million in 2009,
$550,000 in 2010, and $410,000 in 2011. Since January 2006, accounting standard SFAS 123R
applied. Standard SFAS 123R determines the accounting treatment for share-based
compensation to employees. The above future amortization of compensation expense
estimates for 2009, 2010 and 2011 reflect the application of this standard. These
estimates are subject to the amount of granted options at any given point in time. Our
current policy is to grant options at the fair market value known on the date of grant.
For more information, see Note 2l of our 2008 consolidated financial statements.

34

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Impact of Currency Fluctuations

We
hold most of our cash, cash equivalents deposits and marketable securities in U.S.
dollars but incur a significant portion of our expenses, principally salaries and related
personnel expenses and administrative expenses, in New Israeli Shekels. As a result, we
are exposed to the risk that the U.S. dollar will be devalued against the New Israeli
Shekel. Depreciation of the US dollar could have a material adverse effect on our results
of operation and financial condition. The Company entered into derivative instrument
arrangements to hedge a portion of its anticipated New Israeli Shekel (NIS)
payroll and certain operation expenses. None of these derivative instrument arrangements
qualify for hedge accounting under Financial Accounting Standard Board Statement No. 133,
Accounting for Derivative Instruments and Hedging Activities (SFAS 133).
They are recognized on the balance sheet at their fair value, with changes in the fair
value reflected in the statements of operations under financial income/expenses.

# Critical Accounting
Policies

The
preparation of our consolidated financial statements and other financial information
appearing in this annual report requires our management 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 on an on-going basis
these estimates, mainly related to revenues, contingencies, taxation and investment in
affiliates.

We
base our estimates on our experience and on various assumptions that we believe are
reasonable under the circumstances. The results of our estimates form the basis for our
managements judgments about the carrying 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.

Revenue
Recognition

The
Company generated revenues from collaboration research agreement, under which the Company
delivered a number of peptides and performed related services to a customer and from
license fees for software products, as follows:

The
Company recognized revenues from the collaboration agreement in accordance with SAB 104
Revenue recognition and EITF No. 00-21, Revenue Arrangements
with Multiple Deliverables.

Maintenance
and support revenues included in these arrangements are deferred and recognized on a
straight-line basis over the term of the maintenance and support agreement. The VSOE of
fair value of the undelivered elements (maintenance, support and professional services)
is determined based on the price charged for the undelivered element when sold separately
or based on renewal rate.

Revenues
from software license recognized in accordance with Statement of Position (SOP)
97-2, Software Revenue Recognition (SOP 97-2), as amended, when
persuasive evidence of an agreement exists, delivery of the product or service has
occurred, no significant obligations with regard to implementation remain, the fee is
fixed or determinable, and collectability is probable. SOP 97-2 generally requires
revenues earned on software arrangements involving multiple elements to be allocated to
each element based on the relative fair value of the elements. SOP 98-9 requires that
revenues be recognized under the Residual Method when vendor specific
objective evidence (VSOE) of fair value exists for all undelivered elements and no VSOE
exists for the delivered elements and all revenue recognition criteria of SOP 97-2, as
amended, are satisfied.

Revenues
from software license fees that involve customization of the Companys software to
customer specific specifications, development services, integration and installation are
recognized in accordance with SOP 81-1 Accounting for Performance of
Construction-Type and Certain Production-Type Contracts (SOP 81-1),
using contract accounting on a percentage of completion method, over the period from
signing of the license through to customer acceptance in accordance with the Input
Method. After delivery, if uncertainty exists about customer acceptance of the
software, license revenue is not recognized until acceptance. For the years ended
December 31, 2008, 2007 and 2006 the Company recognized revenues in accordance with SOP
81-1 in the amount of $ 0, $ 0 and $ 200, respectively.

Deferred
revenues include amounts received from customers for which revenue has not been
recognized.

35

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FASB
123R

On
January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123 (revised
2004), Share-Based Payment, or SFAS 123(R), which requires the measurement
and recognition of compensation expense based on estimated grant date fair values for all
share-based payment awards made to employees and directors. For periods beginning in
fiscal 2006, SFAS 123(R) supersedes Accounting Principles Board Opinion No. 25, Accounting
for Stock Issued to Employees, or APB 25, under which we previously accounted for
our share based awards granted to employees and directors, for periods beginning in
fiscal 2006. In March 2005, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 107, or SAB 107, relating to SFAS 123(R). We have applied the
provisions of SAB 107 in our adoption of SFAS 123(R).

SFAS
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 our consolidated income statement. Prior to the adoption of SFAS
123(R), we 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, or
SFAS 123.

We
adopted SFAS 123(R) using the modified prospective transition method, which requires the
application of the accounting standard starting from January 1, 2006, the first day of
our fiscal year 2006. Under that transition method, compensation cost recognized in 2006
included compensation cost for all share-based payments that were ultimately expected to
vest (a) based on the grant date fair value estimated in accordance with the original
provisions of SFAS 123 for awards granted prior to, but not yet vested as of January 1,
2006, and (b) based on the grant-date fair value estimated in accordance with the
provisions of SFAS 123(R) for awards granted subsequent to January 1, 2006. Results for
prior periods have not been restated.

We
selected the Black-Scholes model, which is the most common model in use in evaluating
stock options. This model evaluates the options as if there is a single exercise point,
and thus considers and expected option life (expected term). The input factored in this
model is constant for the entire expected life of the option.

We
recognize compensation expenses for the value of awards which have graded vesting based
on the straight line method over the requisite service period of each of the awards, net
of estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of
grant and revised, if necessary, in subsequent periods if actual forfeitures differ from
those estimates. The term forfeitures is distinct from cancellations or
expirations and represents only the unvested portion of the surrendered
option. We currently expect, based on analysis of our historical forfeitures, that
approximately 87% of our options will actually vest, and therefore we have applied an
annual forfeiture rate of 13% for all options that are not vested, but exercisable as of
December 31, 2008.

The
computation of expected volatility is based on realized historical stock price volatility
of peer data as well as historical volatility of our stock starting from our IPO date.
The risk-free interest rate assumption is the implied yield currently available on United
States treasury zero-coupon issues with a remaining term equal to the expected life term
of the options. We determined the expected life of the options according to the
simplified method, using the average of vesting and the contractual term of the option.

Share-based
compensation expense recognized under SFAS 123(R) was $1.9 million, $2.3 million and $1.7
million for the years ended December 31, 2006, 2007 and 2008, respectively.

Contingencies

We
periodically estimate the impact of various conditions, situations and/or circumstances
involving uncertain outcomes to our financial condition and operating results. These
events are called contingencies, and the accounting treatment for such events
is prescribed by the Statement of Financial Accounting Standards No. 5, Accounting
for Contingencies (SFAS No. 5). SFAS No. 5 defines a contingency as
an existing condition, situation, or set of circumstances involving uncertainty as
to possible gain or loss to an enterprise that will ultimately be resolved when one or
more future events occur or fail to occur. Legal proceedings are a form of such
contingencies.

We
are not currently involved in any legal proceedings and are not required to assess the
likelihood of any specific adverse judgments or outcomes of such proceedings or of any
potential ranges of probable losses. A determination of the amount of any accruals, if
required, for these contingencies would be made after careful analysis. For more
information in relation to legal proceedings, see Item 8. Financial Information;
Consolidated Statements and Other Financial Information; Legal Proceedings. It is
possible, however, that future results of operations for any particular quarter or annual
period could be materially affected by changes in our assumptions or as a result of the
effectiveness of our strategies related to these legal proceedings.

36

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Accounting
for Uncertainty in Income Taxes

In
July 2006, the FASB issued Interpretation, or FIN, No. 48, Accounting for
Uncertainty in Income Taxes  An Interpretation of FASB Statement No. 109,
or FIN 48. FIN 48 provides detailed guidance for the financial statement
recognition, measurement and disclosure of uncertain tax positions recognized in an
enterprises financial statements in accordance with SFAS 109. Income tax
positions must meet a more-likely-than-not recognition threshold at the effective date to
be recognized upon the adoption of FIN 48 and in subsequent periods. We adopted FIN 48
effective January 1, 2007 and the provisions of FIN 48 have been applied to all
income tax positions commencing from that date.

Recently
Issued Accounting Standards

In
December 2007, the FASB issued SFAS No. 141R, Business Combinations, or SFAS
141R. SFAS 141R establishes principles and requirements for how the acquirer of a
business recognizes and measures in its financial statements the identifiable assets
acquired, the liabilities assumed, and any non-controlling interest in the acquiree. The
statement also provides guidance for recognizing and measuring the goodwill acquired in
the business combination and determines what information to disclose to enable users of
the financial statement to evaluate the nature and financial effects of the business
combination.

SFAS
141R is effective for financial statements issued for fiscal years beginning after
December 15, 2008. We expect that SFAS No. 141R will have an impact on our consolidated
financial statements beginning in 2009, but the nature and magnitude of the specific
effects will depend upon the nature, terms and size of the acquisitions we consummate
after the effective date. The Company does not expect the adoption of SFAS No. 141R will
have a significant impact on its consolidated financial statements.

In
December 2007, the FASB issued SFAS 160, Non-controlling Interests in Consolidated
Financial Statements. SFAS 160 amends Accounting Research Bulletin 51, Consolidated
Financial Statements, to establish accounting and reporting standards for the
non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. It
also clarifies that a non-controlling 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 non-controlling 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 non-controlling
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 non-controlling 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 does not expect the adoption of SFAS 160 will
have a significant impact on its consolidated financial statements.

In
February 2008, the FASB issued FASB Staff Position (FSP) FAS No. 157-2, Effective
Date of FASB Statement No. 157 (FSP 157-2), to delay the effective date
of FASB Statement 157 for one year for certain nonfinancial assets and nonfinancial
liabilities, excluding those that are recognized or disclosed in financial statements at
fair value on a recurring basis (that is, at least annually).  For purposes of
applying the FSP 157-2, nonfinancial assets and nonfinancial liabilities include all
assets and liabilities other than those meeting the definition of a financial asset or a
financial liability in FASB Statement 159.   FSP 157-2 defers the effective
date of Statement 157 to fiscal years beginning after November 15, 2008, and interim
periods within those fiscal years for items within the scope of this FSP 157-2. The
Company does not expect the adoption of FSP 157-2 to have a material impact on its
financial position, results of operations or cash flows.

In
March 2008, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 161,
Disclosures about Derivative Instruments and Hedging Activities  an amendment of
FASB Statement No. 133 (SFAS 161). SFAS 161 changes the disclosure requirements for
derivative instruments and hedging activities. SFAS 161 requires entities to provide
enhanced disclosures about how and why an entity uses derivative instruments; how
derivative instruments and related hedged items are accounted for under SFAS 133 and its
related interpretations; and how derivative instruments and related hedged items affect
an entitys financial position, financial performance and cash flows. This statement
is effective for financial statements issued for fiscal years and interim periods
beginning after November 15, 2008. The Company is currently evaluating the impact, if
any, that SFAS 161 may have on its financial condition and results of operations. The
adoption of SFAS 161 will change its disclosures for derivative instruments and hedging
activities beginning the fiscal year 2009.

37

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In
May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted
Accounting Principles. SFAS 162 identifies the sources of accounting principles and
the framework for selecting the principles to be used in the preparation of financial
statements of nongovernmental entities that are presented in conformity with generally
accepted accounting principles in the United States. It is effective 60 days following
the SECs approval of the Public Company Accounting Oversight Board amendments to AU
Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted
Accounting Principles. The Company is currently evaluating the impact of SFAS No.
162 on its financial statements, and the adoption of this statement is not expected to
have a material effect on the Companys financial statements.

Results of Operations

Selected
Financial Data

The
following discussion and analysis is based on and should be read in connection with our
audited consolidated financial statements, including the related notes, contained in
Item 18  Financial Statements and the other financial information
appearing elsewhere in this annual report.

|                                                   | Year ended December 31,
|-------------------------------------------------- | -----------------------
|
|
|
|
|Consolidated Statements of Operations Data         |                        
|                                                   |                        
|Revenues                                           |                        
|                                                   |                        
|                                                   |                        
|Cost of revenues                                   |                        
|Research and development expenses                  |                        
|Less - governmental and other grants               |                        
|Research and development expenses, net             |                        
|Selling and marketing expenses                     |                        
|General and administrative expenses                |                        
|                                                   |                        
|                                                   |                        
|Total operating expenses *                         |                        
|                                                   |                        
|Operating loss                                     |                        
|                                                   |                        
|Financial and other income, net                    |                        
|                                                   |                        
|                                                   |                        
|Loss before taxes on income                        |                        
|                                                   |                        
|Taxes on income                                    |                        
|                                                   |                        
|Loss from continuing operations                    |                        
|                                                   |                        
|Loss from discontinued operations                  |                        
|Net loss                                           |                        
|                                                   |                        
|                                                   |                        
|Basic and diluted net loss per ordinary share from |                        
|continuing operations                              |                        
|                                                   |                        
|Basic and diluted net loss per ordinary share from |                        
|discontinued operations                            |                        
|                                                   |                        
|                                                   |                        
|Basic and diluted net loss per ordinary share      |                        
|                                                   |                        
|Weighted average number of ordinary shares used in |                        
|computing basic and diluted net loss per share     |                        
|                                                   |                        

|(*) | Includes
stock based compensation - see Note 10 of our 2008 consolidated financial statements.
|--- | ----------------------------------------------------------------------------------------------

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| |                                                 | As of December 31,
| | ----------------------------------------------- | ------------------
|
|
|
|
| | Consolidated Balance Sheet Data:                |                   
| | Cash and cash equivalents, short-term deposits, |                   
| | marketable securities and cash held in favor of |                   
| | consortium partners (1)                         |                   
| | Investment in Evogene                           |                   
| | Long-term deposits and marketable securities    |                   
| | Trade receivables and Other accounts receivable |                   
| | Assets related to discontinued operations (1)   |                   
| | Total assets                                    |                   
| | Accumulated deficit                             |                   
| | Total shareholders' equity                      |                   

| | (1) | The
amounts set forth for 2006 have been reclassified.
| | --- | ------------------------------------------------------

Years Ended December 31, 2008 and
2007

Revenues. Revenues
increased by 88% from approximately $180,000 in 2007 to approximately           $338,000
in 2008. The increase in revenues was primarily due to license fees           related to
the extension of the LEADS license agreement with Evogene. In 2007,           we began to
recognize revenues based on the new business model which we began to           implement
in 2004. Revenues based on the new business model were $180,000 and           $40,000 for
the years 2007 and 2008, respectively. This decrease is due to the           fact that we
have not yet met all of the conditions required to recognize           certain revenue
from our existing collaborations.

Cost
of Revenues.Cost of revenues attributable to certain research services we provided,
were not significant in either 2007 or 2008 and totaled approximately $7,000 for 2008.

Research
and Development Expenses, Net.Research and development expenses, net increased by
4%, to approximately $8.7 million for 2008 from approximately $8.4 million for 2007. The
increase in our research and development expenses, net, was primarily due to the decrease
in governmental and other research and development grants that we received, which are
subtracted from research and development expenses when calculating research and
development expenses, net. Research and development expenses, net, as a percentage of
total operating expenses, remained 66% in 2007 and 2008.

Research
and development expenses, decreased by 4%, to approximately $9.3 million for 2008 from
approximately $9.7 million for 2007. The decrease in our research and development
expenses was primarily due to a decrease in research and development payroll expenses of
approximately $420,000.

Selling
and Marketing Expenses. Selling and marketing expenses decreased by 25% to
approximately $996,000 for 2008 from approximately $1.3 million for 2007. This decrease
was due to a reduction in the number of our personnel and related expenses. Selling and
marketing expenses, as a percentage of total operating expenses, decreased from 10.5% in
2007 to 7.5% in 2008.

General
and Administrative Expenses.General and administrative expenses increased by 20% to
approximately $3.5 million for 2008 from approximately $2.9 million for 2007. This was
primarily due to an increase of approximately $132,000 of stock based compensation
expenses in 2008 compared to 2007 and approximately $163,000 of accrued compensation
expenses as a result of an executive termination. General and administrative expenses, as
a percentage of total operating expenses, increased from 23% in 2007 to 26% in 2008.

Financial
Income, Net.Financial income, net, decreased by 60% to approximately $348,000 for
2008, from approximately $868,000 for 2007. This decrease was primarily due to a decrease
of cash and cash related account balances, and to lower interest rates on deposits and
marketable securities.

39

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Years
Ended December 31, 2007 and 2006

Revenues.          We
have shifted our business model away from the sale of our software products           in
order to concentrate on identifying therapeutic and diagnostic candidates. As           a
result, revenues decreased by 16% from approximately $215,000 in 2006 to
          approximately $180,000 in 2007. The decrease in revenues was anticipated and primarily
due to decreased sales of Genecarta and related software products           and the shift
away from commercializing our computational software products. In           2007, we
began to recognize revenues based on the new business model which we           began to
implement in 2004. The $180,000 of revenue in 2007 was based entirely           on our
new business model while only $10,000 of the $215,000 of 2006 revenue was           based
on our new business model.

Cost
of Revenues.Cost of revenues decreased by 100% to approximately $0 for 2007 from
approximately $6,000 for 2006. This decrease was primarily due to our cessation of
commercializing our legacy products and the fact that we have not yet generated any
substantial revenues from sales of product candidates.

Research
and Development Expenses, Net.Research and development expenses, net decreased by
8%, to approximately $8.4 million for 2007 from approximately $9.1 million for 2006. The
decrease in our research and development expenses, net, was primarily due to both a
reduction in the number of our personnel and related expenses which followed the
re-organization that we underwent in December 2005. This decrease was partially offset by
the decrease in governmental and other research and development grants that we received,
which are subtracted from research and development expenses when calculating research and
development expenses, net. Research and development expenses, net, as a percentage of
total operating expenses, decreased from 69% in 2006 to 66% in 2007.

Selling
and Marketing Expenses. Selling and marketing expenses decreased by 23% to
approximately $1.3 million for 2007 from approximately $1.7 million for 2006. This
decrease was due to a reduction in the number of our personnel and related expenses.
Selling and marketing expenses, as a percentage of total operating expenses, decreased
from 13.0% in 2006 to 10.5% in 2007.

General
and Administrative Expenses.General and administrative expenses increased by 23% to
approximately $2.9 million for 2007 from approximately $2.3 million for 2006. This was
primarily due to an increase of approximately $294,000 of stock based compensation
expenses in 2007 compared to 2006 and due to an increase of approximately $90,000 in
corporate communication expenses. General and administrative expenses, as a percentage of
total operating expenses, increased from 18% in 2006 to 23% in 2007.

Financial
Income, Net.Financial income, net, increased by less than one percent to
approximately $868,000 for 2007 from approximately $866,000 for 2006.

Governmental Policies that
Materially Affected or Could Materially Affect Our Operations

Until
January 2007, Israeli companies were generally subject to income tax at the corporate tax
rate of 31%. In January 2007, this was reduced to 29%, and was further reduced to 27% in
2008. The tax rate will be further reduced to 26% in 2009 and to 25% in 2010 and
thereafter. However, several investment programs at our facility in Tel Aviv have been
granted Approved Enterprise status under which we are eligible for a reduced rate of
corporate tax under the Law for the Encouragement of Capital Investments, 1959. Subject
to compliance with applicable requirements, the portion of our profits that may be
derived from the approved enterprise programs will be tax-exempt for a period of two
years commencing in the first year in which we generate taxable income from the
applicable Approved Enterprise. The portion of our profits that may be derived from our
approved enterprise programs will be subject, for an additional period of five or eight
years, to reduced corporate tax rates of between 10% and 25%. The tax rate within the
range of 10% and 25% that may actually become payable is a function of the percentage of
non-Israeli investors holding our ordinary shares. These reduced corporate tax rates will
cease to apply upon the expiry of the earlier of twelve years from the time at which we
attain a prescribed level of investment in our approved enterprise (known as commencement
of production) or 14 years from the date on which we received approval for an
Approved Enterprise. The period of tax benefits with respect to our approved enterprise
programs has not yet commenced, because we have not yet generated any taxable income.
These benefits should result in income recognized by us being tax exempt or taxed at a
lower rate for a specified period of time after we begin to report taxable income and
exhaust any net operating loss carry-forwards. However, these benefits may not be applied
to reduce the U.S. federal tax rate for any income that our U.S. subsidiary may generate.
There can be no assurance that such tax benefits will continue in the future at their
current levels, if at all.

40

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As
of December 31, 2008, we had not generated any taxable income. As of December 31, 2008,
our net operating loss carry-forwards for Israeli tax purposes amounted to approximately
$116 million. Under Israeli law, these net operating losses may be carried forward
indefinitely and offset against certain future taxable income.

At
December 31, 2008, the net operating loss carry-forwards of our U.S. subsidiary for
Federal Income tax purposes amounted to approximately $15 million. These losses are
available to offset any future U.S. taxable income of our U.S. subsidiary and will expire
between the years 2018 and 2028.

Use
of our U.S. net operating losses may be subject to substantial annual limitation due to
the change in ownership provisions of the Internal Revenue Code of 1986 and
similar state provisions. The annual limitation may result in the expiration of net
operating losses before utilization.

For
a description of Israel government policies that affect our research and development
expenses, and the financing of our research and development, see Research and
Development, Patents and Licenses; Research and Development Grants in this Item 5
below.

# LIQUIDITY AND CAPITAL
RESOURCES

In
2008, similar to 2007, our sources of cash came from:

| |  | Our
IPO which took place in August 2000
| | - | ---------------------------------------

| |  | Revenues
generated from milestone payments under existing agreements
| | - | --------------------------------------------------------------------

| |  | Revenues
generated from sales
| | - | -----------------------------

| |  | Governmental
and other sources of grants
| | - | ----------------------------------------

| |  | The
exercise of employee stock options
| | - | --------------------------------------

| |  | Financing
income.
| | - | -----------------

| |  | We
used these funds primarily to finance our business operations.
| | - | -----------------------------------------------------------------

Net
Cash Used in Operating Activities

Net
cash used in operating activities was approximately $9.5 million in 2006, approximately
$8.2 million in 2007 and approximately $10.1 million in 2008. These amounts were used to
fund our net losses for these periods, adjusted for non-cash expenses and changes in
operating assets and liabilities including compensation relating to stock options issued
to employees. The sources of cash that we used in our activities through 2008 were the
cash held in the bank, revenues, governmental and other grants that we received, and
financing income. We expect that our sources of cash for 2009 will be similar. Our
subsidiaries are not restricted from transferring funds to Compugen, although we do not
expect any cash flow from them.

Net
Cash Provided By Investing Activities

Net
cash provided by investing activities consists of proceeds from redemption of deposits
and marketable securities, net of purchases of marketable securities and net of purchases
of property and equipment. Net cash generated by investing activities was approximately
$7.0 million in 2006, approximately $3.3 million in 2007 and approximately $13.1 in 2008.
The increase in net cash provided by investing activities in 2008 was mainly attributable
to proceeds from redemption of deposits and marketable securities.

Net
Cash Provided by Financing Activities

Our
net cash provided by financing activities was approximately $665,000 in 2006,
approximately $295,000 in 2007 and approximately $295,000 in 2008. The principal sources
of cash provided by financing activities in 2008 were proceeds that we received from the
issuance of ordinary shares as result of the exercise of stock options by employees.

41

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Net
Liquidity

Liquidity
refers to the liquid financial assets we have available to fund our business operations
and pay for near term future obligations. These liquid financial assets consist of cash
and cash equivalents as well as short-term and long-term deposits and marketable
securities. As of December 31, 2008, we had cash and cash equivalents, and short-term
deposits and marketable securities of approximately $7.2 million, not including the
market value of the 2,150,000 shares of Evogene ordinary shares owned by the Company.
Therefore, the Board of Directors of the Company has adopted a contingency plan that
includes various cost reduction measures which, in the absence of obtaining the required
additional funding (including but not limited to, from the sale of Evogene shares or
otherwise) would enable the Company to continue to support its operations through
December 31, 2009.  The debt and equity markets have been extremely difficult
in the past year, particularly since the dramatic downturn in the global financial
sector. It is unclear whether, and the extent to which, equity and debt resources can be
accessed by us in the near future. Should we be able to raise necessary funds, we cannot
be certain that these funds would be furnished on acceptable terms. Any equity financing
would likely materially dilute the interests of any current shareholder.

# RESEARCH AND
DEVELOPMENT, PATENTS AND LICENSES

We
invest heavily in research and development. Research and development expenses, net, were
our major operating expenses, representing more than 65% of the total operating expenses
for each of 2006, 2007 and 2008. Our research and development expenses, net, were
approximately $8.7 million in 2008, compared with $8.4 million in 2007, and approximately
$9.1 million in 2006. As of December 31, 2008, 41 of our employees were engaged in
research and development on a full-time basis. This represents approximately 72% of our
entire work force.

We
focus our research efforts on the development of our discovery platforms and related
technologies, and the discovery and validation of our therapeutic proteins and diagnostic
biomarker product candidates. We expect that in 2009 our research and development
expenses net will continue to be our major operating expense, representing more than 65%
of our total operating expenses.

We
believe that our future success will depend, in large part on our ability to continue to
expand our inventory of proprietary algorithms, predictive models and discovery platforms
which provide opportunities for the discovery of promising therapeutic and diagnostic
product candidates by us and pursuant to discovery on demand collaborations.

Research
and Development Grants

We
participate in programs offered by the Office of the Chief Scientist under the Industry
and Trade Ministry of Israel (OCS) that supports research and development
activities, by the Israel-U.S. Bi-national Industrial Research and Development Foundation
(BIRD) and by the European Community, under the European Unions 6th Framework
Program. We received grants and other forms of consideration from the OCS, BIRD and
European Union of approximately $1.7 million in 2006, approximately $1.4 million in 2007
and approximately $544,000 in 2008. We have applied for additional grants from the OCS
for research, technological development and demonstration activities for 2009.

The
Office of the Chief Scientist

We
received grants from the OCS for several projects. Under the terms of these grants, we
will be required to pay royalties ranging between 3% to 5% of the net sales of products
developed from the OCS-funded projects, beginning with the commencement of receipt of
revenue with respect to such products and ending when 100% of the dollar value of the
grant is repaid (100% plus LIBOR interest applicable to grants received on or after
January 1, 1999). As of December 31, 2008, our contingent accrued obligation for
royalties, based on royalty-bearing government grants, net of royalties already paid,
totaled approximately $5.5 million payable out of future net sales of products that were
developed under OCS -funded projects.

Israeli
law requires that the manufacture of products developed with government grants will be
carried out in Israel, unless the OCS provides its approval to the contrary. Following
legislative changes to Israeli legislation in 2005, this approval, if provided, is
generally conditioned on an increase in the total amount to be repaid to the OCS, to up
to 300% of the amount of funds granted. The specific increase within this ceiling would
depend on the extent of the manufacturing to be conducted outside of Israel.
Alternatively, the restriction on manufacturing outside of Israel shall not apply to the
extent that plans to manufacture were disclosed when filing the application for funding
(and provided the application was approved based on the information disclosed in the
application). We believe that this restriction does not apply to the commercialization
through licensing of product candidates that we develop by using or based on our
OCS-funded technologies or discoveries. In such circumstances, the OCS will take into
account the proposal that OCS-funded projects will have an overseas manufacturing
component. Under applicable Israeli law, Israeli government consent is required to
transfer to Israeli third parties technologies developed under projects, which the
government funded. Transfer of OCS-funded technologies outside of Israel is prohibited,
unless conducted in accordance with the restrictions set forth under Israeli law. Israeli
law further specifies that both the transfer of know-how as well as the transfer of
intellectual property rights in such know-how are subject to the same restrictions. These
restrictions do not apply to exports from Israel or the sale of products developed with
these technologies.

42

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In
addition to the OCS programs described above, in the past, we participated in a number of
research consortia in which Israeli research institutions and high technology companies
were members. These types of consortia are devoted to the development of generic
technologies in the fields of biotechnology, agricultural biotechnology and
pharmaceuticals. No royalties are payable to the OCS with respect to this funding.

In
general, any member of a consortium that develops technology in the framework of a
consortium retains the intellectual property rights to this technology and all other
consortium members have the right to use and implement this technology without having to
pay royalties to the developing consortium member, provided that the technology will not
be transferred under any circumstances to any entity outside of the consortium.

Bi-national
Industrial Research and Development Foundation (BIRD)

In
2005 we entered into a tripartite cooperation and project funding agreement with OCD and
BIRD based on BIRDs standard terms and conditions. The term of the funded
collaborative project is four years. BIRDs standard terms and conditions require
its grantees to repay 100% of the grant monies, provided that repayment is made within
the first year following expiry of the term of the project. For every year of delay in
these repayments, the amounts to be repaid incrementally increase up to an amount of 150%
in the fifth year following expiry of the term of the project. All amounts to be repaid
to BIRD are subject to us generating revenue from commercializing the funded project and
linked to the U.S. consumer price index.

The
Governments of Israel and of the United States are each entitled to a non-exclusive,
royalty-free license to make and use any products generated from the funded project.
Otherwise, neither we nor OCD are subject to any restrictions relating to the ownership
or commercialization of the intellectual property and products generated from the funded
collaborative project.

As
of December 31, 2008, our contingent accrued obligation for royalties, based on
royalty-bearing BIRD grant, totaled approximately $500,000 payable out of future net
sales of products that were developed under the BIRD-funded project.

The
European Unions 6th Framework Program

In
2005 we joined two research consortia under the European Unions 6thFramework
Program, which is a program based on the Treaty establishing the European Union, with the
aim of promoting research and technology among the European Community members.

We
are the appointed coordinator of one of these research consortia, which means that we are
the consortiums primary contact with the European Community for the purpose of
managing the consortiums progress. This includes a responsibility to distribute the
research grant monies to the consortium members and to provide to the European Community
reports describing the consortiums progress of the funded research.

The
terms of the grant from the European Community do not require us to repay the grant
monies that we receive, unless we or any of our consortium members default in our
obligations such as carrying out the research that we undertook to perform, or in
reporting the progress of the research.

# TREND INFORMATION

Trend
towards consolidation

There
is a trend towards consolidation in the pharmaceutical, diagnostic and biotechnology
industries, which may negatively affect our ability to enter into agreements and may
cause us to lose existing licensees or collaborators as a result of such consolidation.
This trend often involves larger companies acquiring smaller companies, and this may
result in the larger companies having greater financial resources and technological
capabilities. This trend towards consolidation in the pharmaceutical diagnostic and
biotechnology industries may also result in there being fewer potential companies to
license our products and services.

43

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The
pharmaceutical industry appears to be open to in-licensing potential therapeutic products
atvery early stages of their development

We
believe that pharmaceutical and biotechnological companies are becoming more open to
in-licensing product candidates at earlier stages of development, including at
pre-clinical stages. As a result, we expect there to be more interest in entering into
agreements with us for further development and commercialization of our early stage
product candidates. For more information, see Item 3. Risk Factors. We may
not be able to find collaborators or licensees that will agree to license our discoveries
at an early stage, and if we do not find these collaborators or licensees, our business
will likely be materially harmed.

However,
if this is not correct we may be required to invest a substantial amount of money and
other resources to advance each of our product candidates prior to licensing, without
assurance that any such product candidates will be commercialized, and limiting the
number of product candidates that we are able to so advance due to resource constraints.

If,
consistent with our strategy for commercialization of our diagnostic and therapeutic
product candidates, we are successful in commercializing our product candidates at an
early stage of development, our licensees may propose terms that we may not consider
commercially desirable and the consideration that we may receive for each individual
product may be relatively low. The consideration that we would expect to receive for
commercializing our product candidates increases commensurately with the number of such
products commercialized and the stage of development that we attain for them.
Furthermore, considerations regarding our willingness to advance the product candidate at
our risk would likely be of much less importance in discovery on demand collaborations.

# OFF-BALANCE SHEET
ARRANGEMENTS

We
are not a party to any material off-balance-sheet arrangements.

# TABULAR DISCLOSURE OF
CONTRACTUAL OBLIGATIONS

The
table below summarizes our contractual obligations as of December 31, 2008, and should be
read together with the accompanying comments that follow.

|                                   | Payments due by period
(US$ in thousands)
|---------------------------------- | -----------------------------------------
|
|
|
|
|Operating Lease Obligations        |                                          
|Accrued Severance Pay Reflected on |                                          
|our Balance Sheet                  |                                          
|Unrecognized Tax Benefit           |                                          
|Total                              |                                          

The
above table does not include royalties that we may be required to pay to the OCS or BIRD.
For more information, see Research and Development, Patents and Licenses in
this Item 5. We are unable to reasonably estimate the time and the amounts that we will
eventually be required to pay to the OCS and BIRD, if at all, since these amounts and
times depend on our ability to sell products based on the OCS and BIRD-funded
technologies and the timing of any such sales.

The
above table also does not include contingent contractual obligations or commitments that
may crystallize in the future, such as contractual undertakings to pay royalties subject
to certain conditions occurring.

44

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

# Directors and Senior
Management

The
following sets forth information with respect to our directors and executive officers as
of February 15, 2009:

| | Name                     | Age | Positions                                       
| | ------------------------ | --- | ------------------------------------------------
|
|
|
|
| | Prof. Yair Aharonowitz   | 68  | Director(1)                                     
| | Prof. Ruth Arnon         | 74  | Director                                        
| | Martin S. Gerstel        | 67  | President, Chief Executive Officer, and Director
| | Dov Hershberg            | 69  | Director and Chairman of the Board              
| | Alex Kotzer              | 63  | Director                                        
| | Arie Ovadia, Ph.D        | 68  | Director(1)                                     
| | Prof. Joshua Shemer      | 60  | Director(1)                                     
| | Dikla Czaczkes Axselbrad | 35  | Chief Financial Officer                         
| | Yossi Cohen, M.D.        | 37  | Chief Technology Officer                        
| | Anat Cohen-Dayag, Ph.D   | 42  | Vice President, Research and Development        
| | Eli Zangvil, M.D.        | 45  | Vice President, Business Development            
| | Dorit Amitay             | 41  | Director of Human Resources                     

| | (1)          Qualifies
as an external director pursuant to the Israeli Companies Law
| | ------------------------------------------------------------------------------------

Yair
Aharonowitz, Ph.D. joined Compugens board of directors as an external director
in July 2007. He is a Professor (Emeritus) of Microbiology and Biotechnology at Tel Aviv
University (TAU). He was a visiting scientist at Oxford University, an Alberta Heritage
Fellow at the University of Alberta, Edmonton, and a visiting professor at the Karolinska
Institute and at the University of British Columbia. Professor Aharonowitzs
research interests include the molecular genetics and biosynthesis of antibiotics,
molecular biology of microbial pathogens and the development of new targets for new
antibiotics. He served as TAU Vice President and Dean for R&D, Chairman of the
Department of Microbiology and Biotechnology and Chairman of the Institute of
Biotechnology. He served as a member of the TAU Executive Council and is a member of the
TAU Board of Governors. He served as the Chairman of Ramot Fund for Applied Research, as
a member of TAU committee for strategic planning, on the TAU patent committee; he was a
member of the National Committee for Biotechnology. He is a Fellow of the American
Academy of Microbiology and a member of the Israeli Society of Microbiology.

Prof.          Ruth
Arnonjoined Compugens board of directors in May 2007. Formerly           the
Vice-President of the Weizmann Institute of Science (1988-1997), she is a           noted
immunologist, having joined the Institute in 1960.  She served as           Head of
the Department of Chemical Immunology, Dean of the Faculty of Biology           and
Director of the Institutes MacArthur Center for Molecular Biology of
          Tropical Diseases. Prof. Arnon has made significant contributions to the fields
          of vaccine development, cancer research and to the study of parasitic
          diseases.  Along with Prof. Michael Sela, she developed Copaxone® a
          drug for the treatment of multiple sclerosis which is presently marketed
          worldwide.  Prof. Arnon is a member of the Israel Academy of Sciences and
          presently serves as its Vice President.  She is an elected member of the
          European Molecular Biology Organization, served as President of the European
          Federation of Immunological Societies and as Secretary-General of the
          International Union of Immunological Societies.  Her awards include the
          Robert Koch Prize in Medical Sciences, Spains Jiminez Diaz Memorial
Prize,           Frances Legion of Honor, the Hadassah World Organizations
Women of           Distinction Award, the Wolf Prize for Medicine, the Rothschild Prize
for           Biology, the Israel Prize and she received an Honorary Doctorate from
Ben-Gurion           University. Prof. Arnon is the Advisor for Science to the President
of Israel           and the incumbent of the Paul Ehrlich Chair in Immunochemistry.

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Martin
S. Gerstel has served as Compugens President and Chief Executive Officer since
January 2009. From 1997 through 2009, Mr. Gerstel was chairman of the board of directors
of Compugen. Prior to 1994, Mr. Gerstel was co-chairman and CEO of ALZA Corporation,
which he helped found in 1968. Mr. Gerstel is also the Chairman of Evogene Ltd. and
co-founder and co-chairman of Itamar Medical, serves as a director of Yissum Ltd., Yeda
Ltd. and the Foundation for the U.S. Foundation for the National Medals of Science and
Technology. He is a member of the Board of Governors and the Executive Committee of the
Weizmann Institute of Science and the Board of Governors of The Hebrew University of
Jerusalem, and is an advisor to the Burrill Life Science Funds and the board of the
Israel-U.S. BiNational Industrial Research and Development (BIRD) Foundation.
Mr. Gerstel holds a B.S. from Yale University and an MBA from Stanford University.

Dov
Hershberg was appointed as a member of the board of directors and the chairman on
February 9, 2009, prior to which he served as a consultant to the board of directors and
Assistant Chief Executive Officer.  Mr. Hershberg managed the BIRD Foundation for
nine years, until mid 2006.  He is currently a founder and executive director of
Powermat, a wireless electricity company and serves on the advisory board of the Merage
Foundation.  Prior to joining BIRD, Mr. Hershberg held various senior management
positions in software development, marketing and sales. He was the founder and CEO, with
colleagues from Stanford University, of Molecular Applications Group which created
software in biomedical research. He spent eleven years at Digital Equipment Corporation
in various senior management positions in product development, marketing and sales and
worked as a mathematician in the Israeli Aircraft Industry.  Mr. Hershberg holds
graduate degrees in Mathematics, from the Hebrew University in Jerusalem, Israel and in
Applied Mathematics and Operations Research from Columbia University in New York City.

Alex
Kotzerjoined Compugen in September 2005 and served until December 2008 as President
and Chief Executive Officer and a director. Since retiring as President and CEO, Mr.
Kotzer has remained a member of the board of directors. Prior to joining Compugen, he
served for twelve years at Serono (Currently Merck Serono, a global biotechnology leader,
headquartered in Switzerland. During his tenure at Serono, Mr. Kotzer held several senior
positions, most recently as Vice President of Biotechnology Manufacturing. Previously,
Mr. Kotzer was President and Chief Executive Officer of InterPharm, Seronos Israeli
affiliate. Before joining Serono, he held a variety of managerial positions in the food
and chemical industries. Mr. Kotzer received his B.Sc. in Chemical Engineering from the
Technion, Israel Institute of Technology, of Haifa, Israel.

Arie
Ovadia, Ph.D. joined Compugens board of directors as an external director in
July 2007. He 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, Strauss Ltd., Israel Petrochemical Industries, ViryaNet and Elron Electronic
Industries Ltd. He has taught at New York University, Temple University and, in Israel,
at Tel Aviv and Bradford Universities. Dr. Ovadia served as a member of the Israeli
Accounting Board, and is a 14-year member of the Israel Securities Authority. Dr. Ovadia
holds an undergraduate degree and an MBA from Tel Aviv University, and earned his Ph.D.
in economics from the Wharton School at the University of Pennsylvania.

Prof.          Joshua
Shemerjoined Compugens board of directors as an external           director in
July 2007. He is Full Professor of Medicine at the Tel Aviv           University and is
currently the CEO of Steba Biotech N.V. In addition he is a           member of the Board
of Directors of Maccabi Healthcare Services and Chairman of           Assuta Medical
Centers. Prof. Shemer is an Associate Editor at IMAJ and           Harefuah, and a member
of the Editorial Board of the International Journal of           Technology Assessment in
Health Care. He is Director of the Executive Masters           Program in Health Sciences
at the Multi-disciplinary Program for Emergency &          Disaster Management and
teaches Medical Technology Management at the Faculty of           Business Administration
at Tel Aviv University. He was a member and former           chairman of the National
Public Committee for Updating the National List of           Health Services in Israel
and the National Council for Trauma of the Israeli           Ministry of Health. Most
recently, Prof. Shemer was the Director-General of           Maccabi Healthcare Services.
Prof. Shemer was formerly Director-General of the           Ministry of Health and
Surgeon General of the Israel Defense Forces Medical           Corps. He is a graduate of
the Hebrew University and Hadassah School of Medicine           and Board certified in
Internal Medicine in Israel.

Dikla
Czaczkes Axselbrad joined Compugen in March 2002 as director of finance, a position
she held until February 2007. In February 2008, she became Acting Chief Financial Officer
and in August 2008, she assumed her current position as Chief Financial Officer. Prior to
joining Compugen, Ms. Czaczkes Axselbrad was the chief financial officer at Packet
Technologies Ltd, and before that an audit manager at Ernst & Young Israel. She holds
an MBA in finance and a BA in accounting and economics, both from Tel Aviv University;
she is also a certified public accountant in Israel.

Yossi
Cohen, M.D.joined Compugen in 2001, holding several senior research and development
positions until 2005 at which time he was appointed as Compugens Vice President,
Research and Discovery, a position he held until January 2007. From January 2007 until
December 2008, Dr. Cohen served as Compugens Vice President, Research and
Development, at which point he assumed his current position, Chief Technology Officer.
Dr. Cohens diverse prior experience includes serving as a physician in the Israel
Defense Forces and holding various software development positions in the Israeli hi-tech
industry. Dr. Cohen has a B.S. in Electrical and Electronics Engineering from the
Tel-Aviv University, Israel, and an M.S. in Neurobiology and an M.D., both from the
Hebrew University, Israel.

46

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Anat
Cohen-Dayag, Ph.D. joined Compugen in 2002 as Director of Diagnostics, a position she
held until 2005 at which time she became Vice President Diagnostic Biomarkers, a position
she held until January 2007. From January 2007 until November 2008, Dr. Cohen-Dayag
served as Compugens Vice President, Biomarkers and Drug Targets, at which point she
assumed her current position, Vice President, Research and Development. Prior to joining
Compugen, she was head of research and development and member of the Executive Management
at Mindsense Biosystems Ltd. Prior to Mindsense Biosystems, Dr. Cohen-Dayag served as a
scientist at the R&D department of Orgenic. Dr. Cohen-Dayag holds a B.Sc. in Biology
from the Ben-Gurion University, Israel, and an M.S. in Chemical Immunology and a Ph.D. in
Cellular Biology, both from the Weizmann Institute of Science, Israel.

Eli
Zangvil, M.D. joined Compugen in November 2006 as Vice President Business
Development. He previously served as Chief Operating Officer of UltraShape headquartered
in Tel-Aviv, Israel, and prior to that was Head of Medical Services of the Israeli
Defence Forces Central Command where he held the rank of Colonel. Dr. Zangvil holds
an M.D. from the Hebrew University of Jerusalem and specializes in internal medicine, and
a Masters Degree in Health Administration from the Tel-Aviv University, Israel.

Dorit
Amitayjoined Compugen in 2000. She held several positions in Compugens Human
Resources division until 2006 at which time she was appointed as Compugens Director
of Human Resources. Prior to joining Compugen, she was a Placement Manager at an agency
for recruitment and placement in the hi-tech industry. Ms. Amitay holds a BA
from the Faculty of Humanities and Social Sciences and an MBA in Business Administration,
both from the Ben-Gurion University, Israel. In addition, Ms. Amitay holds a Certificate
in Group Facilitation from the Kibbutzim College of Education, Tel Aviv.

# Compensation

The
aggregate compensation paid by us and by our wholly-owned subsidiaries to all persons who
served as directors or senior management for the year 2008 (12 persons) was approximately
$1.7 million. This amount includes approximately $217,000 set aside or accrued to provide
pension, severance, retirement or similar benefits. These amounts also include
compensation paid or accrued to our former CFO for a portion of 2008.

During
2008, we granted a total of 890,000 options to purchase ordinary shares to our directors
and senior management, as a group. These options are exercisable at a range of between
$0.50 and $2.44 per share, and generally expire ten years after their respective
dates of grant. As of December 31, 2008, there were a total of 3,476,655 outstanding
options to purchase ordinary shares that were granted to our directors and senior
management, and 260,000 outstanding options that were granted to the members of our
scientific advisory board. As of January 15, 2009, the number of outstanding options to
purchase ordinary shares decreased by 750,000 representing the number of options waived
as of such date by Martin Gerstel.

All
members of our board of directors who are not our employees or consultants are reimbursed
for their expenses for each meeting attended and are eligible to receive options to
purchase ordinary shares under our share option plans. The aggregate amount paid to all
of our non-employee directors for the year ended December 31, 2008 was approximately
$93,000. Members of our scientific advisory board received cash compensation in 2008 of
approximately $20,000 and were not granted any further options.

On
September 24, 2008, the shareholders of the Company approved the issuance of 15,000
ordinary shares to our then presiding Chief Executive Officer, Alex Kotzer. See Grant
to the Companys Former Chief Executive Officer and Director in this Item 6
below.

Approvals
Required for Compensation to our Directors

Israeli
Companies Law requires, among other requirements, that all payments of any type to
directors be approved by the shareholders. Therefore, in accordance with these
requirements, we determine our directors compensation in the following manner:

| |  | first,
a proposal for  compensation is submitted to our audit  committee,  which then reviews
the          proposal;
| | - | --------------------------------------------------------------------------------------------------------------------

| |  | second,
provided that the audit committee approves the proposed compensation, the proposal is
then submitted to our board of directors for review, except that a director who is the
beneficiary of the proposed compensation does not participate in any discussion or voting
with respect to such proposal;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | finally,
if our board of directors approves the proposal, it must then submit its recommendation
to our shareholders, which is usually done during our shareholdersannual general
meeting; and
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the
approval of a majority of our shareholders is required to implement any such compensation
proposal.
| | - | -------------------------------------------------------------------------------------------------------

| |  | In
addition, the compensation payable to external directors under the Israeli Companies Law
is subject to certain further limitations.
| | - | --------------------------------------------------------------------------------------------------------------------------------------

47

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# Board Practices

Election
of Directors and Terms of Office

Our
board of directors consisted of six members as at December 31, 2008, including our
chairman of the board (Martin Gerstel) and chief executive officer (Alex Kotzer). Other
than our three external directors, our directors are elected by an ordinary resolution at
the annual general meeting of our shareholders. As of January 1, 2009, Martin Gerstel
assumed the position of chief executive officer and resigned as chairman of the board. On
February 9, 2009 the Board of Directors nominated Dov Hershberg as a director and in
addition appointed him chairman of the board pursuant to the Articles of Association of
the Company, all until the next annual general meeting of the shareholders.  Therefore,
as of February 9, 2009, our board of directors consisted of seven members, including our
chairman (Dov Hershberg) and chief executive officer (Martin Gerstel).

Unless
they resign before the end of their term or are removed in accordance with our Articles
of Association and the provisions of the Israeli Companies Law, all our directors, other
than our external directors, will serve as directors until our next annual general
meeting of shareholders.

Professor
Yair Aharonowitz, Dr. Arie Ovadia and Professor Joshua Shemer serve as external directors
pursuant to the provisions of the Companies Law for a three-year term ending at the
annual meeting to be held in 2010.

None
of our directors or officers have any family relationship with any other director or
officer.

None
of our directors are entitled to receive any severance or similar benefits upon
termination of his or her service.

Our
Articles of Association permit us to maintain directors and officers liability
insurance and to indemnify our directors and officers for actions performed on behalf of
the Company, subject to specified limitations.

External
and Independent Directors

The Companies
Law requires Israeli companies with shares that have been offered to the public either in
or outside of Israel to appoint at least two external directors. No person may be
appointed as an external director if that person or that persons relative, partner,
employer or any entity under the persons control, has or had, on or within the two
years preceding the date of that persons appointment to serve as an external
director, had any affiliation with the company or any entity controlling, controlled by or
under common control with 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.
| | - | ----------------------------

No
person may serve as an external director if that persons position or business
activities create, or may create, a conflict of interest with that persons
responsibilities as an external director or may otherwise interfere with his/her ability
to serve as an external director. If, at the time external directors are to be appointed,
all current members of the board of directors are of the same gender, then at least one
external director must be of the other gender.

The
Companies Law requires that at least one external director must have financial and
accounting expertise and the other external directors must possess certain professional
qualifications that are promulgated by regulations to the Companies Law. These
regulations provide that external directors must possess a high level of understanding in
business matters, to the extent that they are able to read and understand financial
statements in depth and to comment on the manner in which financial data is presented.
Each companys board of directors must determine each external directors
qualifications based on his or her education, experience and skills regarding financial
matters and knowledge of financial statements in accordance with the Companies Law and
Israeli securities laws.

48

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

| |  | the
majority of shares voted at the meeting, including at least one-third of the shares held
by non-controlling shareholders voted at the meeting, vote in favor of election of the
director; abstaining votes shall not be counted in this vote, or
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the
total number of shares held by non-controlling shareholders voted against the election of
the director does not exceed one percent of the aggregate voting rights in the company.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The
initial term of an external director is three years and may be extended for an additional
three years term. After such additional three year term, their term of service can be
renewed for additional periods of up to three years and provided that the audit committee
and the board of directors confirms that, in light of the external directors
expertise and special contribution to the work of the board of directors and its
committees, the reelection for such additional period(s) is beneficial to the company.

External
directors may be removed only by the same percentage of shareholders as is required for
their election, or by a court, and then only if the external directors cease to meet the
statutory qualifications for their appointment or if they violate their duty of loyalty
to the company. Each committee of a companys board of directors must include at
least one external director.

An
external director is entitled to compensation as provided in regulations adopted under
the Companies Law and is otherwise prohibited from receiving any other compensation,
directly or indirectly, in connection with service provided as an external director or
any other services to the company.

Professor
Yair Aharonowitz, Dr. Arie Ovadia and Professor Joshua Shemer currently serve as our
external directors under Israeli law and as our independent directors under Nasdaq Global
Marketplace Rules. They all serve on our audit committee.

In
addition to the requirements of the Companies Law as described above, since our shares
are listed on the Nasdaq Global Market, a majority of our directors must be independent
(as defined by the Nasdaq Global Marketplace Rules), and our audit committee must be
comprised of at least three members, all of whom must be independent (subject to limited
exceptions).

Audit
Committee

We
have an audit committee consisting of three independent directors, all of whom are
financially literate and one of whom has accounting or related financial management
expertise. The members of the Audit Committee are, Dr. Arie Ovadia, who serves
as the chairman of our Audit Committee, Professor Yair Aharonowitz, and Professor Joshua
Shemer. All of the members of our audit committee qualify as independent directors under
the current Nasdaq Global Marketplace Rules. The audit committee has adopted a charter.

The
responsibilities of the audit committee include identifying irregularities in the
management of the companys business and approving related party transactions as
required by law. An audit committee must consist of at least three directors, including
all of its external directors. The chairman of the board of directors, any director
employed by or otherwise providing services to the company, and a controlling shareholder
or any relative of a controlling shareholder, may not be a member of the audit committee.
An audit committee may not approve an action or a transaction with a controlling
shareholder, or with an office holder, unless at the time of approval two 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.

Other
Committees

We
do not have a nominating committee nor a compensation committee. Such functions are
performed by the full board of directors. This practice is compliant with Israeli law.

Approval
of Compensation to Our Officers

The
Companies Law prescribes that compensation to officers must be approved by a companys
board of directors. In accordance with Article 52(d) of our Articles of Association, our
board of directors authorized and empowered our chief executive officer to appoint office
holders and determine their terms of employment, without our board of directors
approval (unless such office holders also serve as a members of our board of directors).
Compensation to our officers who serve as members of our board of directors require the
approval of our audit committee, the board of directors and shareholders, as specified
above.

49

---

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Internal
Auditor

Under
the Companies Law, the board of directors must appoint an internal auditor, nominated by
the audit committee. The role of the internal auditor is to examine, among other matters,
whether the companys actions comply with the law and orderly business procedure.
Under the Companies Law, the internal auditor may be an employee of the company but not
an office holder, or an affiliate, or a relative of an office holder or affiliate, and he
or she may not be the companys independent accountant or its representative. We
comply with the requirement of the Companies Law relating to internal auditors. Our
internal auditors examine whether our various activities comply with the law and orderly
business procedure.

Our internal  auditors,  Ezra
Yehudah  Management  Services Ltd., are not employees,  affiliates or office holders of
the company. They were appointed in 1999.

Scientific
Advisory Board

Our
scientific advisory board has convened when there has been a need to review or
consult regarding our therapeutic results and future directions. At the
advisory board meetings, we reviewed our ongoing and planned therapeutic
projects, experimental results, as well as future discovery directions. We also
consulted with its individual members when we needed advice within their specific
expertise. Our scientific advisory board included:

| | Name                       | Affiliation                                                 
| | -------------------------- | ------------------------------------------------------------
|
|
|
|
| | Nabil Hannah, Ph.D.        | Former Executive Vice President, Research, Biogen Idec Inc. 
| |                            | Member, National Academy of Sciences, USA                   
| |                           
| | C. Ronald Kahn, M.D.       | President and Director, Joslin Diabetes Center,             
| |                            | Mary K. Iacocca Professor, Harvard Medical School           
| |                           
| | Joseph Schlessinger, Ph.D. | William H. Prusoff Professor and Chairman of the Department 
| |                            | of Pharmacology of the Yale University School of Medicine;  
| |                            | Member, National Academy of Sciences, USA                   
| |                           
| | Arthur Weiss, M.D., Ph.D.  | Ephraim P. Engleman Distinguished Professor of Rheumatology;
| |                            | Investigator, Howard Hughes Medical Institute, University of
| |                            | California, San Francisco;                                  
| |                            | Member, National Academy of Sciences, USA                   

As of 2009, we have suspended the
activities of our Scientific Advisory Board. We continue to consult with certain members
of the Scientific Advisory Board under individual consulting agreements.

# Employees

The
following table sets out the number of our employees engaged in specified activities, by
geographic location at the end of the fiscal years 2006, 2007 and 2008:

|                     | December 31,
2008 | December 31,
2007 | December 31,
2006
|-------------------- | ----------------- | ----------------- | -----------------
|
|
|
|
|Research &           |                   |                   |                  
|Development         
|Israel               | 40                | 52                | 64               
|United Kingdom       | 1                 |                   |                  
|                    
|Administration,     
|Accounting and      
|Operations          
|Israel               | 12                | 17                | 21               
|                    
|Sales, Marketing,   
|Business Development
|and Support         
|Israel               | 3                 | 2                 | 0                
|USA                  | 1                 | 1                 | 5                
|                    
|Total                | 57                | 72                | 90               

50

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We
and our Israeli employees are subject, by an extension order of the Israeli Ministry of
Welfare, to a few provisions of collective bargaining agreements between the Histadrut,
the General Federation of Labor Unions in Israel and the Coordination Bureau of Economic
Organizations, including the Industrialists Associations. These provisions principally
concern cost of living increases, recreation pay, travel expenses, vacation pay and other
conditions of employment. We provide our employees with benefits and working conditions
equal to or above the required minimum. Our employees are not represented by a labor
union. We have written employment contracts with each of our employees, and we believe
that our relations with our employees are good.

# Share Ownership

Share
Ownership by Directors and Senior Management

All
of the persons listed above under the caption Directors and Senior Managementown
ordinary shares and/or options to purchase ordinary shares. Except as set forth in the
table below, none of the directors or executive officers beneficially owns shares and/or
options amounting to 1% or more of the outstanding ordinary shares. The following table
sets forth certain information as of January 31, 2009, regarding the beneficial ownership
by our directors and executive officers. All numbers quoted in the table are inclusive of
options to purchase shares that are exercisable within 60 days after January 31, 2009.

|Beneficial Owner                                   | Amount Owned | Percent of Class
|-------------------------------------------------- | ------------ | ----------------
|
|
|
|
|Martin S. Gerstel (1)                              |              |                 
|Alex Kotzer (2)                                    |              |                 
|Yossi Cohen (3)                                    |              |                 
|All directors and senior management as a group (4) |              |                 

(1) Includes
550,000 shares held by Shomar Corporation, an affiliate of Mr.           Martin S.
Gerstel, 718,333 shares held by Merrill Lynch IRA for Martin Gerstel,           of which
Martin Gerstel is the beneficiary, and 534,235 shares held in various           brokerage
accounts for the benefit of Martin Gerstel. Martin Gerstel provided           Compugen
with a letter irrevocably waiving his rights in and to options to           purchase
750,000 shares that were outstanding as of January 15, 2009 and as           such, these
options are not included above. The Audit Committee and the Board of           Directors
have resolved to recommend to the shareholders to grant 500,000 new           options to
Mr. Gerstel at an exercise price of $.50 per share. These 500,000           options would
vest over a 4 year period beginning January 1, 2009. This new           issuance of
options is subject to the approval of the shareholders of the           Company and as
such, these options are not included above.

(2) Consists
of 483,125 options that are exercisable within 60 days after           January 31, 2009
and 24,262 ordinary shares.

(3)Consists only of 352,225 options that are exercisable within 60 days
          after January 31, 2009.

(4) Includes
(i) a total of 2,662,180 shares and options that are beneficially owned           by
Martin S. Gerstel, Alex Kotzer and Yossi Cohen, as noted in the first three
          rows of the above table, and (ii) 534,189 options that are beneficially owned
by           other officers and directors. Does not include 200,000 options to Dov
Hershberg           which the Audit Committee and Board of Directors have recommended to
the           shareholders to approve, but which remains subject to shareholder approval.

Share
Option Plans

We
maintain one active share option plan for our and our subsidiaries employees,
directors and consultants. In addition to the discussion below, see Note 11 of our 2008
consolidated financial statements.

Our
board of directors administers our share option plans and has the authority to designate
all terms of the options granted under our plans including the grantees, exercise prices,
grant dates, vesting schedules and expiration dates, which may be no more than ten years
after the grant date. Options may not be granted with an exercise price of less than the
fair market value of our ordinary shares on the date of grant, unless otherwise
determined by our board of directors.

51

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Compugen Share Option Plan (1998)

The
Compugen Share Option Plan (1998) enabled granting options for up to an aggregate of
2,500,000 ordinary shares to our and our subsidiaries employees, directors and
consultants. No further options are being granted under this plan following an October
22, 2007 decision of the board of directors which resolved to cancel the then remaining
available for grant options remaining under the 1998 Option Plan. As of
December 31, 2008, vested options to purchase 53,500 ordinary shares granted at a
weighted average exercise price of approximately $1.71 per share, remained outstanding
and unexercised under the plan. Options to purchase 1,660,774 ordinary shares under the
plan were previously exercised at a weighted average exercise price of approximately
$1.56. If a grantee leaves his or her employment or other relationship with us, the term
of his or her unexercised vested options expire 90 days later.

Compugen Share Option Plan (2000)

Under
the Compugen Share Option Plan (2000), we may grant options for up to an aggregate of
10,191,511 ordinary shares to our and our subsidiaries employees, directors and
consultants. This total number automatically increases on January 1 of every year by the
lesser of 1,500,000 shares or 4% of the total number of our then-outstanding shares, or
such lower amount as shall be determined by the board of directors. The above balance
includes the automatic increase of 1,140,498 options on January 1, 2009. If a grantee
leaves his or her employment or other relationship with us, or if his or her relationship
with us is terminated without cause, the term of his or her unexercised options will
expire 90 days later, unless determined otherwise by the board of directors. As of
December 31, 2008, options to purchase 7,105,614 ordinary shares at a weighted average
exercise price of approximately $2.69 per share were granted under this plan but remain
unexercised. Thus, the 750,000 options that Mr. Gerstel waived on January 15, 2009 were
not deducted from the above number. Options to purchase 829,254 ordinary shares under the
plan have previously been exercised at a weighted average exercise price of approximately
$3.49, and options to purchase 1,116,145 ordinary shares remain available for future
grant as of December 31, 2008. As of January 15, 2009, the number of outstanding options
to purchase ordinary shares remaining for future grant increased by 750,000 representing
the number of options waived as of such date by Martin Gerstel.

In
2003, the terms of this plan were modified and we adopted an addendum to this plan to
comply with changes in the Israeli tax law relating to the taxation of incentive options
to Israeli resident employees. This addendum does not affect grantees that are not
residents of Israel.

Our
board of directors has elected the Capital Gains Track (as defined in Section
102(b)(2) of the Ordinance) for the grant of options to Israeli grantees. Generally,
under the Capital Gains Track, the tax liability to a Grantee resulting from the grant
and exercise of options will be postponed until the time that shares that are acquired
upon the exercise of options will be sold or released from trust, subject to fulfillment
of the requirements of Section 102 of the Ordinance. Entitlement to the benefits under
the Capital Gains Track is contingent upon the grantee of options holding them and/or the
shares issued upon their exercise for a period of at least 24 months from the time of
grant. Under the Capital Gains Track, a fixed rate of 25% applies to gains that are
realized from the sale of shares issued upon exercise of options (i.e., for sales
proceeds in excess of the exercise price of the options, assuming that the exercise price
is equal to the fair market value of the shares on the date of the award), and provided
that the sale occurs after the required holding period.

If
a grantee sells shares or releases them from trust prior to expiration of the required
holding period, the grantee will be subject to income tax on his gains at a rate which is
his or her marginal income tax rate (currently up to 46%), as well as payment of
associated health tax and national insurance payments. Additionally, in such
circumstances, withholding requirements will apply and be carried out by the employing
company in accordance with applicable laws, regulations and rules.

Neither
we nor the grantee will be liable to pay social benefits payments in connection with the
granting or exercise of options that are exercised under the Capital Gains Track
mechanism, or upon the sale of the shares underlying such options or upon the release of
such shares from the trust, provided that such sale or release occurs after the required
holding period. However, if such sale or release occurs before expiry of the required
holding period, for which our consent is required, both we and the grantee will bear each
of our respective liability to pay social benefits payments.

We
will not be entitled to a tax deduction for Israeli income tax purposes with respect to
options granted under the Capital Gains Track.

52

---

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Directors Options

Grants
to Non-Management Directors

On
July 31, 2007, our shareholders approved the following grants to the non-management
members of our board of directors, in addition to the cash consideration paid to such
non-management directors: Each non-management director was granted options to purchase
ordinary shares as follows:

(i) an initial grant to purchase
40,000 ordinary shares was granted to each           non-management director on the
following terms:

| | (a) | the
options were to be granted as of the date of the shareholders          approval;
| | --- | -------------------------------------------------------------------------------------

| | (b) | each
option is exercisable for one ordinary share at an exercise price equal to
               the closing price on the date of such grant as reported by The Nasdaq
Global                Market;
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (c) | the
options shall vest as follows: (1) 10,000 options fully vested at time of
               grant; (2) 10,000 options will vest annually for a period of three years,
               starting from the first anniversary of the initial grant date; and
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (d) | any
and all other terms and conditions pertaining to the grant of the options
               shall be in accordance with, and subject to, the Compugen Share
Option                Plan (2000) and the Companys standard option agreement
that were                executed by each director and by the Company promptly after the
date of the                annual meeting of shareholders;
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

(ii) On
each annual anniversary of the initial grant, an additional annual grant of
          options to purchase 10,000 ordinary shares to each non-management director then
          serving on the board of directors, with the following terms:

| | (a) | each
option is exercisable for one ordinary share at an exercise price equal to
               the closing price on the date of such additional grant, as reported by The
               Nasdaq Global Market;
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (b) | the
options shall vest as follows: 3,333 of the options shall vest on each of
               the first two anniversary dates of such grant and 3,334 on the third
anniversary                date; and
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (c) | any
and all other terms and conditions pertaining to the grant of the options
               shall be in accordance with, and subject to, the Compugen Share
Option                Plan (2000)".
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Notwithstanding
(i) and (ii) above, all options granted to non-management directors shall be fully vested
immediately upon the completion of one or more of the following events, whether by way of
a consolidation, merger or reorganization of the Company or otherwise: (a) a sale of
all or substantially all of Companys issued share capital or assets to any other
company, entity, person or a group of persons, or (b) the acquisition of more than
50% of Companys equity or voting power by any shareholder or group of shareholders.

Notwithstanding
the terms of the Compugen Share Option Plan (2000) all options granted above
which shall be vested as of the date of termination of services by a non-management
director to the Company, may be exercised within one year after the cessation of his or
her term as a director of the Company.

Grants
to Former Chairman of the Board & New Chief Executive Officer and Director

On
April 29, 2003, the Audit Committee, Board and Shareholders approved a grant to Mr.
Gerstel of options to purchase 250,000 ordinary shares of the Company as consideration
for his services as active Chairman of the Board. These options were granted under the
general terms of the Companys Share Option Plan (2000)".

On
July 31, 2007, while serving as Chairman of the Board of the Company, Mr. Gerstel
requested that his compensation be entirely in the form of stock options and none in
cash, and furthermore, that each such option, even if vested, would not be exercisable if
at the time of exercise, the Companys share price was less than $10 per ordinary
share. The Board of Directors, the Audit Committee and the Shareholders of the Company
each approved the grant to Mr. Gerstel of 500,000 options under the general terms of the
Compugen Share Option Plan (2000)".

On
January 15, 2009, Mr. Gerstel provided Compugen with a letter irrevocably waiving his
rights to all of the above options to purchase 750,000 shares that were outstanding as of
January 15, 2009.

The
Audit Committee and the Board of Directors have resolved to recommend to the shareholders
to grant 500,000 new options to Mr. Gerstel for his services as our new Chief Executive
Officer at an exercise price of $.50 per share. These 500,000 options would vest over a 4
year period beginning January 1, 2009. This issuance of options is subject to the
approval of the shareholders of the Company, which approval has not yet been granted.

53

---

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Grants
to the Companys Former Chief Executive Officer and Director

For
calendar year 2006, Mr. Kotzer requested that a portion of his gross salary (which was
previously approved by the shareholders of the Company) be provided to him in the form of
Ordinary Shares and that his salary be determined in New Israeli Shekels. Pursuant to
this request and pursuant to the decision of the shareholders at the Annual General
Meeting held on July 31, 2007, Mr. Kotzers gross salary for 2006 was reduced by
approximately $28,000 and 9,262 ordinary shares were issued to Mr. Kotzer as
consideration for the deduction of such amount from his 2006 salary. In addition the
shareholders approved payment to Mr. Kotzer of a cash bonus, grossed up to cover the
taxes payable by Mr. Kotzer as a result of issuing to him these shares.

For
calendar year 2007, Mr. Kotzer requested that if any bonus was awarded to him, such bonus
be provided to him in the form of ordinary shares plus cash in an amount equal to the
amount required to cover the resulting taxes to be paid on such bonus. Pursuant to this
request, and pursuant to the decision of the shareholders at the Annual General Meeting
held on September 24, 2008, 15,000 ordinary shares were issued to Mr. Kotzer and Mr.
Kotzer was paid a cash bonus, grossed up to cover the taxes payable to Mr. Kotzer as a
result of issuing to him the Bonus Shares.

On
October 22, 2007, the board of directors approved a grant of 150,000 options to Mr.
Kotzer, which grant was approved by the shareholders at the Annual General Meeting of the
shareholders held on September 24, 2008. The options to purchase 150,000 ordinary shares
were granted under Compugens 2000 Option Plan and each such Option is exercisable
for one ordinary share at $1.82 (the last closing price on NASDAQ known on the date of
the Annual General Meeting). The options shall vest on a monthly basis over a period of 4
years starting from October 22, 2007.

Pursuant
to the termination agreement signed with Mr. Kotzer, as of the first date after June 30,
2009 that no consulting agreement is in effect between Mr. Kotzer and Compugen, then
after such date, any unvested options shall be terminated and the right to exercise any
then vested options shall be extended to the later of (i) December 31, 2010, or (ii) 12
months following such date on which no consulting arrangement is in effect, subject to
Shareholder approval.

Grants
to our New Chairman of the Board

During
2008, 100,000 options were granted to Dov Hershberg as a senior manager and employee of
the Company (prior to him being appointed as a director and as the Chairman of the
Board). In recognition of his appointment as Chairman of the Board, the Audit Committee
and Board of Directors have recommended to the shareholders to approve a grant of 200,000
additional options to Dov Hershberg. Such grant remains subject to shareholder approval.
These 200,000 options to Mr. Hershberg, if granted, shall have an exercise price of $.50
per share and would vest over a 4 year period beginning January 1, 2009.

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

# Major Shareholders

The
following table sets forth certain information regarding beneficial ownership of our
ordinary shares as of January 31, 2009 by each person who is known by us to own
beneficially more than 5% of our outstanding ordinary shares. The voting rights of our
major shareholders do not differ from the voting rights of other holders of our ordinary
shares.

|Beneficial Owner                       | Number of Ordinary
Shares Beneficially
Owned | Percent of Ownership
|-------------------------------------- | -------------------------------------------- | --------------------
|
|
|
|
|ClearBridge Advisors, LLC (1)          |                                              |                     
|Clal Industries & Investments Ltd. (2) |                                              |                     
|Martin Gerstel (3)                     |                                              |                     
|AXA Assurances I.A.R.D. Mutuelle (4)   |                                              |                     

(1)          This
disclosure is based on information disclosed by ClearBridge Advisors, LLC           on
Form 13G/A, filed with the SEC on February 10, 2009 reflecting holdings as of
          January 31, 2009.

(2)       
          Includes 10,526 shares held by Clal Industries & Investments Ltd. and
          2,697,698 shares held by Clal Biotechnology Industries Ltd. Clal Biotechnology
          Industries Ltd and Clal Industries & Investments Ltds address is 3
          Azrieli Center, Tel Aviv 67023, Israel. This disclosure is based on information
          disclosed to us by Clal Biotechnology Industries Ltd. on February 25, 2009.

54

---

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(3)       
          Includes 550,000 shares held by Shomar Corporation, an affiliate of Mr. Martin
          S. Gerstel, 718,333 shares held by Merrill Lynch IRA for Martin Gerstel, of
          which Martin Gerstel is the beneficiary and 534,235 shares held in various
          brokerage accounts for the benefit of Martin Gerstel. This disclosure is based
          on information disclosed by Martin Gerstel on Form 13G filed with the SEC on
          December 16, 2008.

(4)       
          This disclosure is based on information disclosed by AXA Assurances I.A.R.D.
          Mutuelle on Form 13G/A, filed with the SEC on February 13, 2009 reflecting
          shareholdings as of December 31, 2008.

As
of December 31, 2008, there were a total of 89 holders of record of our ordinary shares,
of which 60 were registered with addresses in the United States. Such United States
holders were, as of such date, the holders of record of approximately 99% of the
outstanding ordinary shares.

# Related Party
Transactions

It
is our policy to enter into transactions with related parties on terms that, on the
whole, are no less favorable than those that would be available from unaffiliated
parties. Based on our experience in the business in which we operate and the terms of our
transactions with unaffiliated third parties, we believe that all of the transactions
described below met our policy standards at the time they occurred.

Keddem
Bioscience Ltd.

In
1999, we established a chemistry division to carry out a research program in which we
integrated the disciplines of organic chemistry with physics and advanced computational
technologies for the development of a method to substantially increase the predictability
and success rates of small molecule drug discovery. On August 1, 2004, we transferred all
of the assets and liabilities of this division to Keddem Bioscience Ltd., a wholly-owned
subsidiary. In August 2007, we announced the suspension of Keddems operations. In
2008, in order to continue to seek to maximize the value of Keddems intellectual
property, Compugen entered into a term sheet agreement with Mada Ltd., a newly formed
company owned and managed by the former two Co-CEOs of Keddem, under which Compugen will
license the Keddem intellectual property to Mada in exchange for royalties on any future
revenues and certain access rights to any developed technology. Mada intends to seek
third party funding for the development of this intellectual property, but we can give no
assurances that it will be successful in doing so.

For
more information, see Item 4. Information on the Company; Subsidiary; Keddem
Bioscience.

Evogene
Ltd.

As
of December 31, 2008, Martin Gerstel, at such time our chairman of the board, held
approximately 2.7 % of Evogenes issued and outstanding share capital (approximately
2.14% of Evogenes share capital, on a fully-diluted basis), and the power to vote
approximately 2.7% of Evogenes share capital. All such Evogene shares were acquired
by Mr. Gerstel for cash in either the 2006 private placement or the 2007 public offering,
in each case, at the same price and on the same terms and conditions as other investors
in such financing rounds. In addition, since December 19, 2004, Martin Gerstel has served
as the chairman of Evogenes board of directors, and in such capacity has been
granted options through December 31, 2008 for a total of 90,000 Evogene shares, at an
average exercise price of $1.389.

As
of December 31, 2008, we held 2,150,000 Evogene shares, with the ability to vote 9.0% of
Evogenes share capital and 30,000 options to purchase ordinary shares of Evogene.
For more information, see Item 4. Information on the Company; Significant
Investment; Evogene Ltd.

For
more information, see also Note 1b and Note 15 of our 2008 consolidated financial
statements.

DirectorsOptions

For
a description  of options  granted to our directors,  see "Item 6.  Directors,  Senior
 Management and Employees; Share Option Plans; Directors' Options."

55

---

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Compensation
to our Former Chief Executive Officer

For
a description of shares and options granted by the shareholders of the Company to Alex
Kotzer, see Item 6. Directors, Senior Management and Employees; Share Option Plans;
Directors Options; Grants to the Companys Former Chief Executive Officer and
Director.

Mr. Kotzers
employment agreement contained a severance provision granting him           a one-time
payment equal to fifty percent (50%) of his annual salary in the           event of
termination under certain circumstances. On September 24, 2008, on
          recommendation of the Audit committee and the board of directors, the
          shareholders approved a broadening of the circumstances under which this
          provision would apply to include resignation or termination after December 31,
          2008 or after the consummation of a financial or strategic transaction by the
          Company.

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

# Consolidated Statements
and Other Financial Information

Our
consolidated financial statements are included on pages F-1 through F-29 of this annual
report.

Legal
Proceedings

Currently,
we are not a party to any material pending legal proceedings. There are no legal
proceedings pending or, to our knowledge, threatened against us or our subsidiaries and
we are not involved in any legal proceedings that our management believes, individually
or in the aggregate, would have a material adverse effect on our business, financial
conditions or operating results.

Dividend
Distributions

We
have never paid any cash dividends on our ordinary shares, and we do not intend to pay
cash dividends on our ordinary shares in the foreseeable future. Our current policy is to
retain earnings for use in our business.

In
the event that we decide to pay a cash dividend from income that is tax exempt under our
approved enterprise status, we would be liable for corporate tax on the amount
distributed at the rate of up to 25%, which would be in addition to the tax payable by
the dividend payee. See Note 14 of our 2008 consolidated financial statements and Item
10. Taxation. Cash dividends may be paid by an Israeli company only out of retained
earnings as calculated under Israeli law. We currently have no retained earnings and do
not expect to have any retained earnings in the foreseeable future.

Significant
Changes

No
significant changes have occurred since the date of the consolidated financial statements
included in this annual report.

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

Markets and Share Price History

The
principal trading market for our ordinary shares is the Nasdaq Global Market, where our
shares have been listed and traded under the symbol CGEN since our initial
public offering in August, 2000. Our shares have also been traded on the Tel Aviv Stock
Market under the Hebrew symbol which is equivalent to CGEN since January 7,
2002. The following table sets forth, for the periods indicated, the high and low
reported sales prices of the ordinary shares on the Nasdaq Global Market and on the Tel
Aviv Stock Exchange:

56

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|                                       | Nasdaq | *TASE
|-------------------------------------- | ------ | -----
|
|
|
|
|January 2009                           |        |      
|December 2008                          |        |      
|November 2008                          |        |      
|October 2008                           |        |      
|September 2008                         |        |      
|August 2008                            |        |      
|                                       |        |      
|Financial Quarters During the Past Two |        |      
|Full Fiscal Years                      |        |      
|Fourth Quarter 2008                    |        |      
|Third Quarter 2008                     |        |      
|Second Quarter 2008                    |        |      
|First Quarter 2008                     |        |      
|Fourth Quarter of 2007                 |        |      
|Third Quarter 2007                     |        |      
|Second Quarter 2007                    |        |      
|First Quarter 2007                     |        |      
|                                       |        |      
|Last Five Full Financial Years         |        |      
|2008                                   |        |      
|2007                                   |        |      
|2006                                   |        |      
|2005                                   |        |      
|2004                                   |        |      

*the currency in which our stock is
traded on the Tel Aviv Stock Exchange is the New Israeli Shekel. The above dollar amounts
represent a conversion from New Israeli Shekels to Dollar amounts in accordance with the
Dollar  New Israeli Shekel conversion rate as of the relevant date of trade.

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

# Memorandum and Articles
of Association

Objects
and Purposes of the Company

We
are registered under the Companies Law, 1999 as a public company under the name Compugen
Ltd. and public company number 51-177-963-9. The objective stated in our Articles of
Association is to engage in any lawful activity.

Powers
of the Directors

Pursuant
to the Companies Law and our Articles of Association, a director is not permitted to vote
on a proposal, arrangement or contract in which he or she has a personal interest. Also,
the directors may not vote compensation to themselves or any members of their body
without the approval of our audit committee and our shareholders at a general meeting.
The requirements for approval of certain transactions are set forth below in Item
10. Additional Information; Memorandum and Articles of Association; Approval of Certain
Transactions. The powers of our directors to enter into borrowing arrangements on
our behalf are limited to the same extent as any other transaction by us.

Approval
of Certain Transactions

The
Companies Law codifies the fiduciary duties that office holders, including directors and
executive officers, owe to a company. An office holder, as defined in the Companies Law,
is a director, general manager, chief business manager, deputy general manager, vice
general manager, executive vice president, vice president, other manager directly
subordinate to the managing director or any other person assuming the responsibilities of
any of the foregoing positions without regard to such persons title. An office
holders fiduciary duties consist of a duty of care and a duty of loyalty. The duty
of loyalty includes avoiding any conflict of interest between the office holders
position in the company and his personal affairs, avoiding any competition with the
company, avoiding exploitation of any business opportunity of the company in order to
reap personal gain for himself or others, and revealing to the company any information or
documents relating to the companys affairs which the office holder has received due
to his position as an office holder. Each person listed in the table under Directors
and Senior Management, which is displayed under Item 6. Directors, Senior
Management and Employees; Directors and Senior Management, is one of our office
holders. Under the Companies Law, all arrangements as to compensation of office holders
who are not directors, require approval of the board of directors, or a committee thereof
or of persons to whom such power is delegated. Arrangements regarding the compensation of
directors also require audit committee and shareholder approval, with the exception of
compensation to external directors in the amounts specified in the regulations
promulgated under the Companies Law, all as described in Item 6. Directors and
Senior Management; Compensation.

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The
Companies Law requires that an office holder promptly discloses any personal interest
that he or she may have and all related material information known to him or her, in
connection with any existing or proposed transaction by the company. The disclosure must
be made to our board of directors or shareholders prior to the meeting at which the
transaction is to be discussed. In addition, if the transaction is an extraordinary
transaction, as defined under the Companies Law, the office holder must also disclose any
personal interest held by the office holders spouse, siblings, parents,
grandparents, descendants, spouses descendants and the spouses of any of the
foregoing, or by any corporation in which the office holder is a five percent (5%) or
greater shareholder, or holder of five percent (5%) or more of the voting power, director
or general manager or in which he or she has the right to appoint at least one director
or the general manager. An extraordinary transaction is defined as a transaction not in
the ordinary course of business, not on market terms, or that is likely to have a
material impact on the companys profitability, assets or liabilities.

In
the case of a transaction which is not an extraordinary transaction, after the office
holder complies with the above disclosure requirement, only board of directorsapproval
is required unless the Articles of Association of the company provide otherwise. A
transaction must not be adverse to the companys interest. If the transaction is an
extraordinary transaction, then, in addition to any approval required by the Articles of
Association, the transaction must also be approved by the audit committee and by the
board of directors, and under specified circumstances, by a meeting of the shareholders.
An office holder who has a personal interest in a matter that is considered at a meeting
of the board of directors or the audit committee may not be present at this meeting or
vote on this matter.

The
Companies Law applies the same disclosure requirements to a controlling shareholder of a
public company, which is defined as a shareholder who has the ability to direct the
activities of a company, other than in circumstances where this power derives solely from
the shareholders position on the board of directors or any other position with the
company, and includes a shareholder that holds 25% or more of the voting rights if no
other shareholder owns more than 50% of the voting rights in the company. Extraordinary
transactions with a controlling shareholder or in which a controlling shareholder has a
personal interest, and the terms of compensation of a controlling shareholder who is an
office holder, require the approval of the audit committee, the board of directors and
the shareholders of the company.

The
shareholders approval must either include at least one-third of the disinterested
shareholders who are present, in person or by proxy, at the meeting, or, alternatively,
the total shareholdings of the disinterested shareholders who vote against the
transaction must not represent more than one percent (1%) of the voting rights in the
company.

In
addition, a private placement of securities that will increase the relative holdings of a
shareholder that holds five percent (5%) or more of the companys outstanding share
capital, assuming the exercise by such person of all of the convertible securities into
shares held by that person, or that will cause any person to become a holder of more than
five percent (5%) of the companys outstanding share capital, requires approval by
the board of directors and the shareholders of the company. However, subject to certain
exceptions, shareholder approval will not be required if the aggregate number of shares
issued pursuant to such private placement, assuming the exercise of all of the
convertible securities into shares being sold in such a private placement, comprises less
than twenty percent (20%) of the voting rights in a company prior to the consummation of
the private placement.

Under
the Companies Law, a shareholder has a duty to act in good faith towards the company and
other shareholders and refrain from abusing his power in the company. Shareholdersvoting
powers includes their power to vote in the general meetings of shareholders on the
following matters:

| |  | any
amendment to the Articles of Association;
| | - | ---------------------------------------------

| |  | an
increase of the company's authorized share capital;
| | - | ------------------------------------------------------

| |  | a
merger; and
| | - | -------------

| |  | approval
of interested party transactions.
| | - | ------------------------------------------

In
addition, any controlling shareholder, any shareholder who knows it can determine the
outcome of a shareholders vote and any shareholder who, under our Articles of
Association, can appoint or prevent the appointment of an office holder, is under a duty
to act with fairness towards the company. The Companies Law does not describe the
substance of this duty. The Companies Law requires that specified types of transactions,
actions and arrangements be approved as provided for in a companys articles of
association and in some circumstances by the audit committee, by the board of directors
and by the shareholders. In general, the vote required by the audit committee and the
board of directors for approval of these matters, in each case, is a majority of the
disinterested directors participating in a duly convened meeting.

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For
information concerning the direct and indirect personal interests of some of our office
holders and principal shareholders in transactions with us, see Item 7. Major
Shareholders; Related Party Transactions above.

Rights
Attached to Ordinary Shares

Our
authorized share capital consists of 50,000,000 ordinary shares, par value NIS 0.01 per
share. Holders of ordinary shares have one vote per share, and are entitled to
participate equally in the payment of dividends and share distributions and, in the event
of our liquidation, in the distribution of assets after satisfaction of liabilities to
creditors. No preferred shares are currently authorized. All outstanding ordinary shares
are validly issued and fully paid.

Transfer
of Shares

Fully
paid ordinary shares are issued in registered form and may be freely transferred under
our Articles of Association unless the transfer is restricted or prohibited by another
instrument.

Dividend
and Liquidation Rights

We
may declare a dividend to be paid to the shareholders of our ordinary shares according to
their rights and interests in our profits. In the event of our liquidation, after
satisfaction of liabilities to creditors, our assets will be distributed to the
shareholders of our ordinary shares in proportion to the nominal value of their
shareholdings. This right may be affected by the grant of preferential dividend or
distribution rights to the shareholders of a class of shares with preferential rights
that may be authorized in the future. Pursuant to Israels securities laws, a
company registering its shares for trade on the Tel Aviv Stock Exchange (TASE) may not
have more than one class of shares for a period of one year following registration, after
which it is permitted to issue preference shares. Under the Companies Law, the
declaration of a dividend does not require the approval of the shareholders of the
company, unless the companys Articles of Association require otherwise. Our
Articles of Association provide that the board of directors may declare and distribute
dividends without the approval of the shareholders.

To
date, we have not declared or distributed any dividend.

Annual
and Special General Meetings

We
must hold our annual general meeting of shareholders each year no later than 15 months
from the last annual meeting, at a time and place determined by the board of directors,
upon at least 21 days prior notice to our shareholders. The board of directors may,
whenever it thinks fit, convene a special meeting as may be determined by the board of
directors. The board of directors shall be obligated to convene a special meeting, as may
be determined by the board of directors, upon requisition in writing in accordance with
the Companies Law. Not less than twenty-one (21) days prior notice, or thirty-five
(35) days prior notice to the extent required under regulations promulgated under
the Companies Law, shall be given of every general meeting. Each such notice shall
specify the place and the time of the meeting and the general nature of each item to be
acted upon thereat, as well as any other information required by the Companies Law or any
regulation promulgated thereunder, said notice to be given to all shareholders who will
be entitled to attend and vote at such meeting and delivered or publicized in any manner
permitted under the Companies Law.

The
quorum required for a meeting of shareholders consists of at least two shareholders
present in person or by proxy who hold or represent between them at least 33.3% of the
issued share capital. A meeting adjourned for lack of a quorum generally is adjourned to
the same day in the following week at the same time and place or any time and place as
the directors designate in a notice to the shareholders. At the reconvened meeting, the
required quorum consists of any two members present in person or by proxy.

Voting
Rights

Our
ordinary shares do not have cumulative voting rights in the election of directors. As a
result, the holders of ordinary shares that represent more than 50% of the voting power
represented at a shareholders meeting have the power to elect all of our directors,
except the external directors whose election requires a special majority as described
under the section entitled Item 6. Directors, Senior Management and Employees;
Board Practices; External and Independent Directors.

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

Under
the Companies Law, unless otherwise provided in the Articles of Association or by
applicable law, all resolutions of the shareholders require a simple majority and all
shareholders meetings require prior notice of at least 21 days. Our Articles of
Association provide that, except with respect to mattes which require the approval of a
special majority under the Companies Law, all decisions may be made by a simple majority
of the voting power represented at the meeting, in person, by proxy or by proxy card, and
voting thereon. See Item 10. Additional Information; Memorandum and Articles of
Association; Approval of Certain Transactions above for certain duties of
shareholders towards the company.

Limitations
on the Rights to Own Securities

The
ownership or voting of ordinary shares by non-residents of Israel is not restricted in
any way by our articles of association or the laws of the State of Israel, except that
nationals of countries which are, or have been, in a state of war with Israel may not be
recognized as owners of our shares.

Anti-Takeover
Provisions under Israeli Law

The
Companies Law provides that an acquisition of shares in a public company must be made by
means of a tender offer if, as a result of such acquisition, the purchaser would become
shareholder with over 25% of the voting rights in the company. This rule does not apply
if there is already another shareholder of the company with 25% or more of the voting
rights. Similarly, the Companies Law provides that an acquisition of shares in a public
company must be made by means of a tender offer if, as a result of the acquisition, the
purchasers shareholdings would entitle the purchaser to over 45% of the voting
rights in the company, unless there is a shareholder with 50% or more of the voting
rights in the company. These rules do not apply if the acquisition is made by way of a
merger.

Finally,
in general, Israeli tax law treats specified acquisitions less favorably than does U.S.
tax law. However, Israeli tax law provides for tax deferral in specified acquisitions,
including transactions where the consideration for the sale of shares is the receipt of
shares of the acquiring company.

# Exchange Controls

Under
Israeli Law, Israeli non-residents who purchase ordinary shares with certain non-Israeli
currencies (including dollars) may freely repatriate in such non-Israeli currencies all
amounts received in Israeli currency in respect of the ordinary shares, whether as a
dividend, as a liquidating distribution, or as proceeds from any sale in Israel of the
ordinary shares, provided in each case that any applicable Israeli income tax is paid or
withheld on such amounts. The conversion into the non-Israeli currency must be made at
the rate of exchange prevailing at the time of conversion. Under Israeli law, both
residents and non-residents of Israel may freely hold, vote and trade ordinary shares.

# Taxation

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

We
urge shareholders and prospective purchasers of our ordinary shares to consult their own
tax advisers as to the U.S., Israeli, or other tax consequences of the purchase,
ownership and disposition of ordinary shares, including, in particular, the effect of any
foreign, state or local taxes.

Israeli
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

Generally,
Israeli companies are subject to Corporate Tax on their taxable income. The
applicable rates are as follows: in 2006  31%, in 2007  29%, in 2008 27%,
in 2009  26% and in 2010 and thereafter  25%. However, the effective tax rate
payable by a company which derives income from an approved enterprise (as further
discussed below) may be considerably less.

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

The
Law for the Encouragement of Industry (Taxes), 1969, generally referred to as the
Industry Encouragement Law, provides several tax benefits for industrial companies. An
industrial company is defined as a company resident in Israel, at least 90% of the income
of which in a given tax year exclusive of income from specified government loans, capital
gains, interest and dividends, is derived from an industrial enterprise owned by it. An
industrial enterprise is defined as an enterprise whose major activity in a given tax
year is industrial production activity.

Under
the Industry Encouragement Law, industrial companies are entitled to a number of
corporate tax benefits, including:

| |  | deduction
 of purchase of know-how and patents  and/or  right to use a patent over an  eight-year
         period ;
| | - | -------------------------------------------------------------------------------------------------------------------

| |  | the
right to elect, under specified conditions, to file a consolidated tax return with
additional related Israeli industrial companies and an industrial holding company;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | accelerated
depreciation rates on equipment and buildings; and
| | - | --------------------------------------------------------------

| |  | deductibility
of expenses related to a public offering on the Tel Aviv Stock Exchange and as of January
1, 2003, on recognized stock markets outside of Israel, are deductible in equal amounts
over three years.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Under
some tax laws and regulations, an industrial enterprise may be eligible for special
depreciation rates for machinery, equipment and buildings. These rates differ based on
various factors, including the date the operations begin and the number of work shifts.
An industrial company owning an approved enterprise may choose between these special
depreciation rates and the depreciation rates available to the approved enterprise.

Eligibility
for benefits under the Industry Encouragement Law is not subject to receipt of prior
approval from any governmental authority.

We
believe that we currently qualify as an industrial company within the definition of the
Industry Encouragement Law. We cannot assure you that the Israeli tax authorities will
agree that we qualify, or, if we qualify, that we will continue to qualify as an
industrial company or that the benefits described above will be available to us in the
future.

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

Tax
benefits prior the 2005 amendment

The
Law for the Encouragement of Capital Investments, 1959, as amended (effective as of April
1, 2005) (the Investments Law), provides that a proposed capital investment
in eligible facilities may, upon application to the Investment Center of the Ministry of
Industry and Commerce of the State of Israel, be designated as an approved enterprise.

The
Investments Law provides that an approved enterprise is eligible for tax benefits on
taxable income derived from its approved enterprise programs. The tax benefits under the
Investments Law also apply to income generated by a company from the grant of a right of
use with respect to know-how developed by the approved enterprise, income generated from
royalties, and income derived from a service which is ancillary to such right of use or
royalties, provided that such income is generated within the approved enterprises
ordinary course of business. If a company has more than one approval or only a portion of
its capital investments are approved, its effective tax rate is the result of a weighted
average of the applicable rates. The tax benefits under the Investments Law are not,
generally, available with respect to income derived from products manufactured outside of
Israel. In addition, the tax benefits available to an approved enterprise are contingent
upon the fulfillment of conditions stipulated in the Investments Law and regulations and
the criteria set forth in the specific certificate of approval, as described above. In
the event that a company does not meet these conditions, it would be required to refund
the amount of tax benefits, plus a consumer price index linkage adjustment and interest.

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The
Investments Law also provides that an approved enterprise is entitled to accelerated
depreciation on its property and equipment that are included in an approved enterprise
program in the first five years of using the equipment.

Taxable
income of a company derived from an approved enterprise is subject to corporate tax at
the maximum rate of 25%, rather than the regular corporate tax rate, for the benefit
period. This period is ordinarily seven years commencing with the year in which the
approved enterprise first generates taxable income, and is limited to 12 years from
commencement of production or 14 years from the date of approval, whichever is earlier.
The years limitation does not apply to the exemption period.

However,
a company may elect to receive an alternative package of benefits under which (a) its
undistributed income derived from the approved enterprise will be exempt from corporate
tax for a period of between two and ten years from the first year it derives taxable
income under the program, depending on the geographic location of the approved enterprise
within Israel, and (b) it will be eligible for reduced tax rates for the remainder of the
benefits period.We have elected the alternative benefits package.

A
company that has elected the alternative package of benefits that subsequently pays a
dividend out of income derived from the approved enterprise during the tax exemption
period will be subject to corporate tax in respect of the gross amount distributed,
including any taxes thereon, at the rate which would have been applicable had it not
elected the alternative package of benefits, generally 10%-25%, depending on the
percentage of the companys ordinary shares held by foreign shareholders. The
dividend recipient is subject to withholding tax at the rate of 15% applicable to
dividends from approved enterprises, if the dividend is distributed during the tax
exemption period or within twelve years thereafter. The company must withhold this tax at
source.

A
company that has an approved enterprise program is eligible for further tax benefits if
it qualifies as a foreign investors company. A foreign investors company is a
company which more than 25% of its share capital and combined share and loan capital is
owned by non-Israeli residents. A company that qualifies as a foreign investorscompany
and has an approved enterprise program is eligible for tax benefits for a ten-year
benefit period. As specified above, depending on the geographic location of the approved
enterprise within Israel, income derived from the approved enterprise program may be
exempt from tax on its undistributed income for a period of between two to ten years, and
will be subject to a reduced tax rate for the remainder of the benefits period. The tax
rate for the remainder of the benefits period will be 25%, unless the level of foreign
investment exceeds 49%, in which case the tax rate will be 20% if the foreign investment
is more than 49% and less than 74%; 15% if more than 74% and less than 90%; and 10% if
90% or more.

Subject
to applicable provisions concerning income under the alternative package of benefits,
dividends paid by a company are considered to be attributable to income received from the
entire company and the companys effective tax rate is the result of a weighted
average of the various applicable tax rates, excluding any tax-exempt income. Under the
Investments Law, a company that has elected the alternative package of benefits is not
obligated to distribute retained profits, and may generally decide from which years
profits to declare dividends. We currently intend to reinvest any income derived from our
approved enterprise program and not to distribute such income as a dividend.

Currently
we have two approved enterprises programs under the Investment Law. Both are under the
alternative benefits program and in both cases, the tax benefits period for these
programs has not yet begun.

Tax
benefits under the 2005 Amendment

A
2005 amendment to the Investments Law included revisions to the criteria for investments
qualified to receive tax benefits as an Approved Enterprise. The amendment applies to new
investment programs and investment programs commencing after 2004, and does not apply to
investment programs approved prior to December 31, 2004. However, a company that was
granted benefits according to section 51 of the Investment Law would not be allowed to
commence production for a period of 2 years from the companys previous year of
commencement of benefits under the amended investment law.

Under
the amended law, a company wishing to receive the tax benefits afforded under the law is
required to select the tax year from which the period of benefits under the Investment
Law are to commence by notifying the Israeli Tax Authority within 12 months of the end of
that year.

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Our
company will continue to enjoy its current tax benefits in accordance with the provisions
of the Investment Law prior to its revision, but if our company is granted any new
benefits in the future they will be subject to the provisions of the amended Investment
Law. Therefore, the following discussion is a summary of the Investment Law prior to its
amendment as well as the relevant changes contained in the new legislation.

The
amendment simplifies the approval process: according the amendment, only Approved
Enterprises receiving cash grants require the approval of the Investment Center. The
Investment Center will be entitled, to approve such programs only until the end of 2007.

The
Amendment does not apply to benefits included in any certificate of approval that was
granted before the Amendment came into effect, which will remain subject to the
provisions of the Investment Law as they were on the date of such approval.

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

The
duration of tax benefits is subject to a limitation of the earlier of 7 to 10 years from
the Commencement Year, or 12 years from the first day of the Year of Election. The tax
benefits granted to a Benefited Enterprise are determined according to one of the
following new tax routes, which may be applicable to us:

| |  | Similar
to the currently available alternative route, exemption from corporate tax on
undistributed income for a period of two to ten years, depending on the geographic
location of the Benefited Enterprise within Israel, and a reduced corporate tax rate of
10% to 25% for the remainder of the benefits period, depending on the level of foreign
investment in each year. Benefits may be granted for a term of seven to ten years,
depending on the level of foreign investment in the company. If the company pays a
dividend out of income derived from the Benefited Enterprise during the tax exemption
period, such income will be subject to corporate tax at the applicable rate (10%-25%) in
respect of the gross amount of the dividend that we may distribute. The company is
required to withhold tax at the source at a rate of 15% from any dividends distributed
from income derived from the Benefited Enterprise; and
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

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

The
Amendment will apply to approved enterprise programs in which the year of election under
the Investments Law is 2004 or later, unless such programs received approval from the
Investment Center on or prior to December 31, 2004, in which case the 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.

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Special Provisions Relating to
Measurement of Taxable Income

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

| |  | Where
a companys equity, as calculated under the Inflationary Adjustments Law, exceeds
the  depreciated cost of its fixed assets (as defined in the Inflationary Adjustments
Law), a deduction from taxable income is permitted equal to the excess multiplied by the
applicable annual rate of inflation. The maximum deduction permitted in any single tax
year is 70% of taxable income, with the unused portion permitted to be carried forward,
linked to the Israeli consumer price index. The unused portion that was carried forward
may be deductible in full in the following year.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Where
a companys depreciated cost of fixed assets exceeds its equity, then the excess
multiplied by the applicable annual rate of inflation is added to taxable income.
(hereinafter: Inflation supplement). Note, the inflation supplement will only
be added to the corporate income but not to other incomes such as capital gains.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Subject
to specified limitations, depreciation deductions on fixed assets and losses carried
forward are adjusted for inflation based on the change in the consumer price index.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

In
the event that the Israeli consumer price index did not rise in a particular year by
3.0%, then the Israeli government may decide that some or all of the provisions of the
Inflationary Adjustments Law shall not apply with respect to such fiscal year, or that
the rate of increase of the Israeli consumer price index relating to such fiscal year
shall be deemed to be 0%, and to make the adjustments required to be made as a result of
such determination

According
to the law, until 2007 the results for tax purposes were measured adjusted for changes in
the Israeli CPI.

In
February 2008 the Knesset (Israeli parliament) passed an amendment to the
Income Tax (Inflationary Adjustments) Law, 1985, which limits the scope of the law
starting 2008 and thereafter. Starting 2008 the results for tax purposes are measured in
nominal values, excluding certain adjustments for changes in the Israeli CPI carried out
in the period up to December 31, 2007. The amendment to the law includes, inter alia, the
elimination of the inflationary additions and deductions and the additional deduction for
depreciation starting 2008. For additional information, see Note 13 to our consolidated
financial statements.

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.

Capital
Gains Tax on Sales of Our Ordinary Shares

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

64

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Generally,
until the 2006 tax year, capital gains tax was imposed on Israeli resident individuals at
a rate of 15% on real gains derived on or after January 1, 2003, from the sale of shares
in, among others, Israeli companies publicly traded on Nasdaq or on a recognized stock
exchange or regulated market in a country that has a treaty for the prevention of double
taxation with Israel. This tax rate was contingent upon the shareholder not claiming a
deduction for financing expenses in connection with such shares (in which case the gain
was generally be taxed at a rate of 25%), and did not apply to: (i) the sale of
shares to a relative (as defined in the Israeli Income Tax Ordinance); (ii) the sale of
shares by dealers in securities; (iii) the sale of shares by shareholders that report in
accordance with the Inflationary Adjustments Law (that were taxed at corporate tax rates
for corporations and at marginal tax rates for individuals); or (iv) the sale of
shares by shareholders who acquired their shares prior to an initial public offering
(which shares may be subject to a different tax arrangement).

As
of January 1, 2006, the tax rate applicable to capital gains derived from the sale of
shares, whether listed on a stock market or not, is 20% for Israeli individuals, unless
such shareholder claims a deduction for financing expenses in connection with such
shares, in which case the gain will generally be taxed at a rate of 25%. Additionally, if
such shareholder is considered a material shareholder at any time during the
12-month period preceding such sale, i.e., such shareholder holds directly or indirectly,
including with others, at least 10% of any means of control in the company, the tax rate
shall be 25%. Israeli companies are subject to the Corporate Tax rate on capital gains
derived from the sale of shares, unless such companies were not subject to the
Adjustments Law (or certain regulations) at the time of publication of the aforementioned
amendment to the Tax Ordinance that came into effect on January 1, 2006, in which case
the applicable tax rate is 25%. However, the foregoing tax rates do not apply to: (i)
dealers in securities; and (ii) shareholders who acquired their shares prior to an
initial public offering (which shares may be subject to a different tax arrangement).

The
tax basis of shares acquired prior to January 1, 2003 will be determined in accordance
with the average closing share price in the three trading days preceding January 1, 2003.
However, a request may be made to the tax authorities to consider the actual adjusted
cost of the shares as the tax basis if it is higher than such average price.

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

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

Pursuant
to the Convention Between the government of the United States of America and the
government of Israel with Respect to Taxes on Income, as amended (the U.S.-Israel
Tax Treaty), the sale, exchange or disposition of ordinary shares by a person who
(i) holds the ordinary shares as a capital asset, (ii) qualifies as a resident of the
United States within the meaning of the U.S.-Israel Tax Treaty and (iii) is entitled to
claim the benefits afforded to such person by the U.S.-Israel Tax Treaty, generally, will
not be subject to the Israeli capital gains tax. Such exemption will not apply if (i)
such Treaty U.S. Resident holds, directly or indirectly, shares representing 10% or more
of our voting power during any part of the 12-month period preceding such sale, exchange
or disposition, subject to certain conditions, or (ii) the capital gains from such sale,
exchange or disposition can be allocated to a permanent establishment in Israel. In such
case, the sale, exchange or disposition of ordinary shares would be subject to Israeli
tax, to the extent applicable; however, under the U.S.-Israel Tax Treaty, such Treaty
U.S. Resident would be permitted to claim a credit for such taxes against the U.S.
federal income tax imposed with respect to such sale, exchange or disposition, subject to
the limitations in U.S. laws applicable to foreign tax credits. The U.S.-Israel Tax
Treaty does not relate to U.S. state or local taxes.

Taxation
of Non-Resident Holders of Shares

Non-residents
of Israel are subject to income tax on income accrued or derived from sources in Israel.
Such sources of income include passive income such as dividends, royalties and interest,
as well as non-passive income from services rendered in Israel. On distributions of
dividends other than bonus shares, or stock dividends, income tax is withheld at the
source at the following rates: (i) for dividends distributed prior to January 1, 2006
 25%; (ii) for dividends distributed on or after January 1, 2006  20%, or 25%
for a shareholder that is considered a material shareholder at any time
during the 12-month period preceding such distribution, unless a different rate is
provided in a treaty between Israel and the shareholders country of residence.
Under the U.S.-Israel Tax Treaty, the maximum tax on dividends paid to a holder of
ordinary shares who is a Treaty U.S. Resident is 25%. However, under the Investments Law,
dividends generated by an Approved Enterprise (or Benefited Enterprise) are taxed at the
rate of 15%. Furthermore, dividends not generated by an Approved Enterprise (or Benefited
Enterprise) paid to a U.S. corporation holding at least 10% of our issued voting power
during the part of the tax year which precedes the date of payment of the dividend and
during the whole of its prior tax year, are generally taxed at a rate of 12.5%.

65

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For
information with respect to the applicability of Israeli capital gains taxes on the sale
of ordinary shares by United States residents, see above   Capital Gains Tax
on Sales of Our Ordinary Shares.

United
States Federal Income Tax Considerations

Subject
to the limitations described below, the following discussion summarizes certain U.S.
federal income tax consequences of the purchase, ownership and disposition of our
ordinary shares to a U.S. holder that owns our ordinary shares as a capital asset
(generally, for investment). A U.S. holder is a holder of our ordinary shares that is:

| |  | an
individual citizen or resident of the United States;
| | - | -------------------------------------------------------

| |  | a
corporation  (or other entity  taxable as a corporation  for U.S.  federal income tax
purposes)         created or organized  in the United  States or under the laws of the
United  States,  any state or         political subdivision thereof or the District of
Columbia;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | an
estate,  the income of which is subject to U.S.  federal  income tax regardless of its
source;         or
| | - | ------------------------------------------------------------------------------------------------------------

| |  | a
trust if (i) a court  within the United  States is able to exercise  primary  supervision
 over         its  administration  and one or more  U.S.  persons  have  the  authority
 to  control  all of its         substantial  decisions or (ii) that has in effect a
valid election under applicable U.S.  Treasury         Regulations to be treated as a
U.S. person.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Certain
aspects of U.S. federal income taxes relevant to a holder of our ordinary shares that is
not a U.S. holder (a Non-U.S. holder) are also discussed below.

This
discussion is based on current provisions of the Internal Revenue Code of 1986, as
amended (the Code), current and proposed Treasury Regulations, and
administrative and judicial decisions as of the date of this annual report, all of which
are subject to change, possibly on a retroactive basis. This discussion does not address
all aspects of U.S. federal income taxation that may be relevant to any particular U.S.
holder in light of the holders individual circumstances. In particular, this
discussion does not address the potential application of the alternative minimum tax or
the U.S. federal income tax consequences to U.S. holders that are subject to special
treatment, including U.S. holders that:

| |  | are
broker-dealers or insurance companies;
| | - | ------------------------------------------

| |  | have
elected mark-to-market accounting;
| | - | ---------------------------------------

| |  | are
tax-exempt organizations or retirement plans;
| | - | -------------------------------------------------

| |  | are
grantor trusts;
| | - | -------------------

| |  | are
certain former citizens or long-term residents of the United States;
| | - | ------------------------------------------------------------------------

| |  | are
financial institutions or financial services entities;
| | - | ----------------------------------------------------------

| |  | hold
ordinary shares as part of a straddle, hedge or conversion transaction with other
        investments;
| | - | -----------------------------------------------------------------------------------------------------------

| |  | acquired
their ordinary shares upon the exercise of employee stock options or otherwise as
        compensation;
| | - | ----------------------------------------------------------------------------------------------------------------

| |  | are
real estate investment trusts or regulated investment companies;
| | - | --------------------------------------------------------------------

| |  | own
directly, indirectly or by attribution at least 10% of our voting power; or
| | - | -------------------------------------------------------------------------------

| |  | have
a functional currency that is not the U.S. dollar.
| | - | -------------------------------------------------------

If
a partnership (or any other entity treated as a partnership for U.S. federal income tax
purposes) holds our ordinary shares, the tax treatment of the partnership and a partner
in such partnership will generally depend on the status of the partner and the activities
of the partnership. Such a partner or partnership should consult its tax advisor as to
its tax consequences.

This
discussion is not a comprehensive description of all of the tax considerations that may
be relevant to each persons decision to purchase our ordinary shares. For example,
this discussion does not address any aspect of state, local or non-U.S. tax laws or the
possible application of United States federal gift or estate taxes.

66

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Each
holder of our ordinary shares is advised to consult his or her own tax advisor with
respect to the specific tax consequences to him or her of purchasing, owning or disposing
of our ordinary shares, including the applicability and effect of federal, state, local
and foreign income and other tax laws to his or her particular circumstances.

Taxation
of Distributions Paid on Ordinary Shares

Subject
to the discussion below under Tax Consequences if We Are a Passive Foreign
Investment Company, a U.S. holder will be required to include in gross income as
dividend income the amount of any distribution paid on our ordinary shares, including any
non-U.S. taxes withheld from the amount paid, on the date the distribution is received to
the extent the distribution is paid out of our current or accumulated earnings and
profits, as determined for U.S. federal income tax purposes. Distributions in excess of
earnings and profits will be applied against and will reduce the U.S. holders tax
basis in its ordinary shares and, to the extent in excess of that basis, will be treated
as gain from the sale or exchange of ordinary shares. The dividend portion of such
distribution generally will not qualify for the dividends received deduction otherwise
available to corporations.

Dividends
that are received by U.S. holders that are individuals, estates or trusts will be taxed
at the rate applicable to long-term capital gains (currently a maximum rate of 15% for
taxable years beginning on or before December 31, 2010), provided that such dividends
meet the requirements of qualified dividend income. Dividends that fail to
meet such requirements, and dividends received by corporate U.S. holders, are taxed at
ordinary income rates. No dividend received by a U.S. holder will be a qualified dividend
if (1) the U.S. holder held the ordinary share with respect to which the dividend was
paid for less than 61 days during the 121-day period beginning on the date that is 60
days before the ex-dividend date with respect to such dividend, excluding for this
purpose, under the rules of Code Section 246(c), any period during which the U.S. holder
has an option to sell, is under a contractual obligation to sell, has made and not closed
a short sale of, is the grantor of a deep-in-the-money or otherwise nonqualified option
to buy, or has otherwise diminished its risk of loss by holding other positions with
respect to, such ordinary share (or substantially identical securities) or (2) the U.S.
holder is under an obligation (pursuant to a short sale or otherwise) to make related
payments with respect to positions in property substantially similar or related to the
ordinary share with respect to which the dividend is paid. If we were to be a passive
foreign investment company (as such term is defined in the Code) for any taxable
year, dividends paid on our ordinary shares in such year or in the following taxable year
would not be qualified dividends. See the discussion below regarding our passive foreign
investment company status under Tax Consequences if We Are a Passive Foreign
Investment Company. In addition, a non-corporate U.S. holder will be able to take a
qualified dividend into account in determining its deductible investment interest (which
is generally limited to its net investment income) only if it elects to do so; in such
case the dividend will be taxed at ordinary income rates.

Distributions
of current or accumulated earnings and profits paid in foreign currency to a U.S. holder
(including any non-U.S. taxes withheld from the distributions) will generally be
includible in the income of a U.S. holder in a U.S. dollar amount calculated by reference
to the exchange rate on the date of the distribution. A U.S. holder that receives a
foreign currency distribution and converts the foreign currency into U.S. dollars after
the date of distribution may have foreign exchange gain or loss based on any appreciation
or depreciation in the value of the foreign currency against the U.S. dollar, which will
generally be U.S. source ordinary income or loss.

U.S.
holders will have the option of claiming the amount of any non-U.S. income taxes
          withheld at source either as a deduction from gross income or as a
          dollar-for-dollar credit against their U.S. federal income tax liability.
          Individuals who do not claim itemized deductions, but instead utilize the
          standard deduction, may not claim a deduction for the amount of the non-U.S.
          income taxes withheld, but the amount may be claimed as a credit against the
          individuals U.S. federal income tax liability. The amount of non-U.S.
          income taxes that may be claimed as a credit in any taxable year is subject to
          complex limitations and restrictions, which must be determined on an individual
          basis by each U.S. holder. These limitations include rules which limit foreign
          tax credits allowable for specific classes of income to the U.S. federal income
          taxes otherwise payable on each such class of income. The total amount of
          allowable foreign tax credits in any taxable year cannot exceed the pre-credit
          U.S. tax liability for the taxable year attributable to non-U.S. source taxable
          income.

A
U.S. holder will be denied a foreign tax credit for non-U.S. income taxes withheld from a
dividend received on the ordinary shares if (1) the U.S. holder has not held the ordinary
shares for at least 16 days of the 31day period beginning on the date which is 15
days before the ex-dividend date with respect to such dividend or (2) to the extent the
U.S. holder is under an obligation to make related payments with respect to positions in
substantially similar or related property. Any days during which a U.S. holder has
substantially diminished its risk of loss on the ordinary shares are not counted toward
meeting the required 16-day holding period.

67

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Taxation
of the Disposition of Ordinary Shares

Subject
to the discussion below under Tax Consequences if We Are a Passive Foreign
Investment Company, upon the sale, exchange or other disposition of our ordinary
shares, a U.S. holder will recognize capital gain or loss in an amount equal to the
difference between the U.S. holders basis in the ordinary shares, which is usually
the cost to the U.S. holder of the ordinary shares, and the amount realized on the
disposition. A disposition of ordinary shares will be considered to occur on the trade
date, regardless of the U.S. holders method of accounting. Capital gain from the
sale, exchange or other disposition of ordinary shares held more than one year will be
long-term capital gain and may, in the case of non-corporate U.S. holders, be subject to
a reduced rate of taxation (long-term capital gains are currently taxable at a maximum
rate of 15% for taxable years beginning on or before December 31, 2010). Gain or loss
recognized by a U.S. holder on a sale, exchange or other disposition of ordinary shares
will generally be treated as U.S. source income for U.S. foreign tax credit purposes. The
deductibility of a capital loss recognized on the sale, exchange or other disposition of
ordinary shares may be subject to limitations.

A
U.S. holder that uses the cash method of accounting calculates the dollar value of the
proceeds received on the sale as of the date that the sale settles. However, a U.S.
holder that uses the accrual method of accounting is required to calculate the value of
the proceeds of the sale as of the trade date and may therefore realize foreign currency
gain or loss. A U.S. holder may avoid realizing foreign currency gain or loss by electing
to use the settlement date to determine the proceeds of sale for purposes of calculating
the foreign currency gain or loss. In addition, a U.S. holder that receives foreign
currency upon disposition of ordinary shares and converts the foreign currency into
dollars after the settlement date or trade date (whichever date the U.S. holder is
required to use to calculate the value of the proceeds of sale) may have foreign exchange
gain or loss based on any appreciation or depreciation in the value of the foreign
currency against the dollar, which will generally be U.S. source ordinary income or loss.

Tax
Consequences if We Are a Passive Foreign Investment Company

For
U.S. federal income tax purposes, we will be classified as a passive foreign investment
company, or PFIC, for any taxable year in which either, after applying certain look-thru
rules, (i) 75% or more of our gross income is passive income or (ii) at least 50% of the
average value (determined on a quarterly basis) of our total assets for the taxable year
produce or are held for the production of passive income. For this purpose, cash is
considered to be an asset which produces passive income. Passive income includes
dividends, interest, royalties, rents, annuities and the excess of gains over losses from
the disposition of certain assets which produce passive income.

Based
on our income, assets, activities and market capitalization, we do not believe that we
were a PFIC for the taxable year ended December 31, 2008. However, there can be no
assurances that the United States Internal Revenue Service (IRS) will not
challenge this conclusion. There is a risk that we were a PFIC for the taxable years
2001, 2002 and 2003 as a result of our substantial cash position and the performance of
our ordinary shares during those taxable years. If we were a PFIC during 2001, 2002 and
2003, U.S. holders who acquired or held our ordinary shares during those taxable years
generally will be subject to the PFIC rules described below regardless of whether we were
a PFIC for 2008. However, if we were not a PFIC for 2008, U.S. holders who acquired our
ordinary shares in 2008 will not be subject to the PFIC rules unless we are classified as
a PFIC in future years. The tests for determining PFIC status are applied annually and it
is difficult to make accurate predictions of our future income, assets, activities and
market capitalization, which are relevant to this determination. Furthermore, if the
current price of our ordinary shares does not increase during 2009, there is a risk that
we could be classified as a PFIC for 2009.

If
we are a PFIC, a U.S. holder of our ordinary shares could be subject to increased tax
liability upon the sale or other disposition (including gifts) of its ordinary shares or
upon the receipt of amounts treated as excess distributions, which could
result in a reduction in the after-tax return to such U.S. holder. In general, an excess
distribution is the amount of distributions received during a taxable year that exceed
125% of the average amount of distributions received by a U.S. holder in respect of the
ordinary shares during the preceding three taxable years, or if shorter, during the U.S.
holders holding period prior to the taxable year of the distribution. Under these
rules, the excess distribution and any gain on the disposition of ordinary shares would
be allocated ratably over the U.S. holders holding period for the ordinary shares.
The amount allocated to the current taxable year and any taxable year prior to the first
taxable year in which we were a PFIC would be taxed as ordinary income. The amount
allocated to each of the other taxable years would be subject to tax at the highest
marginal rate in effect for the applicable class of taxpayer for that taxable year, and
an interest charge for the deemed deferral benefit would be imposed on the resulting tax
allocated to such other taxable years. The tax liability with respect to the amount
allocated to taxable years prior to the year of the disposition or distribution cannot be
offset by net operating losses. In addition, holders of stock in a PFIC may not receive a
step-up in basis on PFIC shares acquired from a decedent.

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As
an alternative to the tax treatment described above, a U.S. holder could elect to treat
us as a qualified electing fund (QEF), in which case the U.S.
holder would be required to include in income, for each taxable year that we are a PFIC,
its pro rata share of our ordinary earnings as ordinary income and its pro rata share of
our net capital gains as long-term capital gain, subject to a separate election to defer
payment of taxes which deferral is subject to an interest charge. Any income inclusion
will be required whether or not such U.S. holder owns our ordinary shares for an entire
taxable year or at the end of our taxable year. The amount so includable will be
determined without regard to our prior year losses or the amount of cash distributions,
if any, received from us. Special rules apply if a U.S. holder makes a QEF election after
the first taxable year in its holding period in which we are a PFIC. We will supply U.S.
holders that make a request in writing with the information needed to report income and
gain under a QEF election if we are a PFIC. A U.S. holders tax basis in its
ordinary shares will increase by any amount included in income and decrease by any
amounts not included in income when distributed because such amounts were previously
taxed under the QEF rules. So long as a U.S. holders QEF election is in effect with
respect to the entire holding period for its ordinary shares, any gain or loss realized
by such holder on the disposition of its ordinary shares held as a capital asset
ordinarily would be capital gain or loss. The QEF election is made on a
shareholder-by-shareholder basis, applies to all ordinary shares held or subsequently
acquired by an electing U.S. holder and can be revoked only with the consent of the IRS.

As
an alternative to making a QEF election, a U.S. holder of PFIC stock which is marketable
stock (e.g., regularly traded on the Nasdaq Global Market) may in
certain circumstances avoid certain of the tax consequences generally applicable to
holders of stock in a PFIC by electing to mark the stock to market as of the beginning of
such U.S. holders holding period for the ordinary shares. As a result of such an
election, in any taxable year that we are a PFIC, a U.S. holder would generally be
required to report gain or loss to the extent of the difference between the fair market
value of the ordinary shares at the end of the taxable year and such U.S. holders
tax basis in its ordinary shares at that time. Any gain under this computation, and any
gain on an actual disposition of the ordinary shares, would be treated as ordinary
income. Any loss under this computation, and any loss on an actual disposition of the
ordinary shares, generally would be treated as ordinary loss to the extent of the
cumulative net-mark-to-market gain previously included. Any remaining loss from marking
ordinary shares to market will not be allowed, and any remaining loss from an actual
disposition of ordinary shares generally would be capital loss. A U.S. holders tax
basis in its ordinary shares is adjusted annually for any gain or loss recognized under
the mark-to-market election. There can be no assurances that there will be sufficient
trading volume with respect to the ordinary shares for the ordinary shares to be
considered regularly traded or that our ordinary shares will continue to
trade on the Nasdaq Global Market. Accordingly, there are no assurances that the ordinary
shares will be marketable stock for these purposes. As with a QEF election, a
mark-to-market election is made on a shareholder-by-shareholder basis, applies to all
ordinary shares held or subsequently acquired by an electing U.S. holder and can only he
revoked with consent of the IRS (except to the extent the ordinary shares no longer
constitute marketable stock).

The U.S. federal income tax
consequences to a U.S. holder if we were to be a PFIC are complex. A U.S. holder should
consult with his or her own advisor with regard to those consequences, as well as with
regard to whether he or she should make either of the elections described above.

Tax
Consequences for Non-U.S. Holders of Ordinary Shares

Except
as described in Information Reporting and Backup Withholding below, a
Non-U.S. holder of ordinary shares generally will not be subject to U.S. federal income
or withholding tax on the payment of dividends on, and the proceeds from the disposition
of, our ordinary shares, unless, in the case of U.S. federal income taxes:

| | the
item is effectively connected with the conduct by the Non-U.S. holder of a trade or
business in the United States and in the case of a resident of a country which has a
treaty with the United States, the item is attributable to a permanent establishment in
the United States, or in the case of an individual, the item is attributable to a fixed
place of business in the United States; or
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | the
Non-U.S. holder is an individual who holds the ordinary shares as a capital asset and is
present in the United States for 183 days or more in the taxable year of the disposition
and certain other conditions are met.
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Information
Reporting and Backup Withholding

U.S.
holders (other than exempt recipients such as corporations) generally are
          subject to information reporting requirements with respect to dividends paid in
          the United States on, or proceeds from the disposition of, our ordinary shares.
          In addition, a U.S. holder may be subject, under certain circumstances, to
          backup withholding at a rate of up to 28% with respect to dividends paid on, or
          proceeds from the disposition of, our ordinary shares unless the U.S. holder
          provides proof of an applicable exemption or correct taxpayer identification
          number and otherwise complies with applicable requirements of the backup
          withholding rules. A U.S. holder of our ordinary shares who provides an
          incorrect taxpayer identification number may be subject to penalties imposed by
          the IRS.

69

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Non-U.S. holders
generally are not subject to information reporting or backup withholding           with
respect to dividends paid on, or proceeds from the disposition of, our           ordinary
shares, provided that the Non-U.S. holder provides its taxpayer           identification
number, certifies to its foreign status, or establishes another           exemption to
the information reporting or back-up withholding requirements.

Amounts
withheld under the backup withholding rules are not an additional tax and may be refunded
or credited against the U.S. holders federal income tax liability, provided the
required information is furnished to the IRS.

# Documents on Display

We
are required to file reports and other information with the SEC under the Securities
Exchange Act of 1934 and the regulations thereunder applicable to foreign private
issuers. You may inspect and copy reports and other information filed by us with the SEC
at the SECs public reference facilities described below. Although as a foreign
private issuer we are not required to file periodic information as frequently or as
promptly as United States companies, we generally announce publicly our quarterly and
year-end results promptly and file periodic information with the SEC under cover of Form
6-K. As a foreign private issuer, we are also exempt from the rules under the Exchange
Act prescribing the furnishing and content of proxy statements and our officers,
directors and principal shareholders are exempt from the reporting and other provisions
in Section 16 of the Exchange Act.

You
may review a copy of our filings with the SEC, including any exhibits and schedules, at
the SECs public reference facilities in 100 F Street N.W., Washington, D.C. 20549
and at offices of the Israel Securities Authority at 22 Kanfei Nesharim St., Jerusalem,
Israel. You may also obtain copies of such materials from the Public Reference Section of
the SEC, 100 F Street, N.W., Washington, D.C. 20549, at prescribed rates. You may call
the SEC at 1-800-SEC-0330 for further information on the public reference rooms. As a
foreign private issuer we were only required to file through the SECs EDGAR system
as of November 2002. Our periodic filings are therefore available on the SECs
Website www.sec.gov from that date. You may read and copy any reports, statements
or other information that we file with the SEC, through the SECs EDGAR system
available on the SECs website and at the SEC facilities listed above. These SEC
filings are also available to the public on the Israel Securities Authoritys
website at www.isa.gov.il and from commercial document retrieval services.

Any
statement in this annual report about any of our contracts or other documents is not
necessarily complete. If the contract or document is filed as an exhibit to this annual
report, the contract or document is deemed to modify the description contained in this
annual report. We urge you to review the exhibits themselves for a complete description
of the contract or document.

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

We
are exposed to a variety of risks, including changes in interest rates and foreign
currency exchange risk and inflation.

# Interest Rate Risk

As
of December 31, 2008, we had $7.2 million in cash, cash equivalents, deposits and
marketable securities. We invest our cash surplus in bank deposits and marketable
securities. Since these investments typically carry fixed interest rate, and since our
policy and practice is to hold these investments to maturity, financial income over the
holding period is not sensitive to changes in interest rates. For more information, see
Note 5 of our 2008 consolidated financial statements.

# Foreign Currency
Exchange Risk and Inflation

We
hold most of our cash, cash equivalents deposits and marketable securities in U.S.
dollars but incur a significant portion of our expenses, principally salaries and related
personnel expenses and administrative expenses, in New Israeli Shekels. As a result, we
are exposed to the risk that the U.S. dollar will be devalued against the New Israeli
Shekel. Depreciation of the US dollar could have a material adverse effect on our results
of operation and financial condition. The Company entered into derivative instrument
arrangements to hedge a portion of its anticipated New Israeli Shekel (NIS)
payroll and certain operation expenses. For more information, see Note 2q of our 2008
consolidated financial statements.

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

Not
applicable.

70

---

---

# PART II

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

None.

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

# Material Modifications
to the Rights of Security Holders

None.

# Use of Proceeds

None.

|ITEM 15T. |  | CONTROLS AND PROCEDURES
|--------- |  | -----------------------

# Disclosure Controls and
Procedures

Our
disclosure controls and procedures are designed to ensure that information required to be
disclosed in the reports we are required to file are recorded, processed, summarized and
reported on a timely basis. Under the supervision of our Chief Executive Officer and
Chief Financial Officer, we conducted an evaluation of the effectiveness of our
disclosure controls and procedures, as such term is defined under Rule 13a-15(e) and
15d-15(e) promulgated under the Securities Exchange Act of 1934 (the Exchange Act).
Based on this evaluation, our Chief Executive Officer and Chief Financial Officer
concluded that our disclosure controls and procedures were effective as of the end of the
period covered by this annual report. Our Chief Executive Officer and Chief Financial
Officer have also concluded that there were no significant changes in our internal
controls or in other factors that could significantly affect the internal controls
subsequent to that date of evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.

# Management Annual Report
on Internal Control over Financial Reporting

Our
board of directors and audit committee are responsible for establishing and maintaining
adequate internal control over financial reporting. Our internal control system was
designed to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of our consolidated financial statements for external purposes in
accordance with generally accepted accounting principles.

Under
the supervision of our Chief Executive Officer and Chief Financial Officer, we conducted
an evaluation of the effectiveness of our internal control over financial reporting, as
such term is defined under Rule 13a-15(f) and 15d-15(f) promulgated under the Exchange
Act. In making this assessment, we used the criteria established in Internal Control
 Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). Based on this evaluation, our Chief Executive Officer and
Chief Financial Officer have concluded that our internal control over financial reporting
was effective as of the end of the period covered by this annual report.

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

# Firm Report of the
Registered Public Accounting Firm

This
annual report does not include an attestation report of our registered public accounting
firm assessing our internal control over financial reporting. Our managements
report was not subject to attestation by our registered public accounting firm pursuant
to current rules of the SEC that permit us to provide only the managements report
in this annual report.

71

---

---

# Changes in Internal
Control over Financial Reporting

There
were no changes in our internal control over financial reporting that occurred during the
period covered by this report that have materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting.

|ITEM 16. |  | RESERVED
|-------- |  | --------

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

Our
board of directors has determined that each of Prof. Yair Aharonowitz, Mr. Arie Ovadia
and Prof. Joshua Shemer qualifies as an independent director and Mr. Arie
Ovadia qualifies as a financial expert as defined by the Nasdaq Marketplace
Rules.

|ITEM 16B. |  | CODE OF ETHICS
|--------- |  | --------------

Our
board of directors adopted a code of ethics that applies to our chief executive officer,
chief financial officer, controller, and other persons performing similar functions.

The
code of ethics is posted on our website, addressed www.cgen.com.

|ITEM 16C. |  | PRINCIPAL ACCOUNTANT FEES AND SERVICES
|--------- |  | --------------------------------------

The
following table presents the fees paid to our external auditors for professional services
rendered in the years ended December 31, 2008 and 2007:

|                   | 2008 | 2007
|------------------ | ---- | ----
|
|
|
|
|Audit Fees         |      |     
|Audit Related Fees |      |     
|Tax Fees           |      |     
|All Other Fees     |      |     
|Total              |      |     

Audit
Fees are fees for professional services rendered by our principal accountant in
connection with the audit of our consolidated annual financial statements and review of
our unaudited interim financial statements;

Audit
Related Fees are fees for professional services rendered by our principal
accountant in connection with the audit and other assignments, relating to internal
accounting functions and procedures including valuation of options granted to chairman of
the board in 2007;

Tax
Fees are fees for services rendered by our principal accountant in connection with
tax compliance, tax planning and tax advice; and

All
Other Fees are fees for other consulting services rendered by our principal
accountant to us including preparation of response letter to SEC in 2007.

|ITEM 16D. |  | EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
|--------- |  | ----------------------------------------------------------

None.

|ITEM 16E. |  | PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
|--------- |  | ----------------------------------------------------------------------

None.

|ITEM 16F. |  | CHANGES IN REGISTRANT'S CERTIFYING ACCOUNTANT
|--------- |  | ---------------------------------------------

Not
applicable.

|ITEM 16G. |  | CORPORATE GOVERNANCE
|--------- |  | --------------------

There
are no significant differences between our corporate governance practices and those
required of a U.S. domestic issuer under the NASDAQ Stock Market Rules.

72

---

---

# PART III

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

We
have furnished financial statements and related information pursuant to Item 18.

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

See
pages F-1 to F-29.

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

# Index to Exhibits

|Exhibit Number | Description                                            | 
|-------------- | ------------------------------------------------------ | 
|
|
|
|
|1.1            | Form of Articles of Association of Issuer              | 
|              
|12.1           | Certification by Chief Executive Officer pursuant to   | 
|               | section 302 of the Sarbanes-Oxley Act of 2002.         | 
|              
|12.2           | Certification by Chief Financial Officer pursuant to   | 
|               | section 302 of the Sarbanes-Oxley Act of 2002.         | 
|              
|13.1           | Certification by Chief Executive Officer pursuant to   | 
|               | section 906 of the Sarbanes-Oxley Act of 2002.         | 
|              
|13.2           | Certification by Chief Financial Officer pursuant to   | 
|               | section 906 of the Sarbanes-Oxley Act of 2002.         | 
|              
|15.1           | Consent of Kost Forer Gabbay & Kasierer, a member of   | 
|               | Ernst & Young Global, dated March 16, 2009.            | 
|              
|15.2           | Consent of Kesselman & Kesselman, member of            | 
|               | PriceWaterhouseCoopers, independent auditors of Keddem | 
|               | Bioscience, dated March 16, 2009.                      | 
|              
|15.3           | Audit Report by Kesselman & Kesselman, member of       | 
|               | PriceWaterhouseCoopers, independent auditors of Keddem | 
|               | Bioscience, dated March 13, 2008.                      | 

73

---

---

# SIGNATURES

The
registrant hereby certifies that it meets all of the requirements for filing on Form 20-F
and has duly caused and authorized the undersigned to sign this annual report on its
behalf.

| |  | COMPUGEN LTDBy: /s/ Mr. Martin Gerstel
Martin GerstelPresident,  Chief Executive  Officer and
                                                     DirectorDate: March 16, 2009
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

74

---

---

15.3.09

COMPUGEN LTD. AND ITS SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 2008
U.S. DOLLARS IN THOUSANDS

# INDEX

|                                                        | Page          
|------------------------------------------------------- | --------------
|
|
|
|
|Report of Independent Registered Public Accounting Firm | F - 2         
|                                                       
|Consolidated Balance Sheets                             | F - 3         
|                                                       
|Consolidated Statements of Operations                   | F - 4         
|                                                       
|Statements of Changes in Shareholders' Equity           | F - 5         
|                                                       
|Consolidated Statements of Cash Flows                   | F - 6         
|                                                       
|Notes to Consolidated Financial Statements              | F - 7 - F - 29



---

---

| | Kost Forer Gabbay & Kasierer3 Aminadav St.Tel-Aviv 67067, Israel
Tel: 972 (3)6232525Fax: 972 (3)5622555www.ey.com/il
| | --------------------------------------------------------------------------------------------------------------------

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
COMPUGEN LTD.

We
have audited the accompanying consolidated balance sheets of Compugen Ltd. (the
Company) and its subsidiaries as of December 31, 2008 and 2007, 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, 2008. 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 Keddem BioScience Ltd., a wholly-owned
subsidiary, for the years ended December 31, 2007 and 2006 which statements reflect total
assets constituting 0% and 2% and no revenues, in 2007 and 2006, respectively, of the
related consolidated totals. Those statements were audited by other auditors whose
unqualified report, which has been furnished to us, includes an explanatory paragraph on
circumstances which raise substantial doubts regarding Keddem BioScience Ltd.s
ability to continue as a going concern. Our opinion, insofar as it relates to the amounts
included for Keddem BioScience Ltd. 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 consolidated
financial statements referred to above present fairly, in all material respects, the
consolidated financial position of the Company and its subsidiaries as of December 31,
2008 and 2007, and the consolidated results of their operations and their cash flows for
each of the three years in the period ended December 31, 2008, in conformity with U.S.
generally accepted accounting principles.

As
discussed in Note 14i to the consolidated financial statements, in 2007, the Company
adopted the provisions of Statement of FIN No. 48, Accounting for Uncertainty in
Income Taxes an interpretation of FASB Statement No. 109".

|                 |                                 
|---------------- | --------------------------------
|
|
|
|
|Tel-Aviv, Israel | KOST FORER GABBAY & KASIERER    
|March 16, 2009   | A Member of Ernst & Young Global

F - 2

---

---

COMPUGEN LTD. AND ITS SUBSIDIARIES

|                                                           
|-----------------------------------------------------------
|CONSOLIDATED BALANCE SHEETS                                
|                                                           
|U.S. dollars in thousands (except share and per share data)

|                                                              |  | December 31,
|------------------------------------------------------------- |  | ------------
|
|
|
|
|ASSETS                                                        |  |             
|CURRENT ASSETS:                                               |  |             
|Cash and cash equivalents                                     |  |             
|Cash held in favor of other consortium partners               |  |             
|Short-term deposits                                           |  |             
|Marketable securities held to maturity                        |  |             
|Investment in Evogene                                         |  |             
|Trade receivables                                             |  |             
|Other accounts receivable and prepaid expenses                |  |             
|Assets related to discontinued operations                     |  |             
|                                                              |  |             
|                                                              |  |             
|Total current assets                                          |  |             
|                                                              |  |             
|                                                              |  |             
|LONG-TERM INVESTMENTS AND RECEIVABLES:                        |  |             
|Marketable securities held to maturity                        |  |             
|Long-term lease deposits                                      |  |             
|Investment in Evogene                                         |  |             
|Severance pay fund                                            |  |             
|                                                              |  |             
|                                                              |  |             
|                                                              |  |             
|                                                              |  |             
|                                                              |  |             
|PROPERTY AND EQUIPMENT, NET                                   |  |             
|                                                              |  |             
|                                                              |  |             
|Total assets                                                  |  |             
|                                                              |  |             
|                                                              |  |             
|LIABILITIES AND SHAREHOLDERS' EQUITY                          |  |             
|CURRENT LIABILITIES:                                          |  |             
|Trade payables                                                |  |             
|Other accounts payable and accrued expenses                   |  |             
|Deferred revenue                                              |  |             
|Liabilities related to discontinued operations                |  |             
|                                                              |  |             
|                                                              |  |             
|Total current liabilities                                     |  |             
|                                                              |  |             
|                                                              |  |             
|LONG-TERM LIABILITIES:                                        |  |             
|Accrued severance pay                                         |  |             
|                                                              |  |             
|                                                              |  |             
|Total long-term liabilities                                   |  |             
|                                                              |  |             
|                                                              |  |             
|COMMITMENTS AND CONTINGENCIES                                 |  |             
|                                                              |  |             
|SHAREHOLDERS' EQUITY:                                         |  |             
|Share capital:                                                |  |             
|Ordinary shares of NIS 0.01 par value: 50,000,000 shares      |  |             
|authorized at December 31, 2008 and 2007; and 28,512,440 and  |  |             
|28,323,811 shares issued and outstanding at December 31, 2008 |  |             
|and 2007, respectively                                        |  |             
|Additional paid-in capital                                    |  |             
|Accumulated other comprehensive income                        |  |             
|Accumulated deficit                                           |  |             
|                                                              |  |             
|                                                              |  |             
|Total shareholders' equity                                    |  |             
|                                                              |  |             
|                                                              |  |             
|Total liabilities and shareholders' equity                    |  |             
|                                                              |  |             

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

|                                            |                                                     |                                                  
|------------------------------------------- | --------------------------------------------------- | -------------------------------------------------
|
|
|
|
|March 16, 2009                              |                                                     |                                                  
|                                            |                                                     |                                                  
|Date of approval of thefinancial statements | Martin GerstelPresident and Chief Executive Officer | Dikla Czaczkes - AxselbradChief Financial Officer

F - 3

---

---

COMPUGEN LTD. AND ITS SUBSIDIARIES

|                                                           
|-----------------------------------------------------------
|CONSOLIDATED STATEMENTS OF OPERATIONS                      
|                                                           
|U.S. dollars in thousands (except share and per share data)

|                                                                                                                                                                      |  | Year ended December 31,
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -----------------------
|
|
|
|
|Revenues                                                                                                                                                              |  |                        
|                                                                                                                                                                      |  |                        
|                                                                                                                                                                      |  |                        
|Cost of revenues                                                                                                                                                      |  |                        
|                                                                                                                                                                      |  |                        
|Research and development expenses, net of governmental   and other grants amounting to $ 544, $ 1,354 and   $ 1,670 for the years 2008, 2007 and 2006,   respectively |  |                        
|Selling and marketing expenses                                                                                                                                        |  |                        
|General and administrative expenses                                                                                                                                   |  |                        
|                                                                                                                                                                      |  |                        
|                                                                                                                                                                      |  |                        
|Total operating expenses *)                                                                                                                                           |  |                        
|                                                                                                                                                                      |  |                        
|                                                                                                                                                                      |  |                        
|Operating loss                                                                                                                                                        |  |                        
|                                                                                                                                                                      |  |                        
|Financial income, net                                                                                                                                                 |  |                        
|Other income, net                                                                                                                                                     |  |                        
|                                                                                                                                                                      |  |                        
|                                                                                                                                                                      |  |                        
|Loss before taxes on income                                                                                                                                           |  |                        
|                                                                                                                                                                      |  |                        
|Taxes on income                                                                                                                                                       |  |                        
|                                                                                                                                                                      |  |                        
|                                                                                                                                                                      |  |                        
|Loss from continuing operations                                                                                                                                       |  |                        
|Loss from discontinued operations                                                                                                                                     |  |                        
|                                                                                                                                                                      |  |                        
|                                                                                                                                                                      |  |                        
|Net loss                                                                                                                                                              |  |                        
|                                                                                                                                                                      |  |                        
|                                                                                                                                                                      |  |                        
|Basic and diluted net loss per share from continuing                                                                                                                  |  |                        
|operations                                                                                                                                                            |  |                        
|                                                                                                                                                                      |  |                        
|Basic and diluted net loss per share from discontinued                                                                                                                |  |                        
|operations                                                                                                                                                            |  |                        
|                                                                                                                                                                      |  |                        
|Basic and diluted net loss per share                                                                                                                                  |  |                        
|                                                                                                                                                                      |  |                        
|                                                                                                                                                                      |  |                        
|Weighted average number of Ordinary shares used in                                                                                                                    |  |                        
|computing basic and diluted net loss per share                                                                                                                        |  |                        
|                                                                                                                                                                      |  |                        

|*) | Includes
stock-based compensation, see Note 11.
|-- | -----------------------------------------------

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

F - 4

---

---

COMPUGEN LTD. AND ITS SUBSIDIARIES

|                                             
|---------------------------------------------
|STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
|                                             
|U.S. dollars in thousands (except share data)

|                                                                                                                      | Ordinary shares | Additionalpaid-incapital | Accumulated
other
comprehensive
income | Deferred
stock
compensation | Accumulateddeficit | Total
shareholders'
equity | Total other
comprehensive
loss
|--------------------------------------------------------------------------------------------------------------------- | --------------- | ------------------------ | -------------------------------------- | --------------------------- | ------------------ | -------------------------- | ------------------------------
|
|
|
|
|Balance as of January 1, 2006                                                                                         |                 |                          |                                        | 27,846,420                  |                    | $                          | 75                            
|                                                                                                                      |                 |                         
|Employee options exercised                                                                                            |                 |                          |                                        | 315,782                     |                    |                            | 1                             
|Reclassification due to adoption of SFAS 123(R)                                                                       |                 |                          |                                        | -                           |                    |                            | -                             
|                                                                                                                      |                 |                         
|Stock-based compensation relating to options and warrants issued to scientific advisory board members and consultants |                 |                          |                                        | -                           |                    |                            | -                             
|Stock-based compensation relating to options issued to employees                                                      |                 |                          |                                        | -                           |                    |                            | -                             
|Net loss                                                                                                              |                 |                          |                                        | -                           |                    |                            | -                             
|                                                                                                                      |                 |                          |                                        |                             |                    |                            |                               
|                                                                                                                      |                 |                         
|Total comprehensive loss                                                                                              |                 |                          |                                        |                             |                    |                            |                               
|                                                                                                                      |                 |                          |                                        |                             |                    |                            |                               
|                                                                                                                      |                 |                         
|Balance as of December 31, 2006                                                                                       |                 |                          |                                        | 28,162,202                  |                    |                            | 76                            
|                                                                                                                      |                 |                         
|Employee options exercised                                                                                            |                 |                          |                                        | 152,347                     |                    |                            | 1                             
|Issuance of shares to the CEO                                                                                         |                 |                          |                                        | 9,262                       |                    |                            | *)  -                         
|Stock-based compensation relating to options and warrants issued to scientific advisory board members and consultants |                 |                          |                                        | -                           |                    |                            | -                             
|Stock-based compensation relating to options issued to employees                                                      |                 |                          |                                        |                             |                    |                            |                               
|Expired options granted to subsidiary's employees                                                                     |                 |                          |                                        | -                           |                    |                            | -                             
|Cumulative impact of change in accounting for uncertainties in income                                                 |                 |                         
|taxes                                                                                                                 |                 |                          |                                        | -                           |                    |                            | -                             
|Unrealized gain on the investment in Evogene                                                                          |                 |                          |                                        | -                           |                    |                            | -                             
|Net loss                                                                                                              |                 |                          |                                        | -                           |                    |                            | -                             
|                                                                                                                      |                 |                          |                                        |                             |                    |                            |                               
|                                                                                                                      |                 |                         
|Total comprehensive loss                                                                                              |                 |                          |                                        |                             |                    |                            |                               
|                                                                                                                      |                 |                          |                                        |                             |                    |                            |                               
|                                                                                                                      |                 |                         
|Balance as of December 31, 2007                                                                                       |                 |                          |                                        | 28,323,811                  |                    |                            | 77                            
|                                                                                                                      |                 |                         
|Employee options exercised                                                                                            |                 |                          |                                        | 173,629                     |                    |                            | *) -                          
|Issuance of shares to the CEO                                                                                         |                 |                          |                                        | 15,000                      |                    |                            | *) -                          
|Stock-based compensation relating to options and warrants issued to scientific advisory board members and consultants |                 |                          |                                        | -                           |                    |                            | -                             
|Stock-based compensation relating to options issued to employees                                                      |                 |                          |                                        | -                           |                    |                            | -                             
|Unrealized gain on the investment in Evogene                                                                          |                 |                          |                                        | -                           |                    |                            | -                             
|Net loss                                                                                                              |                 |                          |                                        | -                           |                    |                            | -                             
|                                                                                                                      |                 |                          |                                        |                             |                    |                            |                               
|                                                                                                                      |                 |                         
|Total comprehensive loss                                                                                              |                 |                          |                                        |                             |                    |                            |                               
|                                                                                                                      |                 |                          |                                        |                             |                    |                            |                               
|                                                                                                                      |                 |                         
|Balance as of December 31, 2008                                                                                       |                 |                          |                                        | 28,512,440                  |                    | $                          | 77                            
|                                                                                                                      |                 |                          |                                        |                             |                    |                            |                               
|                                                                                                                      |                 |                          |                                        |                             |                    |                            |                               

|*) | Represents
an amount lower than $ 1.
|-- | ------------------------------------

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

F - 5

---

---

COMPUGEN LTD. AND ITS SUBSIDIARIES

|                                     
|-------------------------------------
|CONSOLIDATED STATEMENTS OF CASH FLOWS
|                                     
|U.S. dollars in thousands            

|                                                                     | Year ended December 31,
|-------------------------------------------------------------------- | -----------------------
|
|
|
|
|Cash flows from operating activities:                                |                        
|                                                                     |                        
|Net loss                                                             |                        
|Adjustments required to reconcile net loss to net cash used in       |                        
|operating activities:                                                |                        
|Loss from discontinued operations                                    |                        
|Compensation relating to options and warrants issued to              |                        
|scientific advisory board members and consultants                    |                        
|Compensation relating to options issued to employees                 |                        
|Fair value of shares issued to CEO                                   |                        
|Depreciation                                                         |                        
|Accrued severance pay, net                                           |                        
|Interest and amortization of premium on deposits and marketable      |                        
|securities                                                           |                        
|Capital loss (gain)                                                  |                        
|Decrease (increase) in trade receivables                             |                        
|Decrease (increase) in other accounts receivable and prepaid         |                        
|expenses                                                             |                        
|Increase (decrease) in trade payables and other accounts payable     |                        
|and accrued expenses                                                 |                        
|Increase (decrease) in deferred revenue                              |                        
|                                                                     |                        
|                                                                     |                        
|Net cash used in operating activities from continuing operations     |                        
|                                                                     |                        
|                                                                     |                        
|Net cash provided by (used in) operating activities from             |                        
|discontinued operations                                              |                        
|                                                                     |                        
|                                                                     |                        
|Net cash used in operating activities                                |                        
|                                                                     |                        
|                                                                     |                        
|Cash flows from investing activities:                                |                        
|                                                                     |                        
|Purchase of marketable securities                                    |                        
|Proceeds from redemption of deposits and maturities of marketable    |                        
|securities                                                           |                        
|Investment in bank deposits                                          |                        
|Purchase of property and equipment                                   |                        
|Decrease (increase) in long-term lease deposits                      |                        
|Proceeds from sale of property and equipment                         |                        
|                                                                     |                        
|                                                                     |                        
|Net cash provided by investing activities from continuing operations |                        
|                                                                     |                        
|                                                                     |                        
|Net cash provided by (used in) investing activities from             |                        
|discontinued operations                                              |                        
|                                                                     |                        
|                                                                     |                        
|Net cash provided by investing activities                            |                        
|                                                                     |                        
|                                                                     |                        
|Cash flows from financing activities:                                |                        
|                                                                     |                        
|Proceeds from exercise of options                                    |                        
|                                                                     |                        
|                                                                     |                        
|Net cash provided by financing activities                            |                        
|                                                                     |                        
|                                                                     |                        
|Increase (decrease) in cash and cash equivalents                     |                        
|Decrease in cash and cash equivalents from discontinued operations   |                        
|Cash and cash equivalents at the beginning of the year               |                        
|                                                                     |                        
|                                                                     |                        
|Cash and cash equivalents at the end of the year                     |                        
|                                                                     |                        

Supplemental information on
financing activities not involving cash flow:

In December 2005, the Company issued
shares as a result of exercise of options in the amount of $ 104. The Company
received the proceeds from the exercise of the options in January 2006.

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

F - 6

---

---

COMPUGEN LTD. AND ITS SUBSIDIARIES

|                                             
|---------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   
|                                             
|U.S. dollars in thousands (except share data)

|NOTE 1: | - | GENERAL
|------- | - | -------

| | a. | Compugen
Ltd. (the Company or Compugen) is an early                stage
drug and diagnostic discovery company. The Companys business is
               focused on developing and using predictive computer-based discovery
platforms to                discover potential therapeutic drug candidates and diagnostic
biomarker                candidates. The Company uses experimental biological processes
to validate                product candidates discovered by its predictive platforms. The
Company seeks to                enter into early stage commercial collaborations with
third parties, to develop                candidates that the Company has validated. The
Companys initial discovery                efforts have focused mainly on cancer,
cardiovascular and immune-related                diseases.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Companys headquarters and research facilities are located in Israel.
| | -------------------------------------------------------------------------

| | b. | Investment in Evogene:
| | -- | ----------------------

| | In
1999, the Company established a division focusing on agricultural biotechnology and plant
genomics called Evogene Ltd (Evogene). Evogene is an Israeli corporation
primarily engaged in delivering improved plant traits to the agbio industry through the
use of a platform combining computational genomics, molecular biology and breeding
methods. Following an equity investment round with certain investors in February 2006, in
which the Companys holdings were diluted to less than 20% of Evogenes
ordinary shares and through June 2007, the investment in Evogene was accounted for under
the cost method of accounting, in accordance with Accounting Principles Board Opinion No.
18, The Equity Method of Accounting for Investments in Common Stock. During
June 2007, Evogene completed an initial public offering on the Tel Aviv Stock
Exchange. Prior to the IPO, the excess of losses over investment in Evogene amounted to $ 466
and was presented as a liability included in the Companys balance sheet that
represents excess of losses sustained by Compugen over its investment through the
deconsolidation date. In August 2008, Evogene signed a collaboration agreement involving
an additional equity investment, with a third party. As a consequence of the IPO and the
additional equity investment, the Company currently holds 2,150,000 shares representing approximately
9% of Evogene outstanding Ordinary shares.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of June 30, 2007, the investment in Evogene was accounted for as available-for-sale
marketable security in accordance with Statement of Financial Accounting Standard No.
115, Accounting for Certain Investments in Debt and Equity Securities (SFAS
115).
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Available-for-sale
securities are carried at fair value, with the recognized gains and losses reported as a
separate component of stockholders equity under accumulated other comprehensive
income in the consolidated balance sheet (see Note 5b).
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | In
August 2004, the Company spun off its computational chemistry activity into a
               wholly-owned subsidiary, Keddem BioScience Ltd. (Keddem).
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------

| | Keddem
experienced recurring losses from operations and had a net capital deficiency. These
matters raised substantial doubts about Keddems ability to continue as a going
concern. During the second quarter of 2007, in view of the fact that there were no
assurances that additional financing would be achieved, the Company decided to suspend
Keddems operations and as such, it was classified as discontinued operation in
accordance with Statement of Financial Accounting Standards No. 144, Accounting for
Impairment or Disposal of Long-Lived Assets and EITF No. 03-13, Applying the
Conditions in Paragraph 42 of FASB Statement No.
                    144, Accounting for the Impairment or Disposal of Long-Lived Assets,
in           Determining Whether to Report Discontinued Operations. Accordingly,
the           results of operations, including the results for the years ended
          December 31, 2008, 2007 and 2006, have been reclassified in the
          accompanying statements of operations as discontinued operations. The
          Companys balance sheets at December 31, 2008 and December 31, 2007
          reflect the net assets and net liabilities of discontinued operations within
          current liabilities and current assets.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 7

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COMPUGEN LTD. AND ITS SUBSIDIARIES

|                                          
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

|NOTE 1: | - | GENERAL
(Cont.)
|------- | - | ---------------

| | In
2008, following the discontinuance of Keddems activities, the Company entered into
a term sheet agreement with Mada Ltd. (Mada), a newly formed company owned
and managed by the former two Co-CEOs of Keddem, whereby the Company will license the
Keddem intellectual property to Mada, in exchange for royalties on any future revenues
and certain access rights to any developed technology and subject to a third party
financing. Mada intends to seek third party funding for the development of this
intellectual property but the Company can give no assurances that it will be successful
in doing so.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | d. | In
1997, the Company established its wholly-owned U.S. subsidiary, Compugen USA,
               Inc. and in 2008, its wholly-owned UK subsidiary, Compugen UK Ltd.                 However,
in view of the Companys current corporate needs, neither of these
               subsidiaries is anticipated to have any significant operations during
2009.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | e. | The
Companys net loss and negative cash flow from operating activities as
               of December 31, 2008 amounted to $ 12,527 and $ 10,012,
respectively.                The Companys business is focused on research and
development activities.                To date, the Company has received only minimal
revenues from its initial                licensing activities.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Board of Directors of the Company has adopted a contingency plan that includes various
cost reduction measures which in the absence of obtaining the required additional
funding, (including but not limited to, from the sale of Evogene shares or otherwise)
would enable the Company to continue to support its operations through December 31, 2009.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|NOTE 2: | - | SIGNIFICANT ACCOUNTING POLICIES
|------- | - | -------------------------------

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

| | a. | Use of estimates:
| | -- | -----------------

| | The
preparation of financial statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes. Actual results could differ
from those estimates.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 8

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COMPUGEN LTD. AND ITS SUBSIDIARIES

|                                          
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

|NOTE 2: | - | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|------- | - | ---------------------------------------

| | b. | Financial statements in U.S. dollars:
| | -- | -------------------------------------

| | The
functional currency of the Company and its subsidiaries is the U.S. dollar, as the Companys
management believes that the U.S. dollar is the primary currency of the economic
environment in which the Company and its subsidiaries have operated and expect to
continue to operate in the foreseeable future. A majority of the Companys sales
were made and are expected to be made outside Israel in U.S. dollars. The majority of the
Company and its subsidiaries operations are currently conducted in Israel and most
of the expenses in Israel are currently paid in new Israeli shekels (NIS).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Accordingly,
monetary accounts maintained in currencies other than the dollar are remeasured into U.S.
dollars in accordance with Statement of the Financial Accounting Standard Board (SFAS)
No. 52, Foreign Currency Translation. All transaction gains and losses of the
remeasured monetary balance sheet items are reflected in the statement of operations as
financial income or expenses, as appropriate.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | Basis of consolidation:
| | -- | -----------------------

| | The
consolidated financial statements include the accounts of the Company and its
wholly-owned subsidiaries Compugen USA Inc. and Compugen UK Ltd. Intercompany
transactions and balances have been eliminated upon consolidation.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | d. | Cash and cash equivalents:
| | -- | --------------------------

| | The
Company and its subsidiaries consider all highly liquid investments that are convertible
to cash with original maturities of three months or less at their acquisition date as
cash equivalents.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | e. | Marketable securities:
| | -- | ----------------------

| | The
Company accounts for its investments in marketable securities using SFAS No. 115, Accounting
for Certain Investments in Debt and Equity Securities.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------

| | Management
determines the appropriate classification of its investments in marketable debt at the
time of purchase and re-evaluates such determinations at each balance sheet date. To
date, all debt securities have been classified as held-to-maturity as the Company has the
positive intent and ability to hold the securities to maturity.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | These
investments are stated at amortized cost, including accrued interest. Amortization of the
premium and the accretion of discounts and interest are included in financial income,
net. The Companys investment holdings have been classified in the consolidated
balance sheet according to the maturity date.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Securities
classified as available-for-sale are stated at fair value, with unrealized gains and
losses reported in accumulated other comprehensive income, a separate component of
stockholders equity.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 9

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COMPUGEN LTD. AND ITS SUBSIDIARIES

|                                          
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

|NOTE 2: | - | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|------- | - | ---------------------------------------

| | According
to Staff Accounting Bulletin No. 59, Accounting for Noncurrent Marketable Equity
Securities (SAB No. 59), management is required to evaluate each period
whether a securitys decline in value is other than temporary. The Company also
follows the guidance provided by FSP FAS 115-1 The Meaning of Other-Then-Temporary
Impairment and Its Application to Certain Investments, to assess whether its
investment with unrealized loss position are other than temporarily impaired. Realized
gains and declined in value judged to be other than temporary are determined based on the
specific identification method and are reported to the statement of operations.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | f. | Long-term lease deposits:
| | -- | -------------------------

| | Long-term
lease deposits include long-term deposits as security for motor vehicles leases.
| | ------------------------------------------------------------------------------------------

| | g. | Property and equipment:
| | -- | -----------------------

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

| |                                           | %                                               
| | ----------------------------------------- | ------------------------------------------------
|
|
|
|
| | Computers, software and related equipment | 33                                              
| | Laboratory equipment and office furniture | 6-30 (mainly 30%)                               
| | Leasehold improvements                    | Shorter of the term of the lease or useful  life
| |                                           |                                                 

| | h. | Impairment of long-lived assets:
| | -- | --------------------------------

| | The
long-lived assets of the Company and its subsidiaries are reviewed for impairment in
accordance with SFAS No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets, whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of assets to be held
and used is measured by a comparison of the carrying amount of an asset with the future
undiscounted cash flows expected to be generated by the assets. If such assets are
considered to be impaired, the impairment to be recognized is measured by the amount by
which the carrying amount of the assets exceeds the fair value of the assets. During the
years 2006, 2007 and 2008, no impairment losses have been identified.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | i. | Revenue recognition:
| | -- | --------------------

| | The
Company generated revenues from collaboration research agreement, under which the Company
delivered a number of peptides and performed related services to a customer, and from
license fees for software products, as follows:
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company recognized revenues from the collaboration agreement in accordance with SAB 104,
Revenue Recognition and EITF No. 00-21, Revenue Arrangements
with Multiple Deliverables.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 10

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COMPUGEN LTD. AND ITS SUBSIDIARIES

|                                          
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

|NOTE 2: | - | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|------- | - | ---------------------------------------

| | Maintenance
and support revenues included in these arrangements are deferred and recognized on a
straight-line basis over the term of the maintenance and support agreement. The VSOE of
fair value of the undelivered elements (maintenance, support and professional services)
is determined based on the price charged for the undelivered element when sold separately
or based on renewal rate.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Revenues
from software license recognized in accordance with Statement of Position (SOP)
97-2, Software Revenue Recognition (SOP 97-2), as amended, when
persuasive evidence of an agreement exists, delivery of the product or service has
occurred, no significant obligations with regard to implementation remain, the fee is
fixed or determinable, and collectability is probable. SOP 97-2 generally requires
revenues earned on software arrangements involving multiple elements to be allocated to
each element based on the relative fair value of the elements. SOP 98-9 requires that
revenues be recognized under the Residual Method when vendor specific
objective evidence (VSOE) of fair value exists for all undelivered elements and no VSOE
exists for the delivered elements and all revenue recognition criteria of SOP 97-2, as
amended, are satisfied.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Revenues
from software license fees that involve customization of the Companys software to
customer specific specifications, development services, integration and installation are
recognized in accordance with SOP 81-1, Accounting for Performance of
Construction-Type and Certain Production-Type Contracts (SOP 81-1),
using contract accounting on a percentage of completion method, over the period from
signing of the license through to customer acceptance in accordance with the Input
Method. After delivery, if uncertainty exists about customer acceptance of the
software, license revenue is not recognized until acceptance. For the years ended
December 31, 2008, 2007 and 2006, the Company recognized revenues in accordance with SOP
81-1 in the amount of $ 0, $ 0 and $ 200, respectively.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Deferred
revenues include amounts received from customers for which revenue has not been
recognized.
| | ----------------------------------------------------------------------------------------------------

| | j. | Research and development expenses, net:
| | -- | ---------------------------------------

| | Research
and development expenses are charged to the statement of operations as incurred.
| | -----------------------------------------------------------------------------------------

| | Royalty
and non-royalty bearing grants from the Office of the Chief Scientist of the Israel
Ministry of Industry, Trade & Labor (OCS), the Bi-national Industrial
Research and Development Foundation (BIRD) and the European 6thframework
for funding approved research and development projects, are recognized at the time the
Company is entitled to such grants, on the basis of the research and development expenses
incurred. Such grants are presented as a reduction from research and development expenses.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 11

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COMPUGEN LTD. AND ITS SUBSIDIARIES

|                                          
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

|NOTE 2: | - | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|------- | - | ---------------------------------------

| | k. | Severance pay:
| | -- | --------------

| | The
Companys liability for severance pay for 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.
Some employee arrangements are under section 14 to the Israeli Severance Pay Law, 1963,
pursuant to which the severance pay liability is fully covered by the deposits with the
severance pay funds. Regarding employees that have signed section 14, related obligation
and amounts deposited on behalf of such obligation are not stated on the balance sheet as
they are legally released from obligation to such employees once the deposited amounts
have been paid. Employees are entitled to one months salary for each year of
employment or a portion thereof. The Companys liability for all of its employees is
fully provided by monthly deposits with insurance policies and by an accrual. The value
of these policies is recorded as an asset in the Companys balance sheet.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
deposited funds may be withdrawn only upon the fulfillment of the obligation pursuant to
Israels Severance Pay Law or labor agreements. The value of the deposited funds is
based on the cash surrendered value of these policies, and includes profits or losses
accumulated up to the balance sheet date.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Severance
expenses for the years ended December 31, 2008, 2007 and 2006 amounted to approximately $ 397,
$ 329 and $ 317, respectively.
| | ---------------------------------------------------------------------------------------------------------------------------------------

| | l. | Accounting for stock-based compensation:
| | -- | ----------------------------------------

| | At
December 31, 2008, the Company has two stock-based employee compensation plans, which are
described more fully in Note 10. Effective January 1, 2006, the Company adopted SFAS No. 123
(revised 2004), Share-Based Payment, or SFAS 123R, which requires all
share-based payments to employees, including grants of employee stock options, restricted
stock units and employee stock purchase rights, to be recognized in the financial
statements based upon their respective grant date fair values, and does not allow the
previously permitted pro forma disclosure-only method as an alternative to financial
statement recognition. SFAS 123R supersedes Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees, or APB 25, and related
interpretations and amends SFAS No. 95, Statement of Cash Flows.
SFAS 123R also requires the benefits of tax deductions in excess of recognized
compensation cost be reported as a financing cash flow, rather than as an operating cash
flow as required under previous literature. In March 2005, the Securities and Exchange
Commission (SEC) issued SAB No. 107, Share-Based Payment,
or SAB 107, which provides guidance regarding the interaction of SFAS 123R and
certain SEC rules and regulations. The Company has applied the provisions of SAB 107
in its adoption of SFAS 123R.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Effective
January 1, 2006, the Company adopted the fair value recognition provisions of SFAS 123R,
using the modified-prospective-transition method. Under that transition method,
compensation cost recognized includes: (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 Statement 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 123R. Results for prior periods have not been restated.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 12

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COMPUGEN LTD. AND ITS SUBSIDIARIES

|                                          
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

|NOTE 2: | - | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|------- | - | ---------------------------------------

| | m. | Concentrations of credit risks:
| | -- | -------------------------------

| | Financial
instruments that potentially subject the Company and its subsidiaries to concentrations
of credit risk consist principally of cash and cash equivalents, short term deposits and
marketable securities and long-term lease deposits.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
majority of the Companys cash and cash equivalents are invested in U.S. dollar
deposits with major banks in Israel. Management believes that the financial institutions
that hold the Companys investments are financially sound and accordingly, minimal
credit risk exists with respect to these investments.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Companys marketable securities include investments in corporate bonds. Management
believes that those corporations are financially sound, the portfolio is well
diversified, and accordingly, minimal credit risk exists with respect to these marketable
securities.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | n. | Income taxes:
| | -- | -------------

| | The
Company and its subsidiaries account for income taxes in accordance with SFAS No.109,
Accounting for Income Taxes (SFAS No. 109) and FASB
Interpretation, or FIN, No. 48, Accounting for Uncertainty in Income Taxes -
An Interpretation of FASB Statement No. 109, or FIN 48. SFAS No. 109 prescribes
the use of the liability method whereby deferred tax assets and liability account
balances are determined based on differences between financial reporting and tax bases of
assets and liabilities and are measured using the enacted tax rates and laws that will be
in effect when the differences are expected to reverse. The Company and its subsidiaries
provide a valuation allowance, if necessary, to reduce deferred tax assets to their
estimated realizable value. FIN 48 provides detailed guidance for the financial
statement recognition, measurement and disclosure of uncertain tax positions recognized
in an enterprises financial statements in accordance with SFAS No. 109.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Prior
to 2007 the Company determined its tax contingencies in accordance with SFAS No. 5,
Accounting for Contingencies, or SFAS 5. The Company recorded estimated
tax liabilities to the extent the contingencies were probable and could be reasonably
estimated.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | o. | Net loss per share:
| | -- | -------------------

| | Basic
net loss per share is calculated based on the weighted average number of ordinary shares
outstanding during each year. Diluted net loss per share is calculated based on the
weighted average number of ordinary shares outstanding during each year, plus dilutive
potential in accordance with SFAS No. 128, Earnings per Share.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | All
outstanding stock options 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 number of shares related to outstanding options excluded from the calculations of
diluted net loss per share was 7,159,114, 7,058,845 and 6,652,541 for the years ended
December 31, 2008, 2007 and 2006, respectively.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 13

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COMPUGEN LTD. AND ITS SUBSIDIARIES

|                                          
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

|NOTE 2: | - | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|------- | - | ---------------------------------------

| | p. | Fair value of financial instruments:
| | -- | ------------------------------------

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

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

| | The
fair value of marketable securities is based on quoted market prices and does not differ
significantly from the carrying amount (see Note 5).
| | -------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company adopted the provision of FASB Statement 157, Fair Value Measurements and
Certain Related FASB Staff Positions (Statement 157) on January 1,
2008. Statement 157 defines fair value as the price that would be received from selling
an asset or paid to transfer a liability in an orderly transaction between market
participants at the measurement date. When determining the fair value measurements for
assets and liabilities required to be recorded at fair value, the Company considers the
principal or most advantageous market in which it would transact and consider assumptions
that market participants would use when pricing the asset or liability, such as inherent
risk, transfer restrictions, and risk of nonperformance.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Statement
157 also establishes a fair value hierarchy that requires an entity to maximize the use
of observable inputs and minimize the use of unobservable inputs when measuring fair
value. A financial instruments categorization within the fair value hierarchy is
based upon the lowest level of input that is significant to the fair value measurement.
Statement 157 establishes three levels of inputs that may be used to measure fair value:
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | - | Level
1: quoted prices in active markets for identical assets or liabilities;
| | - | -----------------------------------------------------------------------------

| | - | Level
2: inputs other than Level 1 that are observable, either directly or indirectly,
such as quoted prices in active markets for similar assets or liabilities, quoted prices
for identical or similar assets or liabilities in markets that are not active, or other
inputs that are observable or can be corroborated by observable market data for
substantially the full term of the assets or liabilities; or
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | - | Level 3:
unobservable inputs that are supported by little or no market activity and that are
significant to the fair value of the assets or liabilities.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------

| | q. | Derivative instruments:
| | -- | -----------------------

| | None
of the Companys derivatives qualify for hedge accounting under Financial Accounting
Standard Board Statement No. 133, Accounting for Derivative Instruments and Hedging
Activities (SFAS 133). They are recognized on the balance sheet at
their fair value, with changes in the fair value carried to the statements of operations
and included in financial income/expenses.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
the years ended December 31, 2008, 2007 and 2006, the Company recorded net losses from
hedging transactions in the amount of $ 69, $ 0 and $ 0, respectively.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 14

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COMPUGEN LTD. AND ITS SUBSIDIARIES

|                                          
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

|NOTE 2: | - | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|------- | - | ---------------------------------------

| | r. | Recently issued accounting pronouncements:
| | -- | ------------------------------------------

| | In
December 2007, the FASB issued SFAS No. 141R, Business Combinations,
or SFAS 141R. SFAS 141R establishes principles and requirements for how the
acquirer of a business recognizes and measures in its financial statements the
identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in
the acquire. The statement also provides guidance for recognizing and measuring the
goodwill acquired in the business combination and determines what information to disclose
to enable users of the financial statement to evaluate the nature and financial effects
of the business combination.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | SFAS 141R
is effective for financial statements issued for fiscal years beginning after December 15,
2008. Accordingly, any business combinations the Company will be engaged in, will be
recorded and disclosed following existing GAAP until January 1, 2009. The Company
expects SFAS No. 141R will have an impact on its consolidated financial
statements when effective, but the nature and magnitude of the specific effects will
depend upon the nature, terms and size of the acquisitions it consummates after the
effective date.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
December 2007, the FASB issued SFAS 160, Noncontrolling Interests in Consolidated
Financial Statements. 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 does not expect the adoption of SFAS 160 will
have a significant impact on its consolidated financial statements.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
February 2008, the FASB issued FASB Staff Position (FSP) FAS No. 157-2, Effective
Date of FASB Statement No. 157 (FSP 157-2), to delay the effective date
of FASB Statement 157 for one year for certain nonfinancial assets and nonfinancial
liabilities, excluding those that are recognized or disclosed in financial statements at
fair value on a recurring basis (that is, at least annually).  For purposes of
applying the FSP 157-2, nonfinancial assets and nonfinancial liabilities include all
assets and liabilities other than those meeting the definition of a financial asset or a
financial liability in FASB Statement 159.   FSP 157-2 defers the effective
date of Statement 157 to fiscal years beginning after November 15, 2008, and interim
periods within those fiscal years for items within the scope of this FSP 157-2. The
Company does not expect the adoption of FSP 157-2 to have a material impact on its
financial position, results of operations or cash flows.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 15

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COMPUGEN LTD. AND ITS SUBSIDIARIES

|                                          
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

|NOTE 2: | - | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|------- | - | ---------------------------------------

| | In
March 2008, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 161,
Disclosures about Derivative Instruments and Hedging Activities  an Amendment
of FASB Statement No. 133 (SFAS 161). SFAS 161 changes the disclosure
requirements for derivative instruments and hedging activities. SFAS 161 requires
entities to provide enhanced disclosures about how and why an entity uses derivative
instruments; how derivative instruments and related hedged items are accounted for under
SFAS 133 and its related interpretations; and how derivative instruments and related
hedged items affect an entitys financial position, financial performance and cash
flows. This Statement is effective for financial statements issued for fiscal years and
interim periods beginning after November 15, 2008. The Company is currently evaluating
the impact, if any, that SFAS 161 may have on its financial condition and results of
operations. The adoption of SFAS 161 will change its disclosures for derivative
instruments and hedging activities beginning the fiscal year 2009.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted
Accounting Principles. SFAS 162 identifies the sources of accounting principles and
the framework for selecting the principles to be used in the preparation of financial
statements of nongovernmental entities that are presented in conformity with generally
accepted accounting principles in the United States. It is effective 60 days following
the SECs approval of the Public Company Accounting Oversight Board amendments to AU
Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted
Accounting Principles. The Company determined the adoption of SFSP No. 162 does not
have a material impact on its financial position, results of operations or cash flows.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | s. | Certain
reclassifications were made to prior years financial statements to
               conform to the current presentation.
| | -- | -------------------------------------------------------------------------------------------------------------------------------

|NOTE 3: | - | GOVERNMENTAL AND OTHER GRANTS
|------- | - | -----------------------------

| | The
Company received several grants as follows:
| | -----------------------------------------------

| | Royalty
and non-royalty bearing grants from the Office of the Chief Scientist of the Israel
Ministry of Industry, Trade & Labor (OCS), the Bi-national Industrial
Research and Development Foundation (BIRD) and the European 6thframework
for funding approved research and development projects, are presented as a reduction from
research and development expenses.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | a. | Under
the OCS royalty-bearing programs, the Company is not obligated to repay
               any amounts received from the OCS if it does not generate any income from
the                results of the funded research program. If income is generated and the
research                program is successful, the Company is committed to pay royalties
at a rate of 3%                to 5% of sales of the products arising from such research
program, up to a                maximum of 100% of the amount received, linked to the
U.S. dollar (for grants                received under programs approved subsequent to
January 1, 1999, the maximum to                be repaid is 100% plus interest at LIBOR).
For the years ended December 31,                2008, 2007 and 2006, the Company has an
aggregate of paid and accrued royalties                to the OCS in the amount of $ 2,
$ 6 and $ 7, respectively.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 16

---

---

COMPUGEN LTD. AND ITS SUBSIDIARIES

|                                          
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

|NOTE 3: | - | GOVERNMENTAL AND OTHER GRANTS (Cont.)
|------- | - | -------------------------------------

| | b. | Under
the BIRD royalty-bearing program, the Company is not obligated to repay
               any amounts received from BIRD if no income is generated from the results
of the                funded research program. If such income is generated, the Company
is required to                repay BIRD 100% of the grant that the Company received
provided that the                repayment to BIRD is made within the first year
following expiry of the term of                the project. For every year that the
Company does not make these repayments, the                amounts to be repaid
incrementally increase up to an amount of 150% in the fifth                year following
expiry of the term of the project. All amounts to be repaid to                BIRD are
linked to the U.S. Consumer Price Index.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | As
of December 31, 2008, the Companys aggregate contingent
               obligations for payments to OCS and BIRD, based on royalty-bearing
participation                received or accrued, net of royalties paid or accrued,
totaled approximately to                $ 5,508 and $ 500, respectively. The
liability for royalties is                recorded as cost of revenues at the time the
related royalty-bearing sales are                recognized as revenues in the statement
of operations.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | d. | The
Company is coordinating a consortium, SIMAP, in a three-year collaborative
               project, which commenced on January 1, 2006, funded by the European 6th
               framework. The grants the Company receives from this project do not bear
any                repayment royalties. The Company will enjoy the generic knowledge
accumulated in                the collaborative project. As a coordinator of this
project, the Company                receives the consortium funds from the European
Commission and distributes those                funds to the consortium members based on
an agreement between the consortium                members. As of December 31, 2008, the
Company held a pre-payment from the                European Commission amounting to $ 233
that will be distributed to the                consortium members during 2009, according
to the payment schedule detailed in                the consortium agreement. The Company
presented this amount as Cash held                in favor of other consortium
partners.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|NOTE 4: | - | CASH AND CASH EQUIVALENTS
|------- | - | -------------------------

| |                                                                   | December 31,
| | ----------------------------------------------------------------- | ------------
|
|
|
|
| | Bank deposits in U.S. dollars (bearing an annual average interest |             
| | rate of 2.64% and 4.39% for 2008 and 2007, respectively)          |             
| | Bank deposits in Euro (bearing an annual average interest rate of |             
| | 3.25 % and 2.57% for 2008 and 2007, respectively)                 |             
| | Bank deposits in NIS (bearing an annual average interest rate of  |             
| | 2.67% and 3.67% for 2008 and 2007, respectively)                  |             
| | Cash in banks (current accounts)                                  |             
| |                                                                   |             
| |                                                                   |             
| |                                                                   |             
| |                                                                   |             

F - 17

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---

COMPUGEN LTD. AND ITS SUBSIDIARIES

|                                          
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

|NOTE 5: | - | DEPOSITS AND MARKETABLE SECURITIES
|------- | - | ----------------------------------

| | a. | Held- to- maturity marketable securities:
| | -- | -----------------------------------------

| |                 | Amortized cost | Gross unrealized
gains | Gross unrealized
losses | Fair value
| | --------------- | -------------- | ---------------------- | ----------------------- | ----------
|
|
|
|
| | Corporate bonds |                |                        | $                       | 2,058     
| | Bank deposits   |                |                        |                         | 540       
| |                 |                |                        |                         |           
| |                 |                |                       
| |                 |                |                        | $                       | 2,598     
| |                 |                |                        |                         |           

| | As
of December 31, 2008 and 2007, all the Companys securities above were classified as
held-to-maturity (see Note 2e).
| | -----------------------------------------------------------------------------------------------------------------------

| | In
the years 2008 and 2007, the Company did not sell any securities prior to their maturity
and accordingly, did not realize any gains or losses on held-to-maturity securities. The
unrealized losses on the Companys investments in held-to-maturity securities were
caused mainly by interest rate increases, and are considered insignificant. The
contractual terms of these investments do not permit the issuer to settle the securities
at a price less than the amortized cost of the investment. Since the Company has the
ability and intent to hold these investments until the maturity date, the Company does
not consider these investments to be other-than-temporarily impaired at December 31,
2008. To date there were no interest payment defaults and the Companys assessment
of issuers financial position is stable. In addition, the unrealized losses are in
continuous position for a period not more than twelve months.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
scheduled maturities of held-to-maturity securities at December 31, 2008, are as follows:
| | ---------------------------------------------------------------------------------------------

| |                     | Amortized
cost | Estimated
fair value
| | ------------------- | -------------- | --------------------
|
|
|
|
| | Held-to-maturity:   |                |                     
| | Due within one year |                |                     
| |                     |                |                     

| | b. | Available-for-sale marketable security:
| | -- | ---------------------------------------

| | As
discussed in Note 1b, the Company presents its investment in 2,150,000 Evogenes
shares as available-for-sale.
| | -----------------------------------------------------------------------------------------------------------------

| | The
total amount of unrealized gain in the amount of $ 3,222 and $ 976 was included
as a separate component of shareholders equity Accumulated other
comprehensive income for the years ended December 31, 2008 and 2007, respectively
(see Note 1b).
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 18

---

---

COMPUGEN LTD. AND ITS SUBSIDIARIES

|                                          
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

|NOTE 6: | - | FAIR VALUE MEASURMENTS
|------- | - | ----------------------

| | The
Company adopted SFAS No. 157, Fair Value Measurements, (as impacted by FSP
Nos. 157-1 and 157-2) effective January 1, 2008, with respect to fair value measurements
of (a) nonfinancial assets and liabilities that are recognized or disclosed at fair value
in the Companys financial statements on a recurring basis (at least annually) and
(b) all financial assets and liabilities. The Company measures marketable securities
available-for-sale and foreign currency derivative contracts at fair value. Marketable
securities are classified within Level 1 or Level 2. This is because these assets are
valued using quoted market prices or alternative pricing sources and models utilizing
market observable inputs for identical assets. Foreign currency derivative contracts are
classified within Level 2 as the valuation inputs are based on quoted prices and market
observable data of similar instruments.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Companys financial assets measured at fair value on a recurring basis, excluding
accrued interest components, consisted of the following types of instruments as of
December 31, 2008:
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                       | Fair value measurements using input type
| | ------------------------------------- | ----------------------------------------
|
|
|
|
| | Investment in Evogene                 |                                         
| | Foreign currency derivative contracts |                                         
| |                                       |                                         
| |                                       |                                         
| | Total Financials Assets               |                                         
| |                                       |                                         

|NOTE 7: | - | OTHER ACCOUNTS RECEIVABLE AND PREPAID EXPENSES
|------- | - | ----------------------------------------------

| |                                                          | December 31,
| | -------------------------------------------------------- | ------------
|
|
|
|
| | Grants receivable from the Office of the Chief Scientist |             
| | Government authorities                                   |             
| | Severance pay fund - short term                          |             
| | Prepaid expenses                                         |             
| | Accrued interest                                         |             
| | Other                                                    |             
| |                                                          |             
| |                                                          |             
| |                                                          |             
| |                                                          |             

F - 19

---

---

COMPUGEN LTD. AND ITS SUBSIDIARIES

|                                          
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

|NOTE 8: | - | PROPERTY AND EQUIPMENT, NET
|------- | - | ---------------------------

| |                                           | December 31,
| | ----------------------------------------- | ------------
|
|
|
|
| | Cost:                                     |             
| | Computers, software and related equipment |             
| | Laboratory equipment and office furniture |             
| | Leasehold improvements                    |             
| |                                           |             
| |                                           |             
| |                                           |             
| |                                           |             
| | Accumulated depreciation:                 |             
| | Computers, software and related equipment |             
| | Laboratory equipment and office furniture |             
| | Leasehold improvements                    |             
| |                                           |             
| |                                           |             
| |                                           |             
| |                                           |             
| |                                           |             
| | Depreciated cost                          |             
| |                                           |             

| | For
the years ended December 31, 2008, 2007 and 2006, depreciation expenses were
approximately $ 477, $ 633 and $ 911, respectively.
| | ------------------------------------------------------------------------------------------------------------------------------------

|NOTE 9: | - | OTHER ACCOUNTS PAYABLE AND ACCRUED EXPENSES
|------- | - | -------------------------------------------

| |                                                | December 31,
| | ---------------------------------------------- | ------------
|
|
|
|
| | Employees and related accruals                 |             
| | Accrued severance pay - short term             |             
| | Commitments related to European grant plan (a) |             
| | Unrecognized grants (a)                        |             
| | Consultants and Board members                  |             
| | Accrued expenses                               |             
| | Other                                          |             
| |                                                |             
| |                                                |             
| |                                                |             
| |                                                |             

| | (a) | See Note 3.
| | --- | -----------

|NOTE 10: | - | COMMITMENTS AND CONTINGENCIES
|-------- | - | -----------------------------

| | a. | The
Companys headquarters and research facilities are located in Israel.
               Annual minimum future rental commitment under such non-cancelable
operating                lease for the year 2009 is approximately $ 364. The lease
expires on                December 31, 2009.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Rent
expenses for the Company and subsidiary facilities were approximately $ 500, $ 560
and $ 552 for the years ended December 31, 2008, 2007 and 2006, respectively.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | The
Company provided a bank guarantee in the amount of $ 130 in favor of
               its offices lessor in Israel.
| | -- | ----------------------------------------------------------------------------------------------------------------------

| | c. | See
Note 3 for details on commitments in favor of governmental and other grants.
| | -- | --------------------------------------------------------------------------------

F - 20

---

---

COMPUGEN LTD. AND ITS SUBSIDIARIES

|                                          
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

|NOTE 11: | - | SHAREHOLDERS EQUITY
|-------- | - | --------------------

| | a. | Ordinary shares:
| | -- | ----------------

| | The
Ordinary shares confer upon their holders the right to receive notice to participate and
vote in general shareholders meetings of the Company and to receive dividends, if
declared.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | Share option plans:
| | -- | -------------------

| | In
June 1998, the Company adopted the Compugen Ltd. Share Option Plan (1998) (the 1998
Plan), which provides for the grant of options to purchase up to an aggregate of
2,500,000 Ordinary shares to directors, employees and consultants of the Company and its
subsidiaries. On October 22, 2007, the Board of Directors resolved to cancel the then
remaining available for grant options remaining under the 1998 Option Plan
and the Company will therefore not make any further grants under this plan.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
March 2000, the Company adopted the Compugen Ltd. Share Option Plan (2000) (the
2000 Plan), which provides for the grant of options to purchase 1,500,000 Ordinary
shares to employees and consultants of the Company and its subsidiaries. The number of
shares authorized for issuance under the 2000 Plan automatically increases each January 1
by the lesser of 1,500,000 or 4% of the total number of the Companys then
outstanding shares or such lower amount as shall be determined by the Board of Directors.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
general, options granted under these plans vest over a four-year period and expire 10
years from the date of issuance. The exercise price of the options granted under the
plans may not be less than the nominal amount of the shares into which such options are
exercised. Any options that are cancelled or forfeited before expiration become available
for future grants. Subject to 2000 plans, there were 1,116,145 options to purchase shares
available for future grants as of December 31, 2008.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | All
information below relates to options granted to employees, directors (including former
Chairman of the Board (see d below) and consultants (including scientific board members
(see c below).
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Transactions
related to the grant of options to employees, directors and consultants under the above
plans during the year ended December 31, 2008, were as follows:
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                                        | Year ended December 31, 2008
| | ------------------------------------------------------ | ----------------------------
|
|
|
|
| | Options outstanding at beginning of year               |                             
| | Options granted                                        |                             
| | Options exercised                                      |                             
| | Options forfeited                                      |                             
| |                                                        |                             
| |                                                        |                             
| | Options outstanding at end of year                     |                             
| |                                                        |                             
| |                                                        |                             
| | Options vested and expected to vest at end of year (*) |                             
| |                                                        |                             
| |                                                        |                             
| | Exercisable at end of year                             |                             
| |                                                        |                             

| | (*) | The
options expected to vest are based on the Companys historical           forfeiture
rate.
| | --- | ---------------------------------------------------------------------------------------------

F - 21

---

---

COMPUGEN LTD. AND ITS SUBSIDIARIES

|                                          
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

|NOTE 11: | - | SHAREHOLDERS EQUITY (Cont.)
|-------- | - | ----------------------------

| | Weighted
average fair value of options granted during the years 2008, 2007 and 2006 was $ 0.44,
$ 1.02and $ 1.15, respectively.
| | -------------------------------------------------------------------------------------------------------------------------------

| | The
aggregate intrinsic value of the Companys options is the difference between the
fair value of the Companys Ordinary shares and the exercise price, times the number
of options. The total intrinsic value of options exercised during the years ended
December 31, 2008 and 2007 was $ 91 and $ 154, respectively. The total
intrinsic value of options outstanding at December 31, 2008 and 2007 was $ 0 and $ 16,
respectively. The total intrinsic value of options vested and expected to vest at
December 31, 2008 was $ 0 and $ 16, respectively.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2008, the total unrecognized estimated compensation cost related to
non-vested stock options granted prior to that date was $ 2,530, which is expected
to be recognized over a weighted average period of approximately 1.5 years. During the
years ended December 31, 2008, 2007 and 2006, the Company recorded cash received from the
exercise of stock options of $ 295, $ 295 and $ 665, respectively.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company estimates the fair value of stock options granted using the Black-Scholes- option
pricing model (except for options granted to former Chairman of the Board (see d below).
The option pricing model requires a number of assumptions, of which the most significant
are the expected stock price volatility and the expected option term. Expected volatility
was calculated based upon actual historical stock price movements. The expected term of
options granted assumptions are based on the Company historical experience, in accordance
with the guidance of SFAS 123 (R) and SAB 110. The risk-free interest rate is based on
the yield from U.S. treasury bonds with an equivalent term. The Company has historically
not paid dividends and has no foreseeable plans to pay dividends.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company used the following weighted-average assumptions for granted options:
| | --------------------------------------------------------------------------------

| |                         | Year ended December 31,
| | ----------------------- | -----------------------
|
|
|
|
| | Volatility              |                        
| | Risk-free interest rate |                        
| | Dividend yield          |                        
| | Expected life (years)   |                        

| | The
stock-based compensation expenses are based on the straight line method and included in
the following expense categories:
| | -----------------------------------------------------------------------------------------------------------------------------

| |                                     |  | Year ended December 31,
| | ----------------------------------- |  | -----------------------
|
|
|
|
| | Research and development expenses   |  |                        
| | Selling and marketing expenses      |  |                        
| | General and administrative expenses |  |                        
| |                                     |  |                        
| |                                     |  |                        
| |                                     |  |                        
| |                                     |  |                        

F - 22

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---

COMPUGEN LTD. AND ITS SUBSIDIARIES

|                                          
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

|NOTE 11: | - | SHAREHOLDERS EQUITY (Cont.)
|-------- | - | ----------------------------

| | On
March 10, 2006, the Companys Board of Directors approved a reduction in the
exercise price of 1,793,149 stock options that had been granted to employees and not
exercised as at the date of the resolution. Such employee stock options with an exercise
price higher than $ 4.13 were reduced to the share price as of the close of the last
trading day immediately preceding the time of the resolution, this was $ 4.13.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | Options to consultants and scientific advisory board members:
| | -- | -------------------------------------------------------------

| |                                               |  | Year ended December 31, 2008
| | --------------------------------------------- |  | ----------------------------
|
|
|
|
| | Options outstanding at beginning of year      |  |                             
| | Options granted                               |  |                             
| | Options exercised                             |  |                             
| | Options forfeited                             |  |                             
| |                                               |  |                             
| |                                               |  |                             
| | Options outstanding at end of year            |  |                             
| |                                               |  |                             
| |                                               |  |                             
| | Options vested and expected to vest at end of |  |                             
| | year                                          |  |                             
| |                                               |  |                             
| |                                               |  |                             
| | Exercisable  at end of year                   |  |                             
| |                                               |  |                             

| | The
Company accounts for its options and warrants to consultants under the fair value method
of 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. The fair value of these options was estimated using a Black-Scholes
option-pricing model with the following weighted-average assumptions for 2008, 2007 and
2006: risk-free interest rates of 2.77%, 4.15% and 4.83%, respectively, dividend yields
of 0%, volatility factors of the expected market price of the Companys Ordinary
shares of 65%, 51% and 56%, respectively and a weighted-average contractual life of the
options of six years. As for compensation expenses, see also b above.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | d. | On
July 31, 2007, the Company issued to its then Chairman of the Board of
               Directors, options to purchase 500,000 Ordinary shares of the Company at
an                exercise price $ 2.91, which was also the Companys market
share price                at the date of grant, subject to market conditions, as
described below. The                vesting was based on following schedule: 83,333
options were to vest in August                2007 and the remaining 416,667 options were
to vest on a monthly basis over a                period of 40 months thereafter. Each
vested options would not be exercisable if                at the time of exercise, the
closing price of the Companys share was less                than $ 10 per
Ordinary share.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
fair value of these options was estimated using a Monte Carlo simulation model with the
following assumptions: risk-free interest rates of 4.85%, dividend yields of 0%, expected
volatility in range between 35%-65%, and an expected term of the options of seven years.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
total compensation cost related to this grant is $ 567. As of December 31, 2008, the
Company recognized the amount of $ 457, using the accelerated amortization method.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 23

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---

COMPUGEN LTD. AND ITS SUBSIDIARIES

|                                          
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

|NOTE 11: | - | SHAREHOLDERS EQUITY (Cont.)
|-------- | - | ----------------------------

| | On
January 15, 2009, the Companys former Chairman of the Board of Directors provided
Compugen with a letter irrevocably waiving his rights in and to options to purchase
750,000 shares that were outstanding as of January 15, 2009.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | e. | On
July 31, 2007, the Company granted to its then CEO 9,262 Ordinary shares and
               accordingly recorded the amount of $ 28, which represents the shares               fair
value as a compensation cost in the financial statements.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
September 24, 2008, the Company granted to its then CEO 15,000 Ordinary shares and
accordingly recorded the amount of $ 25, which represents the shares fair
value as a compensation cost in the financial statements.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
September 24, 2008, the Company granted to its then CEO 150,000 options, exercisable for
Ordinary shares at $ 1.82 per share. The options shall vest on a monthly basis over
a period of 4 years starting from October 22, 2007.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Pursuant
to the termination agreement signed with Mr. Kotzer, as of the first date after June 30,
2009 that no consulting agreement is in effect between Mr. Kotzer and Compugen, then
after such date, any unvested options shall be terminated and the right to exercise any
then vested options shall be extended to the later of (i) December 31, 2010, or (ii) 12
months following such date on which no consulting arrangement is in effect, subject to
Shareholder approval. Since the stock option modifications provided for in his
termination agreement are subject to shareholder approval, the change in terms was not
accounted for during 2008.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | f. | On February 5, 2007, the Company extended the contractual life of 770,171 options of
employees who had left the Company and some of whom are still working as Companys
consultants. Pursuant to guidance of SFAS 123R, the Company treated the extension of
terms as a re-measurement and since all of the options were vested, the expense in the
amount of $ 353 was recorded in the Companys financial statements.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 24

---

---

COMPUGEN LTD. AND ITS SUBSIDIARIES

|                                          
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

|NOTE 12: | - | GEOGRAPHIC INFORMATION AND MAJOR CUSTOMERS
|-------- | - | ------------------------------------------

| | The
Companys business is currently comprised of one operating segment, the research,
development and commercialization of therapeutic and diagnostic biomarker product
candidates. The nature of the products and services provided by the Company and the type
of customers for these products and services are similar. Operations in Israel and the
United States include research and development, sales and business development. The
Company follows SFAS No. 131, Disclosures about Segments of an Enterprise and
Related Information. Total revenues are attributed to geographic areas based on the
location of the end customer. The following represents the total revenues for the years
ended December 31, 2008, 2007 and 2006 and long-lived assets as of December 31, 2008 and
2007:
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                                | Year ended December 31,
| | ---------------------------------------------- | -----------------------
|
|
|
|
| | Revenues from sales to unaffiliated customers: |                        
| | United States                                  |                        
| | Europe                                         |                        
| | Israel                                         |                        
| |                                                |                        
| |                                                |                        
| | Total revenues                                 |                        
| |                                                |                        

| |                    | December 31, | 
| | ------------------ | ------------ | 
|
|
|
|
| |                    |              | 
| | Long-lived assets: |              | 
| | Israel             |              | 
| | United States      |              | 
| |                    |              | 
| |                    |              | 
| |                    |              | 
| |                    |              | 

| |                                           | Year ended December 31,
| | ----------------------------------------- | -----------------------
|
|
|
|
| | Sales to a single customer exceeding 10%: |                        
| | Customer A                                |                        
| | Customer B                                |                        
| | Customer C                                |                        
| | Customer D                                |                        

|NOTE 13: | - | FINANCIAL INCOME, NET
|-------- | - | ---------------------

| |                           | Year ended December 31,
| | ------------------------- | -----------------------
|
|
|
|
| | Income (expense):         |                        
| | Interest income           |                        
| | Bank fees                 |                        
| | Hedging transactions loss |                        
| | Exchange rate differences |                        
| |                           |                        
| |                           |                        
| |                           |                        
| |                           |                        

F - 25

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---

COMPUGEN LTD. AND ITS SUBSIDIARIES

|                                          
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

|NOTE 14: | - | TAXES ON INCOME
|-------- | - | ---------------

| | a. | Measurement of taxable income under the Income Tax (Inflationary Adjustments)           Law, 1985:
| | -- | --------------------------------------------------------------------------------------------------

| | Results
for tax purposes are measured in terms of earnings in NIS after certain adjustments for
increases in Israels Consumer Price Index (CPI). As explained in Note
2b, the financial statements are measured in U.S. dollars. The difference between the
annual change in Israels CPI and in the NIS/dollar exchange rate causes a further
difference between taxable income and the income before taxes shown in the financial
statements. In accordance with paragraph 9(f) of SFAS No. 109, the Company has not
provided deferred income taxes on the difference between the functional currency and the
tax basis of assets and liabilities.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | According
to the law, until 2007 the results for tax purposes were measured adjusted for changes in
the Israeli CPI.
| | --------------------------------------------------------------------------------------------------------------------

| | In
February 2008 the Knesset (Israeli parliament) passed an amendment to the
Income Tax (Inflationary Adjustments) Law, 1985, which limits the scope of the law
starting 2008 and thereafter. Starting 2008 the results for tax purposes are measured in
nominal values, excluding certain adjustments for changes in the Israeli CPI carried out
in the period up to December 31, 2007. The amendment to the law includes, inter alia, the
elimination of the inflationary additions and deductions and the additional deduction for
depreciation starting 2008.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | Tax benefits under the Law for the Encouragement of Capital Investments, 1959           (the
Law):
| | -- | ----------------------------------------------------------------------------------------------------

| | In
1994, the production facilities of the Company related to its computational technologies
were granted the status of an Approved Enterprise under the Law. In 1996 and
2000, two expansion programs related to the Companys computational technologies
were granted the status of Approved Enterprise. In 1999 and 2003, the
production facilities of the Company related to the Companys molecular biology
wet lab were granted the status of an Approved Enterprise.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | According
to the provisions of the Law, the Company has chosen to enjoy the Alternative
Benefits track. Accordingly, its income from the Approved Enterprisewill
be tax-exempt for a period of two years, commencing in the first year the Company has
taxable income (after commencement of production as defined in the Law), and subject to
an additional period of five to eight years of reduced tax rates between 10% to 25%,
depending upon the proportion of foreign ownership in the Company in each tax year. Due
to the reported losses, the benefit period has not commenced. The period during which
reduced tax rates of between 10% and 25% apply expires on the earlier of 12 years from
the commencement of production, or 14 years, from the date of approval. The years
limitation does not apply to the exemption period.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
entitlement to the above benefits is conditional upon the Companys fulfilling the
conditions stipulated by the above 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 linked to the Israeli Consumer Price Index.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2008, management believes that the Company meets all of the
aforementioned conditions.
| | ---------------------------------------------------------------------------------------------------------

F - 26

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COMPUGEN LTD. AND ITS SUBSIDIARIES

|                                          
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

|NOTE 14: | - | TAXES ON INCOME (Cont.)
|-------- | - | -----------------------

| | If
the Company distributes a dividend out of income derived from the approved enterprise
during the tax exemption period, it will be subject to corporate tax in respect of the
gross amount distributed, including any taxes thereon, at the rate which would have been
applicable had it not enjoyed the alternative benefits, generally 10%-25%, depending on
the percentage of the Companys Ordinary shares held by foreign shareholders. The
dividend recipient is subject to withholding tax at the rate of 15% applicable to
dividends from approved enterprises, if the dividend is distributed during the tax
exemption period or within twelve years thereafter.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Should
the Company derive income from sources other than the Approved Enterpriseduring
the relevant period of benefits, such income will be taxable at the regular corporate tax
rate.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Investment Law was significantly amended effective April 1, 2005. The amendment includes
revisions to the criteria for investments qualified to receive tax benefits as an
Approved Enterprise and among other things, simplifies the approval process. The
amendment applies to new investment programs. Therefore, investment programs commencing
after December 31, 2004, do not affect the approved programs of the Company.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | Tax benefit under the Law for the Encouragement of Industry (Taxation), 1969:
| | -- | -----------------------------------------------------------------------------

| | Management
believes that the Company is currently qualified as an industrial companyunder
the above law and as such, enjoys tax benefits, including:
| | ------------------------------------------------------------------------------------------------------------------------------------------------------

| | (1) | Deduction
of purchase of know-how and patents and/or right to use a patent over                an
eight-year period;
| | --- | --------------------------------------------------------------------------------------------------------------------

| | (2) | The
right to elect, under specified conditions, to file a consolidated tax
               return with additional related Israeli industrial companies and an
industrial                holding company;
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (3) | Accelerated
depreciation rates on equipment and buildings; and
| | --- | --------------------------------------------------------------

| | (4) | Expenses
related to a public offering on the Tel-Aviv Stock Exchange and as of
               January 1, 2003 on recognized stock markets outside of Israel, are
deductible in                equal amounts over three years.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | d. | Net operating losses carryforward:
| | -- | ----------------------------------

| | As
of December 31, 2008, the Companys net operating losses carryforward for tax
purposes in Israel amounted to approximately $ 116 million. These net operating
losses may be carried forward indefinitely and may be offset against future taxable
income. The Company expects that during the period in which these tax losses are utilized
its income would be substantially tax-exempt.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Compugen
Inc. is subject to U.S. income taxes. As of December 31, 2008, Compugen Inc. has net
operating loss carryforwards for federal income tax purposes of approximately $ 15
million which expires in the years 2018 to 2028. Compugen Inc. also has net operating
loss carryforwards for state income tax purposes of approximately $ 10 million which
expires in the years 2013 to 2028. Utilization of the U.S. net operating losses may be
subject to substantial annual limitation due to the change in ownershipprovisions
of the Internal Revenue Code of 1986 and similar state provisions. The annual limitation
may result in the expiration of net operating losses before utilization.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2008, the net operating losses for discontinued operations are in amount
of approximately $ 4 million.
| | -------------------------------------------------------------------------------------------------------------------------

F - 27

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COMPUGEN LTD. AND ITS SUBSIDIARIES

|                                          
|------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

|NOTE 14: | - | TAXES ON INCOME (Cont.)
|-------- | - | -----------------------

| | e. | Loss before taxes is comprised as follows:
| | -- | ------------------------------------------

| |                   | Year ended December 31,
| | ----------------- | -----------------------
|
|
|
|
| | Domestic (Israel) |                        
| | Foreign           |                        
| |                   |                        
| |                   |                        
| |                   |                        
| |                   |                        

| | f. | Deferred 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. The Company and its subsidiaries deferred tax assets are
comprised of operating loss carryforward and other temporary differences. Significant
components of the Company and its subsidiaries deferred tax assets are as follows:
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                                   | December 31,
| | ------------------------------------------------- | ------------
|
|
|
|
| | Accrued Social Benefits                           |             
| | R&D credit                                        |             
| | Operating loss carryforward                       |             
| |                                                   |             
| |                                                   |             
| | Net deferred tax asset before valuation allowance |             
| | Valuation allowance                               |             
| |                                                   |             
| |                                                   |             
| | Net deferred tax asset                            |             
| |                                                   |             

| | The
Company and its subsidiaries have provided valuation allowances in respect of deferred
tax assets resulting from operating loss carryforward and other temporary differences.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Management
currently believes that since the Company and its subsidiaries have a history of losses
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.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | g. | Reconciliation of the theoretical tax expense (benefit) to the actual tax           expense (benefit):
| | -- | ------------------------------------------------------------------------------------------------------

| | The
main reconciling items between the statutory tax rate of the Company and the effective
tax rate are the non-recognition of tax benefits from accumulated net operating losses
carryforward among the Company andvarious subsidiaries due to the uncertainty of
the realization of such tax benefits and the effect of approved enterprise.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
2007, the Company recorded an accrual in the amount of $ 32 in respect with the
withholding taxes due to the conversion of the interest accrued on the inter-company loan.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 28

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COMPUGEN LTD. AND ITS SUBSIDIARIES

|                                             
|---------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   
|                                             
|U.S. dollars in thousands (except share data)

|NOTE 14: | - | TAXES ON INCOME (Cont.)
|-------- | - | -----------------------

| | h. | Tax rates applicable to the income of the Company:
| | -- | --------------------------------------------------

| | In
June 2004, an amendment to the Income Tax Ordinance (No. 140 and Temporary Provision),
2004 was passed by the Knesset (Israeli parliament) and on July 25, 2005,
another law was passed, the amendment to the Income Tax Ordinance (No. 147)
2005,according to which the corporate tax rate is to be progressively reduced to the
following tax rates:2006  31%, 2007  29%, 2008  27%, 2009  26%,
2010 and thereafter  25%.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | i. | The Company adopted the provisions of FIN 48 on January 1, 2007.
| | -- | ----------------------------------------------------------------

| | A
reconciliation of the beginning and ending amount of unrecognized tax benefits at January
1, 2008 and December 31, 2008 is $ 58.
| | ----------------------------------------------------------------------------------------------------------------------------------

|NOTE 15: | - | RELATED PARTY TRANSACTIONS
|-------- | - | --------------------------

| | In
August 2006, the Company entered into a Software License Agreement with Evogene, under
which the Company agreed to grant Evogene a license to certain software. In consideration
for the grant of the license, Evogene agreed to issue the Company 40,000 Ordinary shares
before December 31, 2006 and an additional 20,000 Ordinary shares within one month
of Evogene entering into its first significant agreement. To date, the Company has been
issued 60,000 Ordinary shares under the Software License Agreement.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
May 2007, the Company entered into an extension to the 2006 Software License Agreement
with Evogene, under which the Company agreed to grant Evogene a license to certain
software in the period between January 1, 2008 and December 31, 2014. In consideration
for the grant of the license, Evogene agreed to pay the Company $ 150 and issue the
Company 100,000 Ordinary shares in Evogene.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 29

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