As filed with the Securities and
Exchange Commission on May 17, 2004.

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

FORM 20-F

|(Mark
  One)
|------------
|            
|            
|            
|            
|            

Commission
File Number 000-29992



OPTIBASE
LTD.(Exact name of Registrant as specified in its charter)

Not Applicable
(Translation of Registrants name into English)

Israel(Jurisdiction of incorporation or organization)

2 Gav Yam
Center
7 Shenkar Street
Herzliya 46120, Israel
+972-9-970-9288(Address of principal executive offices)

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

|Title of Each Class |  | Name of Each Exchange
  on Which Registered
|------------------- |  | -------------------------------------------
|                    |  |                                            
|None                |  | Not Applicable                             

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

Ordinary
Shares,
Nominal value NIS 0.13 per share(Title of class)

Securities for which there is a reporting obligation pursuant to
Section 15(d) of the Act:
Not Applicable
(Title of class)

Indicate the number of
outstanding shares of each of the issuers classes of capital or common stock
as of the close of December 31, 2003, the period covered by the annual report:
12,992,508 Ordinary Shares.

Indicate by check mark
whether the registrant: (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant was required to file
such reports), and (2) has been subject to such filing requirements for the
past 90 days.

Yes
x
No o

Indicate by check mark
which financial statement item the registrant has elected to follow.

Item
17 o
Item 18 x

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TABLE OF CONTENTS

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|PART I | 5       
|       | ITEM 1. 
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2

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|                     | ITEM 11. | QUANTITATIVE AND QUALITATIVE DISCLOSURE
  ABOUT MARKET RISK                    | 75       
|-------------------- | -------- | ------------------------------------------------------------------------------ | ---------
|                     | ITEM 12. | DESCRIPTION OF SECURITIES OTHER THAN EQUITY
  SECURITIES                       | 76       
|                     |          |                                                                                |          
|PART II              | 76      
|                     | ITEM 13. | DEFAULTS, DIVIDEND ARREARAGES AND
  DELINQUENCIES                              | 76       
|                     | ITEM 14. | MATERIAL MODIFICATIONS TO THE RIGHTS OF
  SECURITY HOLDERS AND USE OF PROCEEDS | 77       
|                     | ITEM 15. | CONTORLS AND PROCEDURES                                                        | 77       
|                     | ITEM 16. |                                                                                | 77       
|                     |          | Audit committee expert                                                         | 77       
|                     |          | Code of business conduct
  and ethics                                          | 77       
|                     |          | Fees to auditors                                                               | 77       
|                     | ITEM 17. |                                                                                | 78       
|                     |          |                                                                                |          
|PART III             | 78      
|                     | ITEM 18. | FINANCIAL STATEMENTS                                                           | 78       
|                     | ITEM 19. | EXHIBITS AND FINANCIAL STATEMENTS SCHEDULES                                    | 79       
|FINANCIAL STATEMENTS | F1-F44  
|                     |          | Index to consolidated
  financial statements                                   | F-1      
|                     |          | Report of independent
  auditors                                               | F-2      
|                     |          | Consolidated balance
  sheets                                                  | F-3-F-4  
|                     |          | Consolidated statements
  of operations                                        | F-5      
|                     |          | Statements of changes in
  shareholders equity                                | F-6-F-7  
|                     |          | Consolidated statements
  of cash flows                                        | F-8-F-9  
|                     |          | Notes to consolidated
  financial statements                                   | F-10-F-44
|SIGNATURES           | 81      
|                     |         

3

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Currency
of Presentation and Certain Defined Terms

Unless
the context otherwise requires, references herein to the Company, Optibase,
we, us or our are to Optibase Ltd., a company organized under the laws of
Israel, and its wholly owned subsidiaries, Optibase, Inc., a Californian
corporation, and Optibase B.V., a company organized under the laws of
Netherlands which was dissolved in September 2003. In addition, reference to
our financial statements are to our consolidated financial statements, except
as the context otherwise requires. 
References to U.S. or United States are to the United States of
America, its territories and its possessions.

We
have registered Optibase and the accompanying design, MPEG Organizer,
Progression, VideoPlex and DVDFab! as registered trademarks.  In addition, the names MPEG MovieMaker
200, VideoPlex Xpress, VideoPlex Pro, MPEG MovieMaker, Videoplex,
MPEG ComMotion, MPEG Composer, MPEGLAB VideoPump, MediaPump,
Viewstore, Viewgraphics, DTV:Net and DTV:Com are our trademarks.  This Annual Report also contains trademarks
and trade names of other companies.

In this Annual Report, references to $ or Dollars or
U.S. Dollars are to the legal currency of the United States and references to
NIS are to New Israeli Shekels, the legal currency of Israel.  The Companys financial statements are
presented in accordance with United States generally accepted accounting principles,
or U.S. GAAP.  Except as otherwise
specified, financial information is presented in U.S. Dollars.  References to a particular fiscal year are
to the Companys fiscal year ended December 31 of such year.

Forward-Looking
Statements May Prove Inaccurate

IN
ADDITION TO HISTORICAL INFORMATION, THIS ANNUAL REPORT CONTAINS CERTAIN
FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES
ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF
1934, AS AMENDED.  THE FORWARD-LOOKING
STATEMENTS CONTAINED HEREIN ARE SUBJECT TO CERTAIN RISKS AND UNCERTAINTIES THAT
COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE REFLECTED IN THE
FORWARD-LOOKING STATEMENTS.  FACTORS
THAT MIGHT CAUSE SUCH A DIFFERENCE INCLUDE, BUT ARE NOT LIMITED TO, THOSE
DISCUSSED IN THE SECTIONS ENTITLED RISK FACTORS AND OPERATING AND FINANCIAL
REVIEW AND PROSPECTS AND ELSEWHERE IN THIS REPORT.  READERS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON THESE
FORWARD-LOOKING STATEMENTS, WHICH REFLECT MANAGEMENTS ANALYSIS ONLY AS OF THE
DATE HEREOF.  IN ADDITION, READERS
SHOULD CAREFULLY REVIEW THE OTHER INFORMATION IN THIS ANNUAL REPORT AND IN THE
COMPANYS PERIODIC REPORTS AND OTHER DOCUMENTS FILED WITH THE SECURITIES AND
EXCHANGE COMMISSION FROM TIME TO TIME. WE DO NOT UNDERTAKE ANY OBLIGATION TO
UPDATE ANY FORWARD-LOOKING STATEMENTS, WHETHER AS A RESULT OF NEW INFORMATION,
FUTURE EVENTS OR OTHERWISE.

4

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PartI

Item 1. Identity of Directors, Senior Management and Advisers

Not
required.

Item 2. Offer Statistics and Expected Timetable

Not
required.

Item 3. Key Information

3.A. Selected Financial Data.

We
derived the consolidated statement of operations data for the years ended
December 31, 2001, 2002 and 2003, and consolidated balance sheet data as
of December 31, 2002 and 2003 from the audited consolidated financial
statements appearing elsewhere in this Annual Report.  These financial statements have been prepared in accordance with
accounting principles generally accepted in the United States (U.S.
GAAP).  We derived the consolidated
statement of operations data for the years ended December 31, 1999 and
2000 and the consolidated balance sheet data as of December 31, 1999, 2000
and 2001 from audited consolidated financial statements that are not included
in this Annual Report, which statements have also been prepared in accordance
with U.S. GAAP.  The selected financial
data set forth below should be read in conjunction with ITEM 5 - OPERATING AND FINANCIAL REVIEW AND PROSPECTS and
the financial statements, including the notes thereto, included elsewhere in
this Annual Report.

| |                                                                                           |  | Year Ended December 31,                            |       
| | ----------------------------------------------------------------------------------------- |  | -------------------------------------------------- | ------
| |                                                                                           |  |                                                    |       
| |                                                                                           |  | 1999                                               |       
| |                                                                                           |  |                                                    |       
| |                                                                                           |  | (U.S. dollars in thousands, except per share data) |       
| | Consolidated Statement of Operations Data:                                                |  |                                                    |       
| | Revenues                                                                                  |  | $                                                  | 26,054
| | Cost of revenues                                                                          |  |                                                    | 11,119
| | Gross profit                                                                              |  |                                                    | 14,935
| | Operating expenses:                                                                       |  |                                                    |       
| | Research and development, net                                                             |  |                                                    | 3,078 
| | Selling and marketing, net                                                                |  |                                                    | 6,861 
| | General and administrative                                                                |  |                                                    | 1,682 
| | Impairment of acquired
  intangibles                                                      |  |                                                    |       
| | Restructuring cost                                                                        |  |                                                    |       
| | In process research and
  development write off                                           |  |                                                    |       
| | Total operating expenses                                                                  |  |                                                    | 11,621
| | Operating income (loss)                                                                   |  |                                                    | 3,314 
| | Other income (expenses), net                                                              |  |                                                    | 493   
| | Financial income, net                                                                     |  |                                                    | 547   
| | Net income (loss) before tax                                                              |  |                                                    | 4,354 
| | Provision for tax                                                                         |  |                                                    |       
| | Net income (loss) before
  cumulative effect of 
  changes in accounting principle        |  |                                                    | 4,354 
| | Cumulative effect of changes
  in accounting 
  principle                                 |  |                                                    |       
| | Net income (loss)                                                                         |  | $                                                  | 4,354 
| |                                                                                           |  |                                                    |       
| | Net income (loss) per share:                                                              |  |                                                    |       
| | Basic                                                                                     |  | $                                                  | 0.60  
| | Diluted                                                                                   |  | $                                                  | 0.53  
| | Weighted average shares used in computing net 
  earning (loss) per share (in thousands): |  |                                                    |       
| | Basic                                                                                     |  |                                                    | 6,796 
| | Diluted                                                                                   |  |                                                    | 8,207 

5

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| |                                                                                |  | December 31,                |       
| | ------------------------------------------------------------------------------ |  | --------------------------- | ------
| |                                                                                |  |                             |       
| |                                                                                |  | 1999                        |       
| |                                                                                |  |                             |       
| |                                                                                |  | (U.S. dollars in thousands) |       
| | Consolidated Balance Sheet Data:                                               |  |                             |       
| | Cash, cash equivalents and
  short term 
  investments                         |  | $                           | 22,596
| | Working capital                                                                |  |                             | 25,385
| | Total assets                                                                   |  |                             | 36,654
| | Long term loans and capital lease obligations, 
  including current maturities |  |                             |       
| | Total shareholders equity                                                     |  | $                           | 27,115

3.B
Capitalization and indebtedness

Not
required.

3.C Reasons for the offer and use of
proceeds

Not
required.

3.D
Risk Factors

Our
business operation is subject to various risks resulting from changing
economic, political, industry, business and financial conditions.  In addition, this Annual Report contains
various forward-looking statements that reflect our current views with respect
to future events and financial results. 
Below we attempt to identify and describe the principal uncertainties
and risk factors that in our view at the present time may affect our financial
condition, cash flows and results of operations and our forward-looking
statements.  Readers are reminded that
the uncertainties and risks identified below in this Annual Report do not
purport to constitute a comprehensive list of all the uncertainties and risks,
which may affect our business and the forward-looking statements in this Annual
Report.  In addition, we do not
undertake any obligation to update any forward-looking statements, whether as a result of new information, future
events or otherwise.

(a)          Risks
Relating to Market, Financial Condition and Shareholdings

We
have a history of losses and we might not be able to sustain profitability.Since 2000 and until the quarter ended March 31,
2003, we have been operating at a loss. We returned to profitability in the
quarter ended June 30, 2003 as a result of increased financial income. As of
December 31, 2003, we have accumulated losses of $62.4 million. Given the
market conditions, the uncertainty in the technology sector and the uncertainty
regarding the demand for our products and our research and development and
other expenses, we expect to operate at a loss during 2004. We may not be able
to sustain profitability in the future, and our operating results for future
periods will continue to be subject to numerous uncertainties and risks.  In order to maintain profitability, we will
need, among other matters, to aggressively expand markets for our new products
while continuing to expand market share for our existing products.  We cannot assure you that we will be able to
increase the sales of our products and revenues and sustain profitability.

6

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The
economic outlook may adversely affect the demand for our products and the
results of our operations.The deterioration of the general economy in the United States and
worldwide began in 2000 and continued through 2002, which has especially
curtailed the business opportunities of technology companies.  Although during 2003 there were signs of
improvement in the
economy in the United States and worldwide, there is no assurance that the
improvement will be sustained or that it will lead to an improvement in the
results of our operations. Weak economic conditions have caused, and may
continue to cause, reductions in spending in technology markets in general,
including spending in digital video based products and services.  Consequently, there has been, and may
continue to be, an adverse impact on the demand for our products and services,
which has adversely affected, and may continue to, adversely affect our sales
and results of operations.  In addition,
predictions regarding economic conditions have a low degree of certainty, and
further predicting the effect of the changing economy is even more difficult.  We may not accurately gauge the effect of
the general economy on our business.  As
a result, we may not react to such changing conditions in a timely manner, and
that may result in an adverse impact on our results of operations.  Any such adverse impact to the result of our
operations from a changing economy may cause the price of our ordinary shares
to decline.

The
threat of terrorism worldwide, combined with political unrest in Israel could
have a material adverse effect on our results of operations.  The
threat of the use of weapons of mass destruction and global terrorism are
impacting the global economy. In addition, since September 2000, the State of
Israel and its inhabitants have been subjected to repeated terrorist attacks.
The hostilities between the State of Israel and the Palestinians continued
during the past year. This conflict can have both direct and indirect impacts
on our business as a result of, among other things, military service
obligations of our key employees, changes in monetary and fiscal policies or
the willingness of customers outside Israel to buy our products, including
demands for additional assurances concerning availability of our products.

We
have experienced significant fluctuations in our results of operations at times
in the past and expect these fluctuations to continue. These fluctuations may
result in volatility in our share price.We have
experienced at times in the past, and may in the future experience, significant
fluctuations in our quarterly and annual results.  Factors that may contribute to the fluctuations in our quarterly
results of operations include:

| |  | the timing of purchases of our products by system
  integrators and other large customers;                                                 
| | - | -------------------------------------------------------------------------------------------------------------------------------------------
| |  | the rate of acceptance of new products we introduce;                                                                                       
| |  | the loss of major customers;                                                                                                               
| |  | product introductions and other actions taken by our
  competitors;                                                                        
| |  | market acceptance of video-based Web services;                                                                                             
| |  | market acceptance of IP based video services;                                                                                              
| |  | changing networking standards in the digital video
  industry and our ability to anticipate and react to such changes in a timely
  manner;
| |  | changes in sales and distribution environments and
  costs;                                                                                
| |  | fluctuations in manufacturing yields and delays in
  product shipments;                                                                    
| |  | personnel changes;                                                                                                                         
| |  | changes in foreign exchange rates; and                                                                                                     
| |  | general economic conditions, particularly in those
  countries or regions where we sell our products.                                      

Historically,
the prices of video encoders and decoders and content authoring tools have
decreased over the life of individual products, while the complexity of new
product introductions has increased concurrently.  As a result, we have reduced prices for our products and we
expect to reduce prices in the future. 
In addition, we may have to increase our research, development and
marketing expenditures in response to competitive conditions and the
development of new technologies and products, and we expect to increase such
expenditures in the future. 
Accordingly, investors should not rely on the results of any past
periods as an indication of our future performance.  It is likely that in some future periods, as occurred in the
second quarter of 2002, our operating results may be below expectations of
public market analysts or investors.  If
this occurs, our share price may drop.

The
trading price of our ordinary shares has been highly volatile, and may continue
to fluctuate significantly due to factors beyond our control.The trading price of our ordinary shares is and will continue to be
subject to significant fluctuations in response to numerous factors, including:

| |  | the announcement of new products, services or
  service enhancements by us or our competitors;
| | - | ----------------------------------------------------------------------------------------------
| |  | quarterly variations in our or our competitors
  results of operations;                      
| |  | changes in earnings estimates or recommendations by
  securities analysts;                    

7

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| |  | perceptions of the digital media and networking
  industrys relative strength or weakness;                                                               
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | developments in our industry and change in demand
  for our products; and                                                                                 
| |  | general market conditions and other factors,
  including factors unrelated to our operating performance or the operating
  performance of our competitors.

We
expect this volatility to continue in the future.  In addition, any shortfall or changes in our revenues, gross
margins, earnings or other financial results could cause the price of our
ordinary shares to fluctuate significantly. 
In recent years, the stock market
has experienced significant price and trading volume fluctuations, which have
particularly affected the market price of many technology companies and which
may not be related to the operating performance of those companies.  Volatility in the price of stock of
companies in the digital media and networking industry has been particularly
high.  These broad market fluctuations
have affected and may continue to affect adversely the market price of our
ordinary shares.  In recent years, the
trading price of our ordinary shares has been highly volatile.  From January 2003 through May 7, 2004, the
price of our ordinary shares rose to a high of $8.83 from a low of $1.77.  The fluctuations and factors listed above,
as well as general economic, political and market conditions may further
materially adversely affect the market price of our ordinary shares.

We
may in the future be the target of securities class action or other litigation,
which could be costly and time consuming to defend.In the past, following a period of volatility
in the market price of a companys securities, securities class action lawsuits
have often been instituted against such companies.  We may in the future be the target of similar litigation.  If such a lawsuit were brought against us,
regardless of its outcome, we would incur substantial costs and our management
resources would be diverted in defending such litigation.

We
may not be able to raise additional financing for our future capital needs on
favorable terms, or at all, which could limit our growth and increase our
costs.We received net proceeds in the amount of
approximately $67 million from our secondary public offering in March 2000, and
we spent, or provided to be paid, approximately $37 million in cash as a
component of the consideration paid to acquire the core of Hi-TV in October
2000 and Viewgraphics in December 2000. 
It is probable that we will need to raise additional capital in the
future to continue our longer term expansion plans through acquisitions.  We cannot be certain that we will be able to
obtain additional financing on commercially reasonable terms or at all.  This could inhibit our growth and increase
our operating costs.

Holders
of our ordinary shares who are United States residents face income tax risks.  There is a substantial risk that we will be
classified as a passive foreign investment company, commonly referred to as
PFIC Our treatment as a PFIC could result in a reduction in the after-tax
return to the holders of our ordinary shares and would likely cause a reduction
in the value of such shares.  For U.S.
Federal income tax purposes, we will be classified as a PFIC for any taxable
year in which either (i) 75% or more of our gross income is passive income, or
(ii) at least 50% of the average value of all of our assets for the taxable
year produce or are held for the production of passive income.  For this purpose, passive income includes
dividends, interest, royalties, rents, annuities and the excess of gains over
losses from the disposition of assets that produce passive income, cash is
considered to be an asset, which produces passive income. As a result of our
substantial cash position and the fluctuation in the value of our stock,
including the relatively lower price of our stock in the earlier part of 2003,  there is a substantial risk that we will be
classified as a PFIC under a literal application of the asset test described
above, which looks solely to the market value. 
If we are to be a PFIC for U.S. federal income tax purposes, highly
complex rules would apply to U.S. Holders owning ordinary shares.  Accordingly, you are urged to consult your
tax advisors regarding the application of such rules. In addition, there can be
no assurance that we will not be classified as a PFIC in the future, because
the determination of whether we are a PFIC is based upon the composition of our
income and assets from time to time, and such determination cannot be made with
certainty until the end of a calendar year. United States residents should
carefully read ITEM 10E. ADDITIONAL INFORMATION - TAXATION, UNITED STATES FEDERAL INCOME TAX CONSEQUENCES
for a more complete discussion of the U.S. federal income tax risks related to
owning and disposing of our ordinary shares.

Our
officers, directors and affiliated entities own a large percentage of our
ordinary shares and could significantly influence the outcome of actions.Our executive officers, directors and
entities affiliated with them, in the aggregate, beneficially own approximately
23.146%of our outstanding
ordinary shares, of which Festin Management Corp., with which Tom Wyler, our
Chief Executive Officer and Chairman of the Board, is affiliated, holds 23.01%;
see ITEM 7A  MAJOR SHAREHOLDERS.  These shareholders, if acting together,
would be able to significantly influence all
matters requiring
approval by our shareholders, including the election of directors and the
approval of mergers or other business combination transactions.

8

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

(b)          Risks
Relating to Our Business

The
digital video and streaming products market is highly competitive, and we may
lose sales to our competitors and be forced to lower the prices for our
products, which may result in reduced revenues.Competition
in the digital video and streaming products industry is intense, and we expect
competition to increase.  Demand for
digital video and streaming products has grown rapidly over recent years, and,
as a result, competition among providers of these products has substantially
increased, particularly in the areas of digital video transmission and delivery
and content creation.  To compete
effectively, we must continue to respond promptly and effectively to changing
customer preferences, feature and pricing requirements, technological change
and competitors innovations.

Our
principal competitors in the digital video and streaming markets include TUT
Systems, Tandberg Television ASA, Harmonic Inc., Minerva Inc., VBrick Systems
Inc., Amnis Systems (formerly Optivision, Inc.), Winnov Inc., Pinnacle Systems
Inc., Sigma Designs, Inc., Matrox, Vela Research, Inc., Darim Vision Ltd.,
Canopus, SkyStream Inc., DVS, Viewcast Inc. and Vweb Inc. We also expect to see
increasing indirect competition from vendors of software encoders and decoders
like Digital Rapids, Ligos and Intervideo. 
Some of our actual and potential competitors may have longer operating
histories, greater name recognition, access to larger customer bases and significantly
greater financial, marketing, technical and other resources than we do.  Our competitors also sell products that
provide some of the benefits of the products that we sell, and we could lose
sales to our competitors.  Moreover, the
digital video products industry is undergoing a period of consolidation in
which companies, including some of our competitors, are participating in
business combinations.  These
combinations may result in the emergence of competitors who have greater market
share, customer base, sales force, product offering, technology expertise
and/or marketing expertise than we do. 
As a result, our competitors may be able to adapt more quickly to new or
emerging technologies and changes in customer requirements or to devote greater
resources to the promotion and sale of their products than we can.  Thus, we cannot assure you that we will be
able to compete successfully against current and future competitors, or that we
will be able to make the technological advances necessary to improve or even
maintain our competitive position or that our products will achieve market
acceptance.

In
addition, we expect price competition to escalate in the video streaming
industry.  We have consistently
attempted to minimize the effect of price reductions in the market by introducing
more sophisticated products at the top of our product line, and thereby attempt
to maintain higher selling prices. 
However, competition in the future may force us to lower product prices
or to add new products and features at lower prices, or we may otherwise be
unable to introduce new products at higher prices.  We cannot assure you that we will be able to compete successfully
in this kind of price competitive environment. 
Lower prices and reduced demand for our products would reduce our
ability to generate revenue.  Failure by
us to mitigate the effect of these pressures through cost reduction of our
products or changes in our product mix could have a material adverse effect on
our business, financial condition and results of operations.

We
have a limited backlog of orders and have to plan production and inventory
levels on unpredictable ordering patterns. 
Maintaining sufficient inventory levels to meet anticipated demand
increases the risk of inventory obsolescence and associated write-offs.The timing and volume of orders are difficult to forecast for each
quarter, as a substantial portion of our sales are booked and shipped in the
same quarter pursuant to purchase orders. 
We have a limited backlog of orders for our products and must maintain
or have available sufficient inventory levels to satisfy anticipated demand on
a timely basis.  Maintaining sufficient
inventory levels to assure prompt delivery of our products increases the risk
of inventory obsolescence and associated write-offs.  A shift in demand could also result in inventory write-offs,
which could harm our financial performance.

In
addition, the ordering patterns of some of our large customers have been
unpredictable in the past and we expect that ordering patterns by customers
will continue to be unpredictable.  In
view of this inherent unpredictability, we
must plan our production and inventory levels based on internal forecasts of
customer demand, which may fluctuate substantially and sometimes varies
substantially from early estimates provided by customers to us for planning
purposes.

9

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We
derive a significant portion of our revenues from one type of product, and the
failure of this type of product to meet market demands could have a
disproportionate impact on our revenues and income.Our MovieMaker encoder product family
accounted for 42% of our revenues in 2001, 52% of our revenues in 2002 and 43%
of our revenues in 2003.  We expect that
this product family will continue to account for a significant portion of our
revenues in the foreseeable future.  If
this product fails to match the price, availability, quality or other features
of competing products or to otherwise meet our expectations with respect to
market demand, our business will suffer.

We
depend on several large customers and the loss of one or more of these
customers, or a significant decrease in revenue from any of these customers,
could have a disproportionate impact on our revenues and income.Historically, a substantial portion of our revenues has come from large
purchases by a small number of customers. 
For example, our top three customers in 2001 accounted for approximately
25% of our revenues, our top three customers in 2002 accounted for 30% of our
revenues and our top three customers in 2003 accounted for 18% of our
revenues.  In 2003, sales to Cisco
Networks accounted for approximately 7% of our revenues, sales to Hoei Sangyo
Ltd accounted for approximately 6% of our revenues, and sales to Beijing
Digital Express accounted for approximately 5% of our revenues.  We expect to continue to depend on sales to
a small number of customers.  We have a
limited number of long-term purchase agreements with our top customers, and as
such, we have a limited number of commitments from our top customers to
purchase specific quantities of products. We cannot assure that we will be able
to continue those agreements under current or future market conditions.  We expect that our largest customers will
vary from period to period.  If we lose,
one or more of our large customers, or one or more of our large customers
significantly reduces its purchases of our products, and we fail to add new
customers that generate significant revenues, our results of operations could
be seriously harmed.  For example, the
decrease in revenues during 2003 was partly related to a decrease in purchase
orders from our large customers, including Prediwave, SeaChange and Cisco.

Our
long sales cycle depends on factors beyond our control and may cause revenues
to vary significantly.Sales of our streaming products, which generally
must be integrated within a larger system, require an extended sales
effort.  The period from an initial
sales call to the receipt of a purchase order for such products typically
ranges from six to twelve months, and can be longer.  Also, because our products are often used as part of a larger
project, the timing of an order for our products is often dependent upon the
timing of the projects, which is beyond our control.  In addition, due to the operating procedures in many large
organizations considering the purchase of our products, an extended period of
time may be required for technical evaluation to be completed and capital
expenditure authorization to be obtained within the customer.  Accordingly, if a forecast of revenues from
a specific customer for a particular period is not realized in that period, our
operating results for such period will suffer.

We
depend on third parties to distribute and market our products.  If we cannot retain effective distributors
or fail to develop new distributor relationships, we may be unable to
effectively market and distribute our products.A
significant portion of our sales efforts worldwide is conducted through a
network of independent distributors. 
Our combined sales to three of these distributors accounted for
approximately 13% of our revenues in 2001, approximately 14% of our revenues in
2002 and approximately 15% of our revenues in 2003.  We are unable to predict whether and the extent to which some of
these distributors will be successful in marketing and selling our products in
the future.  While we have a policy of
using only distributors who do not distribute competing products, we have experienced,
and may experience in the future, sales by our distributors of products that
compete with our products.  In such
cases, we may have to seek new distributor relationships, and we may not be
able to establish relationships on the same terms as the prior
relationships.  Furthermore,
distributors may terminate their relationships with us upon short notice with
little or no penalty.

Our
future performance also depends on our ability to attract additional
distributors who will be able to market and support our products effectively,
especially in markets in which we have not previously been active.  Effective distributors must possess
sufficient technical, marketing and sales resources and must devote these
resources to a lengthy sales cycle and subsequent first-line customer
support.  We may not be able to retain
our current distributors and may not be able to recruit additional or
replacement distributors with sufficient technical expertise in the networking
and video content fields.  The loss of
one or more of our major distributors, especially in a key market, or the
failure by one or more major distributors to adequately provide customer
support could harm our business.

10

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We
believe it is becoming increasingly important for our success to develop
relationships with several large original equipment manufacturers, or OEMs, of
video server equipment with technical and support expertise.  We presently have a limited number of OEM
relationships and we may not be able to maintain these relationships.  Moreover, we may not be able to develop new
OEM relationships on favorable terms or at all.  Our failure to retain existing or to develop new OEM relationships
will have a material adverse effect on our ability to sell our products and our
operation results.

If
the digital video market does not grow as we expect, the demand for our
products and technology may continue to decline and our revenue will decrease.Digital video products generally, and digital video streaming products
and tools specifically, are part of a rapidly evolving market.  Our growth will depend on our ability to
predict which segments of that market are most likely to succeed and to
successfully penetrate those segments. 
We have devoted substantial effort and expense to the development of new
products based on our prediction of the market trends, and our future growth
will depend on our ability to successfully market these products.  The demand for these products depends on the
rate and level of penetration of networked video applications and digital video
equipment into the mass market generally. 
Because of the early stage of development of the digital video market,
the demand for, and market acceptance of, our products are subject to a high
degree of uncertainty.  If market growth
rates do not meet our expectations, or if we are unsuccessful in identifying
and penetrating those segments of the digital video market which provide the
greatest opportunity for growth, our business will suffer.  In addition, the general weak economic conditions have had an
adverse impact on the industry and on the demand of our products.  If the economic conditions persist and
demand does not increase, our revenues will continue to decline, and our
business will continue to suffer.

The
digital video and streaming market is characterized by rapid technological
changes and multiple evolving standards. 
If we fail to enhance our existing products, develop new and more
technologically advanced products and successfully market these products, the
results of our operations will suffer.  The markets for our products are
characterized by rapidly changing technology, evolving industry standards and
frequent new product introductions.  We
believe that our future success will depend on our ability to maintain
expertise in the networked video technologies, enhance our existing products
and introduce new products and features to meet changing customer requirements
and evolving industry standards.  Our
present products are based on the non-proprietary digital video compression
standards and file formats, known as MPEG standards and formats, developed by
the moving picture expert groups, or MPEG, working group in the International
Organization for Standardization, or ISO. Although MPEG has evolved as the de facto standard for compression and
decompression of digital video, we cannot assure you that the current de facto standards will not be replaced in
the future.  In addition, we, or our
competitors, may announce products that have the potential to shorten the life
cycle of, or replace, our products.  We
have made such announcements in the past and may do so in the future.  Such announcements could cause customers not
to buy our products or to defer decisions to buy our products.  In addition, we cannot assure you that
products or technologies developed by others will not render our products or
technologies non-competitive or obsolete.

Our
future success also depends upon our ability to enhance our existing products
and develop, launch and market new technologies and products in a
cost-effective and timely fashion.  We
have devoted, and will continue to devote, substantial effort and expenses to
the development of new technologies and products.  However, we cannot assure you that we will be able to complete
testing and successfully launch our new products.

Our
products could contain defects, which would reduce sales of those products or
result in claims against us.We develop complex and evolving products.  Despite testing, errors may be found in
existing or new products.  Reliability,
quality or compatibility problems with our products could significantly delay
or reduce market acceptance of our products, could require the devotion of
significant time and resources to addressing errors, could divert our
engineering and other resources from other tasks and development efforts, and
could damage our reputation and adversely affect our ability to retain our
existing customers and to attract new customers.  We could also be subject to material product liability claims by
customers.

We
depend on a limited number of third parties to manufacture, distribute and
supply critical components of our products and we may be unable to operate our
business if these parties fail to perform their obligations.We depend upon sole source suppliers for key components used in our
products.  These key components include,
for example:

11

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| |  | Various modules, which are integrated in our new
  generation system, the MGW5100 including: a switch supplied by PTI
  (Performance Technologies Inc.), a host supplied by Motorola backplane, a
  Pentium module supplied by Jumptech Adastra and a Compact Pci platform
  supplied by EPS (Israel) TECH 1992 Ltd.;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Digital Signal Processing, or DSP, compression
  techniques, manufactured by Equator Inc., which are used in our MGW 2400 and
  Movie Maker 400 products;                                                                                                                                                            
| |  | Video compression chips manufactured by LSI Logic;                                                                                                                                                                                                                                                                   
| |  | Audio compression chips manufactured by Crystal
  Semiconductor Corporation, or Crystal, a subsidiary of Cirrus Logic, which
  are included in our decoders;                                                                                                                                                         
| |  | Motorola, Inc.s DSPs, which are included in our
  decoders and encoders; and                                                                                                                                                                                                                                        
| |  | MP503 manufactured by Cyclone Microsystems, the
  supplier of one of the hardware platforms for our MediaPump product.                                                                                                                                                                                               

We
may have sole source suppliers for additional products in the future.

We
purchase these sole source components pursuant to purchase orders placed from
time to time.  We do not carry
significant inventories of these sole source components and we have no
guaranteed supply arrangements or other long-term agreements.  The lack of guaranteed supply arrangements
can result in delays in obtaining components from time to time.  The time and resources that these third
parties devote to our business is not within our control.  We cannot be sure that these parties will
perform their obligations as expected or that any revenues, cost savings or
other benefits will be derived from the efforts of these parties.  If any of these parties breaches or
terminates its agreement with us or otherwise fails to perform its obligations
in a timely manner, the manufacture of our products may be delayed or
cancelled.  If any of these events
occur, we may be required to look for alternative sources of supply for our
sole source components, which may be time consuming and we may incur additional
expenses, which in turn may affect our sales and operation results.

We
depend on a limited number of key personnel who would be difficult to replace,
and if we lose the services of these individuals or cannot hire additional
qualified personnel, our business will be harmed.Our
continued growth and success largely depend on the managerial and technical skills
of key technical, sales and management personnel. If any of the current members
of the senior management team are unable or unwilling to continue in our
employ, our results of operations could be materially and adversely affected.  Our success also depends to a substantial
degree upon our ability to attract, motivate, and retain other highly qualified
personnel.  The technology associated
with digital video is at a relatively advanced stage, and there are many competitors
in this area.  Consequently, there is
considerable competition for the services of technical, sales, management and
engineering personnel.  In addition, our
U.S. operations are largely based in Silicon Valley, a highly
competitive marketplace.  Therefore, we
may be at a disadvantage to the extent potential employees may favor larger,
more established employers, and we may not
be able to retain our current personnel, or obtain the services of additional
qualified personnel if and when needed.

Cost-reduction
efforts may adversely impact our productivity and service levels.During 2003, we continued
implementing various cost-control measures affecting various aspects of our
business operations. In September 2001, we reduced our workforce by
approximately 19% of our total workforce at that time.  During 2002 we performed additional
reductions mainly in our U.S based research and development workforce and
during 2003 we performed additional reductions mainly in our Israel-based
research and development workforce. Given current economic conditions and our
declining revenues, we may in the future be required to take additional
cost-saving actions to reduce our operating losses and to conserve cash. The
failure to achieve such future cost savings could have a material adverse effect
on our financial condition. On the other hand, even if we are successful with
these efforts and can generate the anticipated cost savings, these actions may
adversely impact our employees morale and productivity, the competitiveness of
our products and business, and the results of our operations.

We
may continue to seek to expand our business through acquisitions that could
result in a diversion of resources and our incurring additional expenses, which
could disrupt our business and harm our financial condition.As we have in the past, we may in the future continue to pursue
acquisitions of businesses, products and technologies, or the establishment of
joint venture arrangements, that could expand our business.  The negotiation of potential acquisitions or
joint ventures as well as the integration of an acquired or jointly developed
business, technology, service or product could cause diversion of managements
time as well as our resources.  Future
acquisitions could result in:

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| |  | additional operating expenses without additional
  revenues;
| | - | ------------------------------------------------------------
| |  | potential dilutive issuances of equity securities;          
| |  | the incurrence of debt and contingent liabilities;          
| |  | amortization of goodwill and other intangibles;             
| |  | research and development write-offs; and                    
| |  | other acquisition-related expenses.                         

Acquired
businesses or joint ventures may not be successfully integrated with our
operations.  If any acquisition or joint
venture were to occur, we may not receive the intended benefits of the
acquisition or joint venture.  If future
acquisitions disrupt our operations, our business may suffer.

Our
proprietary technology is difficult to protect and unauthorized use of our
proprietary technology by third parties may impair our ability to compete
effectively.Our success and ability to compete depend in
large part upon protecting our proprietary technology including both hardware
and software components of our products. 
We currently rely on a combination of patent, trade secret, trademark
and copyright laws, nondisclosure and other contractual agreements and
technical measures to protect our proprietary rights.  We cannot assure you that any patents will be issued to us as a
result of current or future patent applications or that patents issued to us
will not be invalidated, circumvented or challenged.  In addition, we cannot assure you that the rights granted under
any such patents will provide us competitive advantages.  We cannot assure you that any patents issued
to us will be adequate to stop unauthorized third parties from copying our
technology, designing around the patents we own or otherwise obtaining and
using our products, designs or other information.  Moreover, we cannot assure you that others will not develop
technologies that are similar or superior to our technology.  Additionally, our products may be sold in
foreign countries that provide less protection to intellectual property than
that provided under United States or Israeli laws.

Because
our products may be subject to claims of infringement on the intellectual
property rights of third parties, our business will suffer if we are sued for
infringement or cannot obtain licenses to these rights on commercially
acceptable terms.We are subject to the risk of adverse claims and
litigation alleging that we infringe the intellectual property rights of
others.  Many participants in the
digital video encoding, decoding and video streaming industries have an
increasing number of patents and patent applications and have frequently
demonstrated a readiness to pursue litigation based on allegations of patent
and other intellectual property infringement. 
All of our products rely on technology that could be the subject of existing
patents or patent applications of third parties.  Third parties may assert infringement claims in the future with
respect to our current or future products. 
These claims may require us to enter into license arrangements, or may
result in protracted and costly litigation that would require us and our
management to make significant expenditures of time, capital and other
resources, regardless of the merits of these claims.  Any necessary licenses may not be available or if available, may
not be obtainable on commercially reasonable terms.  If we cannot obtain all necessary licenses on commercially
reasonable terms, we may be forced to stop selling all or some of our products,
and our business would be harmed.

The
prices of our products may become less competitive due to foreign exchange
fluctuations.Foreign currency fluctuations may affect the
prices of our products.  Our prices in
all countries are incurred or determined in dollars.  If there is a significant devaluation in a specific country, the
prices of our products will increase relative to the local currency and may be
less competitive.  Also, we cannot be
sure that our international customers will continue to place orders incurred or
determined in dollars.  If they do not,
our reported revenue and earnings will be subject to foreign exchange
fluctuations.

Business
interruptions could adversely affect our business.Our operations are vulnerable to interruption
by fire, earthquake, power loss, telecommunications failure and other events
beyond our control, especially because our facilities are located in Israel and the State of
California.  We do not have a detailed
disaster recovery plan. In the event these blackouts, earthquake or other
interruptions occur, they could disrupt the operations of our affected
facilities.  In addition, we do not
carry sufficient business interruption insurance to compensate us for losses
that may occur and any losses, and any potential damages resulting from such
interruptions could have a material adverse effect on our business.

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The
market values of our portfolio investments are subject to fluctuations and
impairment of the investments could harm our earnings.We
maintain an investment portfolio of various holdings, types and maturities.
These securities are generally classified as available for sale and,
consequently, are recorded on the Consolidated Balance Sheets at fair value
with unrealized gains or
losses reported as a separate component of accumulated other comprehensive
income (loss). Changes in the current economic situation and other factors may
adversely affect the value of our portfolio. As a result, we may recognize in
earnings the decline in fair value of our portfolio investments when the
decline is judged to be other- than- temporary. For information regarding the
sensitivity of and risks associated with the market value of portfolio
investments and interest rates, refer to ITEM 11 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Furthermore, our equity investments in private companies are subject to risk of
loss of investment capital. These investments are inherently risky as the
market for the technologies or products they have under development are
typically in the early stages and may never materialize. We could lose our entire
investment in these companies.

(c)          Risks
Relating to Operations in Israel

A
continuing deterioration in the economic conditions in Israel may adversely
affect our financial condition and results of operations.  We are
incorporated and currently derive a portion of our revenues from markets within
the State of Israel. Primarily due to the global economic downturn and Israels
security and political situation, the Israeli economy slipped into recession in
2000. The rate of unemployment has risen, consumer spending has decreased and
many businesses are experiencing financial difficulties. A continuing
deterioration in the economic conditions in Israel may adversely affect usage
patterns of our services and the ability of our customers to pay for our
services, which would adversely affect our financial condition and results of
operations. If the economic deterioration in Israel continues, it may also
affect the ability of Israeli banks to provide us with financing on reasonable
terms and conditions, should we need it in the future.

Potential
political and military instability in Israel may adversely affect our results
of operations.  Our
principal offices and a significant portion of our operations are located in
Israel.  Accordingly, political,
economic and military conditions in Israel 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.  A state of
hostility, varying in degree and intensity, has led to security and economic
problems for Israel.  Since October
2000, there has been a significant deterioration in the relationship between
Israel and the Palestinian Authority, which has resulted in increased
violence.  The violence includes
terrorist acts in Israel and military operations in the West Bank and
Gaza.  We could be adversely affected if
these hostilities intensify or spread to additional areas in Israel. We cannot
assure you that we are fully prepared for every disaster or emergency situation
or that we could recover fully from such an occurrence, and we cannot predict
the effect on us of any such circumstances. 
Further deterioration of the situation into a full scale armed conflict
might require more widespread military reserve service by some of our
employees, which may have a material adverse effect on our business.  In addition, several countries still
restrict business with Israel and Israeli companies.  These restrictive laws
and policies may seriously harm our operating results, financial condition or
the expansion of our business.

Our
results of operations may be negatively affected by the obligation of key
personnel to perform military service.Some of our executive officers and employees in
Israel, including Zvi Halperin, our president and chief financial officer are
obligated to perform up to 30 days, or longer under certain circumstances, of
military reserve duty annually. Additionally, all such reservists are
subject to being called to active duty at any time under emergency
circumstances. Our operations could be
disrupted by the absence for a significant period of one or more of our
executive officers or key employees due to military service.  Any disruption in our operations would harm
our business.

Because
most of our revenues are generated in U.S. dollars but a portion of our
expenses in Israel are incurred in New Israeli Shekels, our results of
operations may be seriously harmed by inflation in Israel and currency
fluctuations.We generate most of our revenues in U.S. dollars
but incur a portion of our expenses in NIS. 
As a result, we are exposed to risk to the extent that the rate of
inflation in Israel exceeds the rate of devaluation of the NIS in relation to
the dollar or if the timing of devaluation lags behind inflation in
Israel.  In either event, the dollar
cost of our operations in Israel will increase and our dollar-measured results
of operations will be adversely affected. 
Specifically, the inflation rate in Israel was approximately 1.4% in
2001 and approximately 6.5% in 2002, while in 2003 the deflation rate was
approximately 1.9%.  At the same time
the devaluation of the NIS against the dollar was approximately 9.3% in 2001 and
approximately 7.3% in 2002, while in 2003 the valuation of the NIS against the
dollar rose and was approximately 7.6%. 
As a result of this differential, we experienced a decrease in the
dollar costs of operations in Israel in 2001 and 2002, and an increase in 2003,
all of which did not materially affect our results in such periods.  The fluctuations in the dollar costs of our
operations in Israel related primarily to the costs of salaries in Israel,
which are paid in NIS and constitute a portion of our expenses.  We cannot assure you that we will not be
materially adversely affected in the future if inflation in Israel exceeds
the devaluation of NIS against the dollar or if the timing of such devaluation lags
behind increases in inflation in Israel. 
Our operations also could be adversely affected if we are unable to
guard against currency fluctuations in the future.  Accordingly,
we may enter into currency hedging transactions to decrease the risk of
financial exposure from fluctuations in the exchange rate of the dollar against
the NIS.  These measures, however, may
not adequately protect us from material adverse effects due to the impact of
inflation in Israel.

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The
government programs and tax benefits that we currently participate in or
receive require us to meet several conditions and may be terminated or reduced
in the future, which would increase our costs.We receive grants
from the Office of the Chief Scientist, or OCS, in the Israeli Ministry of
Industry and Trade for research and development programs that meet specified
criteria.  In addition, we received
grants for overseas marketing from the Israel Fund for the Encouragement of
Marketing Activities, or the Marketing Fund. 
We also receive tax benefits under Israeli law for capital investments
that are designated as Approved Enterprises. 
To maintain our eligibility for these programs and tax benefits, we must
continue to meet conditions, including paying royalties with respect to grants
received and making specified investments in fixed assets.  In addition, some of these programs restrict
our ability to manufacture particular products or transfer particular
technology outside of Israel.  If we fail
to comply with these conditions in the future, the benefits received could be
cancelled.  We could also be required to
refund any payments previously received under these programs of up to 300% of
the granted funds, or pay increased taxes. 
Through December 2003, we received an aggregate of $4.8 million in
grants from the OCS.    Since 1992,
grants from the Marketing Fund have totaled $2.8 million, although no new
grants were received in 2001, 2002 or 2003.

The
Israeli Law for the Encouragement of Capital Investment, 1959 and
regulations prescribe an expiry date for the grant of new benefits. The expiry
date has been extended several times in the past. The last expiry date that was
in effect was in June 2004, and no new benefits will be granted after that date
unless the expiry date is again extended. A government committee is reviewing
the benefits program under the law. There can be no assurance that new benefits
will be available after June 2004, however benefits already granted will stay
in effect throughout the plan period. As we
have already been granted approved enterprise status under this Law, the
deadline does not have any affect on such status or on the benefits we receive.We also receive funding as part
of our participation in the Office of Chief Scientist Magnet program operated
by Israels Ministry of Industry and Trade and under a series of research and
development programs sponsored by the Commission of the European Union.  Through December 31, 2003, we have
received an aggregate of $4 million in grants from the Magnet program.  In 2002 and 2003, grants from the OCS, the
Magnet and the European Union programs totaled $4.5 million. The Israeli
government has reduced the benefits available under these programs in recent
years and has indicated that it may reduce or eliminate these benefits in the
future.  These programs and some tax
benefits may not continue in the future at their current levels or at any
level.  From time to time, we submit
requests for new grants from the OCS and the Magnet program and for expansion
of our Approved Enterprise programs (see ISRAELI TAXATION - ITEM 10.E) or for new programs.  These requests might not be approved.  The termination or reduction of these grants and tax benefits
could seriously harm our business, financial condition and results of
operations.

Israeli
courts might not enforce judgments rendered outside of Israel, which may make
it difficult to collect on judgments rendered against us.We are incorporated in Israel. 
Some of our directors, officers and the Israeli experts named herein are
not residents of the United States and some of their assets and our assets are
located outside the United States. 
Service of process upon our non-U.S. resident directors, officers or the
Israeli experts named herein and enforcement of judgments obtained in the United
States against us, and our directors and executive officers, or the Israeli
experts named herein, may be difficult to obtain within the United States.

We
have been informed by our Israeli legal counsel, that there is doubt as to the
enforceability of civil liabilities under U.S. securities laws in original
actions instituted in Israel.  However,
subject to certain time limitations, an Israeli court may declare a foreign
civil judgment enforceable if it finds that all of the following terms are met:

| |  | the judgment was rendered by a court which was,
  according to the laws of the state of the court, competent to render the
  judgment;                                                                          
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the judgment is no longer appealable;                                                                                                                                                                           
| |  | the obligation imposed by the judgment is
  enforceable according to the rules relating to the enforceability of
  judgments in Israel and the substance of the judgment is not contrary to
  public policy; and
| |  | the judgment is executory in the state in which it
  was given.                                                                                                                                                 

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Even
if the above conditions are satisfied, an Israeli court will not enforce a
foreign judgment if it was given in a state whose laws do not provide for the
enforcement of judgments of Israeli courts (subject to exceptional cases) or if
its enforcement is likely to prejudice the sovereignty or security of the State
of Israel.  An Israeli court also will
not declare a foreign judgment enforceable in the occurrence of any of the
following:

| |  | the judgment was obtained by fraud;                                                                                                                                 
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | there was no due process;                                                                                                                                           
| |  | the judgment was rendered by a court not competent
  to render it according to the laws of private international law in Israel;                                     
| |  | the judgment is at variance with another judgment
  that was given in the same matter between the same parties and which is still
  valid; or                       
| |  | at the time the action was brought in the foreign
  court a suit in the same matter and between the same parties was pending
  before a court or tribunal in Israel.

Anti-takeover
provisions could negatively impact our shareholders.  The Israeli Companies Law of 1999, or the
Companies Law, provides that an acquisition of securities in a public company
must be made by means of a special tender offer, if as a result of the
acquisition the purchaser would hold 25% or more of the voting rights in a
company.  This rule does not apply if at
the time of acquisition there is already a holder of 25% or more of the voting
rights in the company. Similarly, the Israeli Companies Law provides that an
acquisition of securities in a public company must be made by means of a
special tender offer, if as a result of the acquisition the purchaser would
hold more than 45% of the voting rights in a company.  This rule would not apply, if at the time of the acquisition
there is a holder of more than 50% of the voting rights in the company.

Pursuant
to the Companies Law, if following any acquisition of shares of a public
company or of a class of shares of a public company, the purchaser holds more
than 90% of the companys shares or more than 90% of any class of the companys
shares, then the purchaser must conduct a tender offer for all of the remaining
shares of the company or of the particular class of shares of the company,
which procedure is referred to as a full tender offer. In the event that
shareholders who did not respond favorably to the tender offer hold less than
5% of the issued share capital of a company, or less than 5% of the issued
class of shares of a company, the holders of all the remaining shares of such
company are obligated to transfer their shares in the company to the acquirer
at the tender offer price. In the event a full tender offer is accepted in
accordance with the mandatory sale procedure described above, any offeree may
petition the relevant Israeli court, within three months of the date of
acceptance, to declare the price paid for the companys shares to be less than
their fair value, and obligate the offeror to pay the shareholders the fair
value of the shares. Such petition may be filed as a class action. Furthermore,
the Israeli Companies Law provides that as long as a shareholder in a public
company holds more than 90% of a companys shares or class of shares, such
shareholder shall be precluded from purchasing any additional shares of that
type other than through a tender offer for the remaining shares or class of
shares of the Company. These rules to some extent reduce the risk of a
takeover; however, no assurance can be given that a takeover will not occur nor
that in the event of a takeover that it will not have a negative impact for our
other shareholders.

Item 4. Information on the Company

4.A History and development of the Company

Company
overview

Optibase
was founded and incorporated in the State of Israel in 1990.  Our principal executive offices are located
at 2 Gav Yam Center, 7 Shenkar Street, Herzliya 46120, Israel, and
our telephone number at that location is 972-9-970-9288.  Our website is located at www.optibase.com. Optibase is subject to the provisions of the
Companies Law.  Our U.S. subsidiary,
Optibase, Inc., is located at 1250 Space Park Way, Mountain View, CA 94043.

16

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We
provide high-quality, cost-effective networked systems that enable the
preparation of digital video based on video compression using the non-proprietary
MPEG standards and the proprietary Windows MediaTM standards, and its delivery over Internet
protocol, or IP, asynchronous transfer mode, or ATM (a network technology based
on transferring data in cells or packets of a fixed size), digital video broadcast,
or DVB and other packet-based networks. 
Based on our expertise
in both networking and video compression technologies, we have created a suite
of products used in applications such as delivery of video over broadband
networks, digital video archiving, distance learning, business television and
content creation.  We have developed
products that allow for real-time compressed video uploading to video servers
and live multicasting over networks. 
Our products meet the challenges of achieving exceptional video quality
within the constraints and changing parameters of existing networks.   Due to general market conditions, we
experienced a decrease in our level of revenues in recent years, from $29.4
million in revenues in 2001 to $20.4 million in revenues in 2002 and $19.4
million in revenues in 2003.  Our
operating loss has decreased from $39.9 million in 2001 to $15.3 million in
2002 and to $3.9 million in 2003.  Our net
loss has decreased and changed to a net profit of $1.8 million in 2003 from a
net loss of $12.9 million in 2002 and a net loss of $39.1 million in 2001.  The change was mainly a result of both our efforts to reduce operating expenses and improve
financial performance and a significant increase in our financial income, net.

Digital
video technologies have emerged to address the inherent limitations of analog
video technologies.  The advantages of
digital video technologies, combined with the proliferation of digital networks
and their increased bandwidth, allow for the incorporation of digital video
into various Web-based services. 
Broadband network access for the home and office is increasing at a
rapid rate. According to MRG IP/Broadband Video market research from April
2003, by 2006, 47 million homes worldwide will be able to receive broadcast TV
services from a telephone service provider, or Telco, and over 8 million will
subscribe to receive TV services. According to Cahners In-Stat Group (from a
study dated July 2002), by 2005, 55 million homes in North America will be able
to receive broadcast TV services from a Telco and over 12 million will
subscribe to receive TV services. According to Cahners In-Stat Group, (from a
study dated July 2002) the market for Business
Oriented Streaming Media Equipment will exceed $12 billion in 2006.

Our
in-depth understanding of network protocols has allowed us to develop real-time
digital video transfer products.  In
1992, we introduced our first decoder, PCMotion,
which allowed high-quality viewing of MPEG-1 streams on stand-alone personal
computers, or PCs.  In 1993, we became
one of the first companies to offer a real-time MPEG-1 encoder, MPEG Lab Pro.  MPEG-2 specifications were substantially finalized in 1993.  By 1995, we released our first MPEG-2
decoder and, in 1996, our first MPEG-2 encoder.  Since
1993, we have produced content creation tools. 
In 1995, we introduced our video compact disc, or VCD, content creation
tool.  We further developed our content
creation products by introducing our MPEG-based digital video disc, or DVD,
content creation tool called DVDFab in 1998. 
Since 1996, we have combined our extensive networking and MPEG expertise
to introduce a series of video networking products.  In the first quarter of 2000, we released MPEG ComMotion Pro, a scalable, Web-based
networking software application enabling the transmission of MPEG-1 and MPEG-2
digital video and MP3 digital audio over broadband networks, and in November
2000, we released our MGW 2000, the first product of our new MGW product line which
provides streaming media gateway solutions for enterprises and broadband
markets.  In December 2002, we released
the MGW 5100, a carrier grade product that enables encoding, transcoding and
streaming of video over broadband IP and ATM networks. With the acquisition of
Viewgraphics in December 2000, two main new product families were added to our
product portfolio  the MediaPump, a DVB to peripheral component interconnect,
or PCI, interface product line, and the VideoPump, which are products using an uncompressed
serial digital interface, or SDI, to PCI interface. During 2001, the MediaPump
was redesigned and enhanced, and an entirely new and improved product family,
the MediaPump 533 was introduced. We also introduced the MGW 3100 DVB/IP
Gateway system, based on the MediaPump products. In the third quarter of 2002,
due to the loss of SeaChange as a customer of our MediaPump products and after
assessing market conditions, we decided to cease additional research and
development efforts for the MediaPump, VideoPump and the MGW 3100 product
lines. We also decided to shut down the VideoPump and MGW 3100 product lines,
while continuing to support and sell the MediaPump.

During
2003 we released the MGW2000e product, which uses traffic smoothing, a
technology designed to level the load of data transmitted over a particular
network, improving network performance. The MGW2000e was released with the
Optibase Player, providing a streaming solution in which the time that elapses
between the occurrence of a captured event and its display on the receiving
device is relatively short. This feature is referred to as low latency and is
required for monitoring and video conferencing applications.. In 2003, we also
released Composer 3.7, which added compliance to CableLabs and enables the
combining, or multiplexing, of high quality digital audio in the Dolby AC3 5.1
format by the MPEG MovieMaker 200, enabling content creation for use by cable
television companies at their local facilities, or the cable head-end, to
provide video on demand services to subscribers. In the first quarter of 2004
we released the MPEG MovieMaker 400 as part of our MPEG MovieMaker product
line. The MPEG MovieMaker 400 is a dual channel MPEG-4 PCI encoder. The MPEG
MovieMaker 400 is packaged with a software development kit, or SDK, very
similar to the one we provide for the MPEG MovieMaker 200, and, in addition,
supports streaming of the audio and video data over IP
networks in compliance with specifications of interoperability standards promoted by the
Internet Streaming Media Alliance, or ISMA. The MPEG MovieMaker 400 product is
an enabler for surveillance, archiving and enterprise streaming applications.
Also, during the first quarter of 2004 we released the Videoplex HD, a new member
of our Videoplex decoder product line, that decodes high definition, or HD,
video content at all resolutions developed by the Advanced Television Systems
Committee, or ATSC. The Videoplex HD product uses technology developed by
Mikrom and is exclusively distributed worldwide by Optibase. It is intended for
use in Digital Cinema, Digital Signage and for content creation in HD broadcast
installations. We sell our products through a combination of a direct sales
force, system integrators, independent distributors and value added resellers,
or VARs.  A key element of our sales and
marketing strategy is to cultivate strategic relationships, similar to our
relationships with Cisco Systems, Inc. and Oracle Corp, to promote reference
sales with the potential for significant revenue impact.  Our streaming and content creation products
are used by a diverse group of system integrators and end-users including
Cisco, NEC, IBM Corporation and SeaChange International Inc.

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Our
headquarters, including research and development, selling and marketing,
finance and general management and administration personnel, are located in
Israel.  We established Optibase, Inc.,
a wholly owned subsidiary, in 1991 as a California corporation to manage our
North American sales, marketing and customer support activities.    In April 1997, Optibase, Inc. relocated to
San Jose, California and has relocated in 2001 to Mountain View, California to
the former offices of Viewgraphics, Inc., a company we acquired in a merger
transaction in December 2000, in part to maintain a closer proximity with
potential customers and system integrators in related sectors.  We maintain our business development and
sales activities in Europe through local employees residing in certain European
countries.  We have such an office in
France, while the activity in other countries is managed directly from
Israel.  In 1999 and 2000 we established
offices in Japan and in China to cultivate closer relationships with local
sales forces and potential system integrators and expand our business
development activities in the local market.

Capital
Expenditures for the Past Three Years

In
October 2000, we acquired the core team of the HiTV unit from ECI Telecom.  The acquisition consisted of acquisition of
certain assets, co-ownership of certain technologies, permanent royalty free
license of other technologies and the transfer of eight employees to
Optibase.  The people and technologies
acquired in this transaction serve as the basis for one of our key product
lines  the MGW 5100.  We paid $3.75
million in connection with this acquisition and assumed certain liabilities
related to the acquired activity. During the quarter ended September 30, 2001,
we wrote down impaired intangibles related to the acquisition totaling $2.2
million.

In
November 2000, we signed an agreement with a privately held company called
Mobixell Networks Inc., or Mobixell pursuant to which we granted Mobixell a
license to use certain of our MPEG-4 technologies for $300,000, and committed
to invest through one of our subsidiaries at least $1 million in its first
round of financing. In December 2000, we invested $1.064 million in Mobixells
Series A Preferred shares financing round and received shares of Mobixell
representing 10.90% of its equity on a fully diluted basis.  Mobixell was founded by Amir Aharoni, our
former President and Chief Operating Officer, and Yehuda Elmaliach, our former
Chief Technology Officer.  Mobixell
develops rich-media infrastructure platforms for mobile telecommunications
carriers. During the first quarter of 2003, based on updated information and
revised internal estimates, the Company decided to adjust downward the value of
its investment in Mobixell by its full amount, totaling $1.36 million. However,
during the third quarter of 2003, Mobixell entered into an additional financing
round that included new strategic investors. As part of the financing round, we
reassessed the investment and decided to participate in the financing round in
the amount of $300,000 in Mobixells Series B Preferred shares. As a result, we
hold shares of Mobixell representing 7.61% of its equity on a fully diluted
basis. In May 2004, the Company signed a term sheet to invest an additional
$400,000 in Mobixells Series C preferred shares as part of a total investment
round participated by the current shareholders totaling $4 million.
Consequently, the Company will keep its relative pro rata portion in Mobixells
equity on a fully diluted basis. We may participate in future financing rounds
in Mobixell and our holdings may be further diluted.

18

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In
December 2000, we acquired Viewgraphics Incorporated, a privately held company
based in Mountain View, California and a provider of hardware and software
products for digital media infrastructure applications.  The people and technology of Viewgraphics
served as the basis for our DVB and open system media gateway
capabilities.  Immediately following the
acquisition, Viewgraphics became a wholly owned subsidiary of Optibase, Inc.,
our U.S. subsidiary, and operated under the name of Optibase U.S., Inc., until
it was merged into Optibase, Inc. in June 2001.  In connection with
the acquisition, we paid an aggregate consideration of approximately $43.6 million, of which $11.813
million (net of issuance expenses) was paid in 1.37 million newly issued
ordinary shares.  Substantially all of
the employees of Viewgraphics accepted our employment offers.  John Krooss, the principal shareholder and
the Chief Executive Officer of Viewgraphics, joined us as the Chief Technology
Officer of Optibase, Inc. and as a member of our board of directors. Mr. Krooss
ceased to be the Chief Technology Officer in September 2001, and resigned from
his service as a director of the Company in July 2002. 364,023 ordinary shares,
which were held in escrow as part of the acquisition agreement with
Viewgraphics, were returned to us by a former employee and by the shareholders
of Viewgraphics, following a settlement agreement that we signed with them in
January 2002. As a result, the aggregate consideration paid by Optibase for the
acquisition of Viewgraphics decreased to $43.3 million, including the value of
1.006 million ordinary shares. During the second quarter of 2002, due to the loss
of SeaChange as a customer of our MediaPump products and due to the decrease of
our market value at that time, we recorded an impairment of intangibles related
with the acquisition. Related impairment of intangibles consists of an
adjustment made for the valuation of the technology purchased from Viewgraphics
and totaled at approximately $6.8 million. During the second quarter of 2002
and in accordance with the requirements of SFAS 142 Goodwill and other
Intangible Assets (SFAS 142), we completed our goodwill impairment analysis
and recognized a transitional goodwill impairment loss of $854,000 as of
January 1, 2002, which was recorded as the cumulative effect of a change in
accounting principle in our consolidated statement of operations.

Amortization
and impairment of other intangible assets during 2001 totaling at $23.4 million
related to existing technology, assembled workforce, customer base and goodwill
in connection with the merger and including impairment of intangibles totaled $18.7
million. Subject to SFAS No. 141 Business Combinations (SFAS 141) and SFAS
142 issued in June 2001, goodwill and intangible assets will no longer be
amortized, but will be subject to annual impairment tests. Other intangibles
will continue to be amortized over their useful lives. We started to apply the
new rule as of the beginning of fiscal year 2002.

Beginning
February 2001, Festin Management Corp., a British Virgin Island corporation
jointly owned by Tom Wyler and Arthur Mayer-Sommer started to acquire our
ordinary shares on the open market. 
Based on the Schedule 13D Festin filed with the SEC (last amended on
November 25, 2003), Festin currently holds 3,000,000 ordinary shares,
representing 23.01% of our capital stock based on 13,036,321 ordinary shares
outstanding as of May 1, 2004. In June 2001, our board of directors appointed
Wyler to serve as a director of the Company and in September 2001, the board of
directors appointed Wyler to serve as the chairman of our board of directors.
In February 2002, Wyler also assumed the role of Chief Executive Officer in
charge of our operations and was appointed as our chief executive officer in
September 2003. In our 2002 annual general meeting of shareholders, our
shareholders approved the grant of 200,000 options to Wyler exercisable into
200,000 shares, subject to amendments, representing approximately 1.5% of our
issued share capital.

In
July 2001, we signed an agreement with a privately held Israeli company called
V.Box Communication Ltd., or V.box. We committed to invest through one of our
subsidiaries an initial amount of $250,000. We continued to invest in V.Box, with
the other shareholders pro rata to our holdings in V.Box. To date we have
invested an aggregate of $1.55 million in exchange for convertible notes issued
by V.Box in several rounds. During April 2004, the Company decided to invest in
V.Box, with the other shareholders of that company pro rata to our holdings an
additional amount of $250,000. Following V. Boxs acquisition of BroadLogics
Satellite Express(TM) and DTV Product Lines, we signed an agreement with V.Box
to sell and distribute the above-mentioned products in the North America market.
Additionally, we support V.Box operational activities. Pursuant to this
agreement V.Box utilizes our manufacturing abilities and strong U.S. presence
to enhance its revenues.

During
the third quarter of 2002 we decided to cease additional research and development efforts for the MediaPump, VideoPump
and the MGW 3100.  We also decided to
shut down the VideoPump and MGW 3100 product lines. The costs related to
these actions were approximately $505,000.

Recent
developments

On
March 26, 2004, we entered into an debtor-in-possession, or DIP, loan agreement
and asset purchase agreement with Media 100 Inc., or Media 100, (OTCBB:
MDEA.OB) in connection with a voluntary bankruptcy proceeding filed by Media
100 in the U.S. Bankruptcy Court in the District of Massachusetts under Chapter
11 of the U.S. Bankruptcy Code, or Chapter 11. 
Media 100 is a U.S. based provider of professional video editing and
compositing

systems for the video
post-production market. Media 100s products combine software and hardware to
enable the multi-layered editing of video content and the design of complex
video effects, all on a personal computer. We see Media 100s products as
complementary to our own products. 
Under the DIP loan agreement we will provide up to one million dollars
to Media 100 to finance its continued operations during the bankruptcy
proceeding.  The court has ordered an
expedited hearing, and has ordered sale procedures, which include notice and
overbid provisions which will be applicable to the sale of Media 100s
assets.  The assets are to be sold to
the successful bidder approved by the court in the bankruptcy proceeding.  Subject to court approval, we have agreed,
under the asset purchase agreement, to acquire substantially all of the assets
of Media 100, including their intellectual property, patents, registered
trademarks, inventory and good will, in a sale under Section 363 of the U.S.
Bankruptcy Code, or Section 363 sale, which is part of the Chapter 11 proceeding.  The Section 363 sale is anticipated to take
place in late May 2004.

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While
the bankruptcy proceedings are pending we have met and will continue to meet
with the Media 100 employees and we intend to make offers of employment to many
of them to work for us after the sale if we are the successful bidder in the
Section 363 sale.  As a result our total
number of employees would increase by as many as 55 people.  These employees will be located in
Massachusetts and will be employed by our U.S. subsidiary, Optibase, Inc.  The business activity of Media 100 would
become one of our business units. 
Integration of these employees and the business activity of Media 100
involve certain risks, which if not successfully implemented could have an
adverse effect on our business.  We will
be obliged to obtain a suitable lease either in the same location where Media
100 is currently located, or some other location in order to conduct the
business.  If we are unable to obtain a
suitable lease under acceptable terms and conditions it could have an adverse
effect on our ability to integrate the business activity of Media 100 into our
business.

In
the event we are not the successful bidder in the Section 363 sale, the
outstanding loan amount, a penalty fee and certain other expenses will be
repaid to us by Media 100 from the amounts it receives from the successful
bidder.  Thus, our financial risk in the
event we are not successful in acquiring the assets is significantly
reduced.  However, there is a risk that
a competitor of ours may acquire the assets.

4.B
Business overview

The
use of video images as a means of enhancing and enriching electronic
communications has become pervasive in todays commercial and consumer
markets.  Video images have been
historically produced, stored and distributed almost exclusively in analog
formats.  This medium has a number of
inherent technical limitations in the areas of image resolution and color
correctness.  Digital video products
have emerged to address these limitations. 
During the production process, digital content is easier to manipulate
than analog, and the quality of digital content is unaffected by time, usage or
successive copying.  Digital video can
be indexed and searched using powerful, readily available database technology,
and storage of digital video occupies a fraction of the physical space required
for analog tapes.  Finally, digital
video can be transmitted over digital networks and requires less bandwidth than
analog video transmission, and is therefore more accessible and less expensive.

The
efficiency of digital video transmission, storage and distribution depends upon
the use of compression technology.  For
example, it would require 370 CDs to store approximately two hours of
uncompressed, high-quality digital video, whereas storage of the same data
compressed would require only eleven CDs or one DVD disk.  By digitizing and compressing incoming
analog video content, the encoder creates individual audio and video streams,
which are then multiplexed into a single synchronized data stream.  This stream can be further multiplexed with
other data streams achieving an even greater efficiency in network transmission.  A decoder at the intended destination
separates, or de-multiplexes, the transmitted streams to provide usable digital
video content.  While a variety of
digital video compression formats have been developed, the MPEG standard has
emerged as the leading open standard and has been chosen for DVD and digital
television, or DTV. Internet streaming applications, however, require
compression formats that can achieve higher compression ratios than many other
applications due to the low bandwidth available over the Internet. A number of
different formats are emerging for streaming over IP networks. Microsofts
Windows Media is very dominant, but is a proprietary format. MPEG offers MPEG-4
part 2 and MPEG-4 part 10 (AVC), which yield video quality comparable to that
of Windows Media at low bit rates. The Internet Streaming Media Alliance
(ISMA), founded in 2002 by Cisco, IBM, Sun Microsystems and others, set as its
goal, the specification of open standards for the transmission of
audiovisual content over the Internet. The ISMA specifications have adopted
MPEG-4 and other Internet protocols like real-time transport protocol, or RTP,
thus enabling interoperability between products from different vendors. Video content
comes from a variety of sources, including live video feeds and previously recorded
video that may have been digitally authored. 
The video must then be encoded before it can be stored in a video server
or transmitted live across the network. 
Content stored in a video server is provided on demand, allowing a
client to access, search and view video non-linearly.  Video on demand is well suited for applications such as video
archiving and news editing.  Video
transmitted live can be sent to a group of addresses simultaneously, or
multicast, enabling concurrent distribution of video to pre-specified
clients.  Multicasting is well suited
for applications such as business television, distance learning and residential
multi-channel television.  In either
case, the video must be formatted to match the network protocol and bandwidth
constraints before it can travel from the video interface or the video server
to the end-user over the network.  To
replay the transmitted or stored digital content, different types of playback
devices may be used, all of which contain a decoder to decompress the video
stream and reconstitute it into a viewable image.

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The
technologies required for the transmission and reception of digital video over
networks are currently available. 
However, there are a number of problems that create substantial inefficiency
and complexity in the delivery of digital video files.  First, there are several competing software
protocols for the transmission and reception of video files.  In addition, different networks operate at
widely varying data transmission rates, and different viewing appliances, such
as PCs, PDAs, and cell phones, operate at widely varying processing
speeds.  To fill the needs of all
markets, a video service provider would have to offer separate files of the same
content, each encoded using different software protocols and be able to
transmit each of these files at different speeds, which would demand extremely
large amounts of data storage and system complexity.  Moreover, the user would have to be well versed in the technology
and have to manually request a digital video file in the proper software
protocol and transmission rate for his or her reception device.

Distribution
of digital video content over packet-based networks requires software
application layers on top of the encoders and decoders that can successfully
manage the transmission of packetized data and optimize image quality for a
given bandwidth.  The task of
integrating software, encoders and decoders for this purpose becomes increasingly
complex in packet-based network environments where there are multiple standards
and simultaneous users, each multitasking across several applications.  For example, ensuring a high-quality display
of digital video content on a home computer system where the user is operating
a single application while viewing the image can be accomplished relatively
simply.  However, in a corporate network
environment such as a brokerage firm, where there may be hundreds of
application-intensive users, each trying to receive e-mail, real-time stock
quotes and live digital video news feeds simultaneously, the challenges of
overcoming network errors and delivering a high-quality, real-time video image
over limited and changing system bandwidth require increasingly sophisticated
solutions.

We
provide high-quality, cost-effective networked systems that enable the
preparation and delivery of digital video over IP and other networks.  Based on our expertise in both networking
and video compression technologies, we have created a suite of products used in
applications such as delivery of video over broadband networks, digital video
archiving, distance learning, business television and content creation.  We have developed products that allow for
real-time compressed video uploading to video servers and live multicasting
over networks.  Our products meet the
challenges of achieving exceptional video quality within the constraints and
changing parameters of existing networks.

We
have developed products that provide for the capture, encoding and preparation
of video content and allow for the transmission of digital video streams across
the network.  Using our encoding
technology, video can be compressed and transmitted over IP and other networks.  Our video streaming technology bridges the
real-time nature of the encoder with the packet-based network protocol, which
is not well suited for real-time applications due to the non-linear
transmission of data packets.  Our
products enable network clients to decode this digital video stream and to view
it either as a live multicast transmission or on demand if the video content
was previously stored in the video server. 
Our network systems are comprised of a combination of our hardware
platforms and our software applications and tools, which allow system
integrators to easily incorporate new hardware platforms into their existing
applications and to rapidly develop new applications by building on their
existing knowledge of our software.

The
technologies and products that came with our acquisition of Viewgraphics enable
the delivery of digital video where the DVB protocol is required.  Utilizing the DVB expertise of the
Viewgraphics employees, we now offer products that bridge the gap between the
Broadcast and the network worlds, by offering the capability to translate in
real time, DVB streams over the IP protocol as well as to transmit IP streams
over DVB networks.

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The
recently released MGW 5100, a carrier grade video streaming system,
demonstrates the integration of ViewGraphics DVB technology with our encoding
and streaming technologies. This product also adds transcoding (decompressing
and recompressing an already compressed video source in a different compression
format and/or compression ratio) and pre-processing (compression enhancing)
technologies to our product portfolio along with other system level
capabilities such as redundancy (an ability to allocate extra product modules
for automatically backing-up other modules in case of failure for enhanced
reliability and service availability) and hot swap (the ability to change
system parts while the system is operating).

Our
breadth of products, including our networking systems, software applications,
hardware platforms, integration tools and content creation tools, allow us to
meet the video networking needs of a wide variety of customers and strategic
partners.  As the use of networked video
applications continues to expand, we intend to leverage our expertise in
digital video technologies and network protocols to continue to develop and
provide products that make these applications more accessible and easy to use.

Business
Strategy

Our
business is built on two strategic efforts: Building Blocks and Broadband
television. Our goal is to be a leading market player with both strategic
efforts.

Building
Blocks.

We
sell encoding and decoding PCI platforms along with our enabling software to
OEMs, system integrators and professional users. As technologies for video
compression are becoming more pervasive, the market is requiring increasingly
higher performance and quality from our products and at lower cost. As the size
of the market is not growing rapidly, the pressure from competition is increasing.
Continuous advances in the computational speed of personal computers have also
enabled some software encoder vendors to compete with us in some markets. These
trends have caused a decline in our revenues from these products in 2003
compared to 2002. We cannot guarantee that our revenues from these products
will not decrease in 2004 and in the future. On the other hand, as available
bandwidth increases and digital video becomes more accessible and easy to
deploy, new video applications are being introduced, increasing the potential
market for our products. We are therefore continuously enhancing and improving
the quality of our current offerings and looking for emerging applications in
order to meet their new requirements.

We
also sell encoding and streaming systems to system integrators for enterprise
streaming applications. The enterprise streaming market is expected to grow
over the next few years. Our products are interoperable with those of key
vendors (for example Microsofts Windows Media Technologies) and compatible
with standards and specifications like MPEG and ISMA.

Broadband
Television.  We sell MGW 5100, an encoding, transcoding
and streaming carrier-grade system to telephone operators and service
providers, who use digital subscriber lines, or DSL, and fiber communications
technologies to increase infrastructure capacity and add multi channel
television to their services. The television over DSL market is expected to
grow significantly over the next few years. We believe our system is one of the
most advanced in the market. We intend to leverage our technological leadership
in this market to gain a leading position and market share. We are partnering
with key vendors and system integrators to make service deployments easier.

|PRODUCTS                        | DESCRIPTION                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          | APPLICATIONS                                                                                                                   
|------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | -------------------------------------------------------------------------------------------------------------------------------
|Media Streaming Products       
|MGW 5100
  Last release Q1/2004 | A multi-service platform that lets carriers stream
  TV over broadband IP or ATM networks such as xDSL, LMDS and FTTx.  MGW 5100 encodes, transcodes, transmits and
  recasts up to 24 26 MPEG-1, MPEG-2 or MPEG-4 ISMA channels.  In the future we also plan to support
  Windows Media Technologies (WMT) and MPEG-4 AVC/H.264. An SNMP Element Management System
  (EMS) offers provisioning, monitoring, alarming and control and enabling
  smooth integration into a variety of networks and access management
  applications. | TV broadcast over IP/ATM broadband networks 
  Video server upload for VOD services and nPVR (network personal video recording)

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|PRODUCTS                              | DESCRIPTION                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          | APPLICATIONS                                                                                                                                
|------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | --------------------------------------------------------------------------------------------------------------------------------------------
|MGW 2400
  Last release Q4Q3/20022003 | A multi-channel WMT encoding and streaming server
  designed to enable the deployment of advanced streaming media services over
  the broadband Internet and corporate networks.  MGW 2400 encodes and streams up to six live Microsoft WMT
  compliant streams over broadband terrestrial and wireless networks such as
  ADSL, FTTx, satellite, cable, Ethernet LANs and the Internet.  It supports live WMT stream upload to
  Microsoft Windows Media Server and IP multicast, unicast, UDP and HTTP
  protocols, ensuring efficient transmission over a wide range of networks. | TV Broadcast over IP to Home PCs
  Webcasting
  Video server upload for Web streaming
  Business TV
  Corporate training
  Distance learning
|MGW 2000e
  Last release:  Q2/2003    | Rack mountable, modular video streaming server
  supports up to 6 MPEG 1 & 2 encoding modules in single enclosure.  Reliable, using embedded OS and no moving
  parts.  Supports IP multicast and
  comes with web based management system. 
  In particular, has a low latency mode for surveillance applications.                                                                                                                                                                                                                                                                  | Video over IP for Enterprise networks
  Video server upload
  Monitoring
  Surveillance
  High quality TV to the desk top                   

Products

Most
of our products embody both a hardware platform and proprietary software.  The hardware platform determines certain
basic features, such as the resolution of the encoded stream, the types of
video and audio inputs and the availability of certain preprocessing functions.
Some of the products are networking devices, which also determine the
networking input and output interfaces.

|Content Creation (typically
  used with our Integrator Tools and Platforms, shown below)
|----------------------------------------------------------------------------------------
|Composer 
  Last release: Q2/2003                                                       

|Integrator Tools and
  Platforms For Encoding
|---------------------------------------------
|MovieMaker 200
  Released: Q4/1999           
|MovieMaker 100S
  Release Q2/2001            
|MovieMaker 200S
  Last Release: Q2/2003      
|MovieMaker 400
  Released: Q1/2004           

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|Integrator Tools and
  Platforms For Decoding
|---------------------------------------------
|VideoPlex PlusReleased: Q1/1996              
|VideoPlex Pro
  Released: Q2/1998            
|VideoPlex XpressLast release: Q2/2001        
|VideoPlex HD
  Last release: Q1/2004         

|DVB System and Interface Products
|---------------------------------
|MGW 3100
  Last Release: Q1/2002 
|MediaPump
  Last Release: Q1/2003

|Software Development Products        
|-------------------------------------
|RTD SDK
  Last Release: Q1/2002      
|RTE SDK
  Last Release: Q3/20022003  
|MediaPump SDK
  Last release: Q1/2003

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|Networking Software                  
|-------------------------------------
|ComMotion Pro
  Last release: Q4/2001
|ComMotion UDP
  Last release: Q4/2002

Our
breadth of products offers high quality and cost-effective solutions.  We use large-scale integrated circuits to
manufacture our products on a single printed circuit board.  Designed for use with all current Microsoft
operating systems, these single-board solutions are both compact and
cost-effective for our customers.

Products
Under Development.We are currently developing new features for MGW
2000, MGW 5100, MovieMaker 400 and MovieMaker 200S. We are also developing a
new generation of the MovieMaker200S product line with many new capabilities.

Markets and
Customers

Our
products are marketed to a wide range of customers.  They include companies with which we have developed strategic
relationships, many of which purchase our products directly, while others help
generate reference sales; system integrators, large and small, which integrate
our products into larger systems; distributors which sell in a specific
territory and manage a large network of resellers; and resellers which sell
directly to end users.  Our products are
aimed at four major markets:

| |  | broadband television telephone
  operators and service providers;                                             
| | - | --------------------------------------------------------------------------------------------------------------
| |   |                                                                                                               
| |  | the broadcast market, such as
  advertising insertion and digital cable TV transmission;                      
| |   |                                                                                                               
| |  | professional video content
  creation markets; and                                                            
| |   |                                                                                                               
| |  | the enterprise and corporate
  markets which include applications such as distance learning and business
  TV.

These markets vary greatly in
the required video quality, acceptable price tags and other feature
requirements.  Our breadth of products
and wide range of feature sets, allow us to answer the needs of these widely
different markets.

Listed
below are representative applications, integrators and end-users using our
products:

|Markets      | Applications                                   | Integrators/End-Users                                                             
|------------ | ---------------------------------------------- | ----------------------------------------------------------------------------------
|Broadband    | Multi channel TV over DSL and
  FTH            |      Chunghwa Telecom
       Fastweb
       HTC
       Piedmont Communications
|Broadcasting | Video on Demand (VOD),
  Near VOD, Hospitality |      SeaChange
  International                                                   

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|Markets                      | Applications                               | Integrators/End-Users                                                                                                        
|---------------------------- | ------------------------------------------ | -----------------------------------------------------------------------------------------------------------------------------
|                             | Near VOD, Hospitality                      |      Prediwave
       N2 Broadband                                                                                         
|                             | Ad Insertion                               |      SeaChange
  International
       IBM Corporation 
       AdTech, Inc.
       Maddox Broadcasting                    
|                             | Cable TV transmission                      |      Harmonic Inc.                                                                                                          
|                             | MPEG-2 transport stream
  splicing         |      Seachange
  International                                                                                              
|                             | Interactive TV                             |      Open TV
       Worldgate
       Liberate                                                                             
|Enterprise                   | Business TV                                |      German Foreign
  Ministry
       Cisco 
       Michigan House of Representatives                                     
|                             | ELearning                                  |      Safari
       Rockford college
       Nanyang Technological University                                               
|                             | Point-of-Sale, Point of
  Information      |      Italian Postal
  Service
       ITEC Corporation
       The J. Paul Getty Museum
       Virgin Records America, Inc.
|                             | Monitoring and Satellite 
  News Gathering |      Antena 3
       National Telecommunications, Ltd. (UK)
       Livewire                                               
|                             | Telemedicine                               |      Stanford University
       Network Concepts/NCI
       Biologic                                                      
|Professional ContentCreation | Video Archiving/Cataloging                 |      CNN
       British Broadcasting Corporation
       French National Library                                           
|                             | DVD and VCD creation                       |      Nimbus CD International
       Various players in APAC
       Fish & Neave                                           

The
following application examples illustrate the use of our products:

Antena
3.  Foregoing costly dedicated satellite links,
Antena 3, a major television broadcaster in Spain, is using our encoding and
transmission platforms to transmit news items between production centers over
Native ATM, which refers to the use of ATM without using the IP protocol for
the network layer, and IP networks. The news stories are transmitted live or
uploaded via file transfer protocol, or FTP. The offices handle two types of
video footage: footage that is edited and stored for later transmission and
footage that is transmitted live to the News Operation Center, or NOC. In the
first case, the video footage is encoded by the MPEG MovieMaker 200S and
uploaded to the NOC by FTP. In the second case,
a live video stream is fed into the MPEG MovieMaker 200S, encoded into
broadcast quality MPEG-2 digital video, and then, using our MPEG ComMotion UDP
streaming software, streamed live over an IP network to a receiving computer at
the NOC.

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The
video contribution network offers Antena 3 tangible advantages: using an ATM
network is far more cost effective than a dedicated satellite uplink. An ATM
network affords greater flexibility since it is available at all times.
Further, our products offer broadcast quality video.

Safari.  The
Rockford Public School district in Grand Rapids, Michigan wanted a reliable,
flexible and easy-to-use video on demand, or VOD, system with a rapid response
time that would benefit educators and their students.  Each of the twelve Rockford Public Schools houses its own video
cassette recorders, or VCRs, and digital video disc, or DVD players, and
utilizes Safari Source Controllers to allow remote local area network, or LAN-based
control of the analog video sources. For the real-time MPEG streaming of analog
sources, Safari uses our MGW 2000, a TV streaming platform that enables the
delivery of TV over IP services to the classrooms. With Safaris customized
architecture, each school is able to access, control and view analog video
media located in any of the other schools. 
By making it straight-forward to access programs and video content
located in other schools, the VOD system eliminates the need for duplicate
content to be stored in video home system, or VHS, or DVD format in each
individual school. It is a cost efficient solution that offers students and
staff a much wider selection of programming.

Cisco.  In
order to provide the best financial service to its customers, a large
international banking institution wanted to keep its stock traders constantly
updated on market changes with live news feeds and stock analysis data.  To meet this challenge, Cisco Systems and Optibase
teamed together to provide a private video distribution network to the stock
traders.

The network is powered by Cisco IP/TV 3400
broadcast server using our MPEG MovieMaker
200 encoder.  The MovieMaker captures live video feeds and
encodes and compresses the data, which is then streamed to the desktops of 750
stock traders.  Each stock trader has
four monitors on their desktop powered by an Hewlitt Packard Kayak computer
containing our VideoPlex XpressMPEG
decoder.  Stock traders can view live
transmissions of news services such as Bloomberg news or Financial Times TV in
a small window on any of the monitors along with real-time financial data.  Besides its importance as a real-time
information tool, the network will also be used for live video briefings and
updates from the banks senior account managers.

Chunghwa
Telecom (Taiwan`s largest broadband network operator).In order to deliver multimedia on-demand services
such as video-on-demand and karaoke-on-demand to more than 20,000 of its ADSL
subscribers, Chunghwa Telecom selected our MGW 2000 streaming server. This
product is a multi-channel streaming server with an embedded operating system,
capable of encoding and transmitting sixteen live and pre-recorded streams
simultaneously, and delivering full-screen, full-motion, high quality video.
Its scalability and flexibility, combined with the ability to replace deployed
encoding modules without interrupting service, proved to be winning factors in
the stringent trials conducted by Chunghwa Telecom.

Michigan
House of Representatives.
In order to stream live content of House proceedings to the desktop computers
of 720 representatives and support staff, the Michigan House of Representatives
selected the MGW 2000 streaming server. 
This Business TV application is comprised of MGW 2000 units, which
stream six channels of live MPEG-1 content in real-time over an IP
infrastructure. Content includes live coverage of proceedings taking place in
House Chambers and committee rooms as well as a live feed from CNN. The system
also accommodates the Houses data transmission needs. Representatives and
staff can now stay abreast of floor debates as well breaking news around the
country, without leaving their desks.

Concurrent. 
Concurrent Computer Corporation, or Concurrent, provides a digital video
system to a large U.S. aerospace corporation for use in its United Kingdoms
WAH-64 Apache Longbow Helicopter Training Program.  The digital video system consists of Concurrents MediaHawk VOD
technology, and our MPEG MovieMaker 200encoder,
MPEG ComMotion and video
streaming software.

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The debrief systems can simultaneously record the
actions of one crew in a helicopter flight simulator while playing back the
events of a previous session for a second crew.  The systems can accommodate multiple video channels or streams,
each of which is completely independent and interactive.  Users are able to select, play, stop and
pause on each digital video stream independently with prompt and predictable
response times.

Our proprietary software tools played a crucial
role in the seamless integration of the MovieMaker
encoder with the MediaHawk video server.

Chin
Shan. The First Nuclear
Power Plant in Taiwan selected the MGW2000 to enable the live delivery of video
content to over 400 of the plants employees. In order to facilitate internal
communications and convey information regarding weather forecasts, power
cutsand training content, the plants management decided to install a video
delivery system that would stream live video to 400 employees desktop
computers and to twelve 42 Plasma TV monitors located throughout the plant.
After an intense selection and testing process, Chin Shan, working with an
Optibase partner in Taiwan for system integration, chose a solution based on
Optibases MGW 2000 streaming server and InfoValues QuickVideo software.

KIA
Motor Corporation.KIA
Motor Corporation, part of the Hyundai-KIA Automotive Group selected the MGW2400
to enable the delivery of corporate training capabilities to KIAs executive
team in its training center in Osan, Korea. KIA sought a high-quality
computer-based training system that would enable its executive team access to
professional courses in their respective disciplines as well as corporate
procedures and updates. Assisted by an Optibase partner in Korea, KIA Motors
chose Optibases MGW 2400 multi-channel Windows Media encoding and streaming
server to be the heart of the solution. The MGW2400 delivers high-quality video
at low bit rates to employee desktop personal computers equipped with a Windows
Media Player.

Sales
and Marketing

We sell our products through the combined efforts
of our direct sales force and through indirect channels, including independent
distributors, system integrators and resellers.  A key element of our sales and distribution strategy is to
cultivate strategic relationships with companies that can promote reference
sales with the potential for significant revenue impact.  The particular mix of sales and distribution
methods we use varies according to geographic region.

Our sales efforts in North America, Central
America and South America are managed by Optibase, Inc., which is headquartered
in Mountain View, California.  Our North
American sales activities are conducted primarily through our direct sales
organization, which focuses on key accounts, which include system integrators
and OEM accounts, that offer strategic opportunities or large volume
potential.  North American sales efforts
are supplemented by our VAR (Value Added Reseller) channel, through which our
products are sold directly to end-users. 
North America accounted for approximately 52% of our total sales in
2001, approximately 61% of our total sales in 2002 and approximately 56% of our
total sales in 2003.

Outside of North America, the majority of sales
are handled via a network of distributors and resellers that manage both small
and large accounts.  As a rule, this
channel is responsible for stocking an inventory of our products to meet
immediate local demand, providing first-line sales and technical support for
their customers, and, with the use of co-op funds from us for these purposes,
conducting local marketing efforts, including trade shows, seminars,
advertisements and mailings.

Distributors also generate and follow up on sales
leads; act as the sole interface with customers, translate our promotional and
technical written materials and endeavor to meet agreed sales targets.  Depending on market size and potential, the
number of distributors and other partners in a given geographic region
varies.  Each is carefully selected
based on its background in video and networking technology, its knowledge of
the local market, its customer base and its reputation.  In addition, we strive to work with partners
who will devote significant time and effort promoting our products and who do
not have product line conflicts.  None
of our distributors has exclusive rights with respect to any of our products or
market segments, and none of our distribution agreements limits our ability to
independently develop products or to enter markets, except for certain
geographical restrictions that are generally terminable on three to six months
notice.  While most of our relationships
can be terminated by either party upon short notice and without significant
penalty, we have
maintained long-standing relationships with a vast majority of our
distributors.  Many of our largest
distributors have carried our products for over three years.

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Distributor and direct account relationships
outside of North America are managed from our headquarters in Israel.  In Europe these distributors and customers
are supported by two Optibase sales managers, one in France and the other in
Israel.  This local presence approach
brings with it many advantages related to culture and language.  The European Sales Managers report to
headquarters in Israel.  Our sales
efforts in China and Hong Kong are directed by our office in Bejing, China and
those in Japan are aided by our Japanese representative in Tokyo.  Other regions in Asia Pacific or APAC are
managed directly from our headquarters in Israel.  European sales constituted approximately 15% of our total
revenues in 2001, approximately 12% of our total revenues in 2002, and
approximately 17% of our total revenues in 2003, while sales in Eastern Asia,
including Japan, constituted approximately 25% of our total revenues in 2001,
approximately 23% of our total revenues in 2002, and approximately 24% of our
total revenues in 2003.  Sales in Israel
and other areas outside of North America was approximately 8% of our total
revenues in 2001, approximately 4% of our total revenues in 2002 and
approximately 3% of our total revenues in 2003.

Combined sales to the three leading distributors
of our products accounted for approximately 13% of our worldwide sales in 2001,
approximately 14% of our worldwide sales in 2002, and approximately 15% of our
worldwide sales in 2003.  Combined sales
to our three leading system integrators accounted for approximately 23% of our
sales in 2001, approximately 30% of our sales in 2002, and approximately 13% of
our sales in 2003.

We also received grants from the Marketing Fund
for specific overseas marketing expenses. 
The grants were based upon the expenses reported by us to the Marketing
Fund.  All marketing grants recorded
from the Marketing Fund until 1997 are linked to the dollar and are repayable
as royalties at the rate of 3% of the amount of increases in export sales
realized by us, up to a total amount equal to the grants we received from the
Marketing Fund.  Grants recorded from programs
beginning on or after January 1, 1998 bear royalties of 4% plus interest at
LIBOR.  We will face royalty obligations
on grants from the Marketing Fund only to the extent we actually achieve
increases in export sales.  The proceeds
of these grants were presented in the Consolidated Financial Statements as a
reduction of selling and marketing expenses. 
Through December 31, 2003, we had recorded grants from the Marketing
Fund in the aggregate amount of $2.8 million, and had no contingent liability
for which we had not yet recognized royalty obligations. No funds were received
from the Marketing Fund during the years 2001, 2002 and 2003.

Technology

Since our inception, we have focused the efforts
of our team of experienced personnel on developing expertise in MPEG-based
digital video.  MPEG-1 was finalized as
a standard in 1991, and by 1992 we had introduced our first MPEG-1 PC decoder,
which enabled high-quality viewing of digital video content on stand-alone PCs.
In 1993, we became one of the first companies to offer a real-time MPEG-1
encoder for the PC. In 1995, we expanded our expertise to include the streaming
of video content over IP and other packet-based networks.  In 1996, we combined our networking
expertise and extensive MPEG experience to introduce our first MPEG networking
products, and in the third quarter of 1998, we began shipping our MPEG-based
content creation tool, DVDFab!.  In the first quarter of 2000, we released ComMotion Pro, which is a scalable,
Web-based networking software application enabling the transmission of MPEG-1
and MPEG-2 digital video and MP3 digital audio over private broadband
networks.  Our in-depth understanding of
network protocols and the MPEG standard has allowed us to develop real-time MPEG
data transfer products and content creation tools.  Each of our products is defined by a hardware platform used in
conjunction with a core proprietary software technology.

In November 2000, we released our MGW 2000, which
is the first product of our new MGW product line that provides streaming media
gateway solutions for enterprises and broadband markets.  In November 2002 we released the MGW 2400,
which enables direct streaming of video into the Internet, Intranets and other
broadband IP networks using the MPEG-4 format and compliant with Windows Media
Technologies (WMT). In December 2002, we released the MGW 5100, a carrier grade product
that enables the encoding and transcoding of video content from one format to
another and the streaming of video over broadband IP networks.

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In
December 2000, we acquired Viewgraphics Inc. 
Viewgraphics adds critical expertise in DVB (Digital Video Broadcast)
technology, which primarily involves the transmission of MPEG-2 over digital
cable networks.  Viewgraphics also has contributed
expertise in uncompressed serial digital video technology and open systems
based software technology.  Viewgraphics
was founded in 1985.  Between 1985 and
1991 Viewgraphics designed and developed imagery frame buffer technology under
contract to US defense contractors. 
Between 1991 and 2000 Viewgraphics sold a product called Viewstore, a
high-end video sequencer, to the video research marketplace.  Over this period Viewgraphics became a
leader in advanced video technologies and interface methodologies.  In 1996, Viewgraphics brought out the
MediaPump and VideoPump products for DVB and SDI (Serial Digital Interface)
respectively.  Viewgraphics had become
the leader in DVB interface technology primarily through superior technology in
the areas of video stream processing, video stream splicing and overall signal
integrity and operational reliability. 
In 2000, Viewgraphics introduced DTV:Net and DTV:Com software
products.  These products are
respectively a DVB to IP streaming gateway and a gateway that can combine
non-video data with DVB streams (a DVB data injector).  The core MPEG-2 streaming and stream
processing technology embodied in these products adds DVB expertise to our
MPEG-2 and streaming expertise. During
2001, the MediaPump was redesigned and enhanced. We introduced an entirely new
and improved product family, the MediaPump 533. We also introduced the MGW 3100
DVB/IP Gateway system, based on the MediaPump products. The MGW3100 is a bridge
between DVB and IP networks for the transmission of video over IP between two
remote sites, or backhaul, and the distribution of DVB content over IP.  In addition, we successfully incorporated
the DVB de-multiplexing technology of the MediaPump into the MGW5100 to enable
the transcoding of video content from satellite and cable feeds and its
distribution over IP and ATM-based access networks. In the third quarter of
2002 due to the loss of SeaChange as a customer of our MediaPump products and
after assessing markets conditions, we decided to cease additional research and
development efforts for the MediaPump, VideoPump and the MGW 3100.  We also decided to shut down the VideoPump
and MGW 3100 product lines, while continuing to support and sell the MediaPump.

Encoder
and decoder related technology.  Firmware, the low-level
software that resides on the printed circuit board in our products, provides
for the basic audio/video compression operations.  We have implemented our own MPEG-audio compression algorithm on a
dedicated digital signal processor, or DSP, and we have integrated an
implementation of a Dolby AC3audio encoder on the same DSP. We have
developed a high quality MPEG-4 encoder on a powerful multimedia DSP from
Equator Technologies for some of our products. We are also researching and
developing algorithms to be implemented by firmware and DSP to improve the
quality of our encoders using advanced preprocessing techniques. Real-time
audio and video layers handle the real-time processing of the elementary audio
and video streams that are generated through the encoder hardware.  At the audio/video synchronization layer,
our patent pending EverSync
technology enables synchronization of both audio and video, even with unstable
video sources or random noise and disconnections, eliminating the need for an
external correction device.  Another
related technology that we have developed is a two-pass variable bit rate
encoding process that allows for better optimization of the bit per frame ratio
to achieve even quality throughout the entire range of content.

Another layer is used to handle the multiplexing,
of the elementary audio and video streams into a single stream.  This layer allows for multiplexing of
programs originated from multiple encoders into a single transport stream and
can handle multiplexing of variable bit rate MPEG streams as well as constant
bit rate streams.  In addition, despite
the fact that MPEG standards do not provide for certain lower frame rates, our SmartMux patent pending technology
embodied in this layer enables generation of variable frame rate streams that
can achieve higher quality streams at a given bit rate.  Another component handles the frame accurate
operation of the encoding process and time code manipulation to enable frame
accuracy within specific parameters of a content creation product.  A real-time preview component allows for
previewing encoded material via an external MPEG decoder.

Because
our proprietary software is compatible across most of our hardware platforms, a
separate component is able to automatically detect the hardware installed,
determine its capabilities and report them to the user application without the
user needing to know which hardware platform is installed.  Other components combine with decoder
hardware to allow smooth back-to-back playback of clips without black frames or
artifacts during transitions and provide our Genlock feature, which allows
locking of decoder hardware to external signals.

DVB
(Digital Video Broadcast) Technology.  We provide proprietary
technology to record, play and process multiple program transport
streams, or MPTS, of DVB.  Our MediaPump
PCI card can capture all the programs in a multiple program transport stream.   Also, on output the MediaPump takes
several single program transport streams, orSPTS, and combines them together
into one multiple program transport stream using the MediaPumps
multiplexer.  The MediaPump then plays
this stream out.  Before creating the
output multiple program transport streams, the MediaPump can also splicetogether the digital data bits for
two single program transport streams. 
This patent pending technology
 represents an important  technological  advantage  since it makes it possible to switch between MPEG-2 streams  without either
losing the picture  entirely for a second or generating  an ugly  break-up of the  television  picture.  We have  recently  developed a
DVB-compliant  scrambling  capability  implemented on the MediaPump  hardware.  Scrambling is employed by DVB programming  providers to
assure that only paying  subscribers  have access to content.  The  scrambling  process is quite complex and not easily  implemented in
software.  It therefore  requires a dedicated product that scrambles the content emitted by the MediaPump before  transmission.  Having
the scrambling feature implemented in our hardware reduces for our customers the total costs of providing a service.

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IP
Network-related technology.  We have developed
transport and control protocols for the streaming of multimedia over IP
networks, such as the real time transport protocol, or RTP, the real time
control protocol, or RTCP, and the real time streaming protocol, or RTSP, that
are becoming widely adopted and standard in the industry. In particular, we
have implemented the specifications of the ISMA [already defined] for the
transmission of audiovisual content over the Internet. We have also developed proprietary mechanisms that allow system
integrators to develop packet-based network solutions.  These mechanisms bridge the real-time nature
of MPEG encoders and the non-real-time nature of packet-based networks, and
allow for unicast, broadcast and multicast capabilities.  One of these mechanisms, known as
clock-locking, is used to lock the encoder to the network clock and enable
unlimited continuous playback of synchronized audio and video. Another
mechanism enables our decoders to recovery gracefully when encountering
network,We support de-multiplexing on the host processor and also on our
decoder hardware. The latter allows the PC to perform other time critical tasks
and also enables multiple boards to run on one PC without overloading the PC
processor.  The MGW 3100 DVB to
IP product is based on sophisticated streaming and routing software, and
includes patent pending techniques for clock locking, drift compensation and
data multiplexing for packet networks. 
The MGW 3100 also has advanced multicast and quality of service, or QoS,
technologies. In the third quarter of 2002
after assessing markets conditions, we decided to shut down the MGW 3100
product line.

SDK
(software development kit) technology.  All of
the encoder and decoder related technology as well as the networking related
technology described above is contained within our software development kits,
or SDKs.  These various components and
tools are organized within the SDKs, which are structured to manage the
inter-dependency of these various components in an optimal manner.  The SDKs are designed to allow system
integrators to easily incorporate our MPEG encoders, DVB interfaces, and SDI
video interface hardware platforms into their own digital video systems and
establish links with existing end-user applications, exploiting the full range
of our core technologies for their applications in a productive manner.  The SDK has been designed so that once it
has been used to incorporate one of our products into a customers system, the same
system can easily be upgraded to incorporate new generations of our products or
expanded to incorporate new products and capabilities.

Content
creation technology.  Specific technology contained in the encoder
SDKs, which facilitates video content creation, is embodied in our content
creation software.  The software
incorporates much of the proprietary technology described above, including EverSync, variable bit-rate encoding,
advanced multiplexing, SmartMux
and smooth playback, to facilitate the content creation process.  We are also developing support for the
Material Exchange Format, or MXF in the Composer. MXF is a file format that is
optimized for the interchange of audiovisual material and its associated
descriptive data for the content creation industries. The Composer with MXF
support will assist TV production installations to migrate from existing
tape-oriented work flows to digital video server-oriented workflows, in which
they can easily create audiovisual content and associate descriptive data with
the content for later reference or modification by editing and archiving
systems.

Broadband
Internet related technology.  We are developing the video and
audio compression algorithms targeted to meet the broadband Internet bandwidth
and quality requirements.  We define the
broadband Internet to include the bandwidth range of 10kbps to 3.5 Mbps, which
can be served by cable modems, various types of digital subscriber line, or
xDSL, modems and wireless technology. 
The video encoding technology that we are developing is based on the
MPEG-4 video international standard, and has been implemented on a powerful
multimedia DSP.  The technology includes
advanced pre-processing algorithms, advanced motion estimation algorithms and
improved rate control algorithms.  We
have also integrated an advance audio coding, or AAC, encoder into our MPEG-4
products.

Management
technology. As
part of the development of our media gateways products we have developed
management software. We have implemented hyper text markup language, or HTML,
software for management using web-based browsers. We have also implemented a
simple network management protocol, or SNMP, interface for use with more complex systems, which require interoperability
with generic network management systems that use SNMP, like HPOpenView.

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Transcoding
technology. An
important feature developed for the MGW5100 is the ability to transcode one
media format to another. We have developed the ability to transcode compression
formats from MPEG-2 to MPEG-4, from MPEG-2 to Windows Media compliant
compression and to transrate from MPEG-2 at a high bit rate to MPEG-2 at a
lower bit rate. The source can be either a variable bit rate, or VBR, or
constant bit rate, or CBR, compression format. We have also developed the
ability to pass-through specified elements of the audiovisual information
without transcoding, such as closed captions and audio streams. In addition to
transcoding at the compression layer, we have further enhanced our networking
capabilities to perform translation of the network layer between DVB,
IP/Ethernet and ATM according to the needs of the service provider. With regard
to ATM we have developed the capability of transmitting audiovisual content
over native ATM and over IP over ATM.

Carrier
Class systems related technology.  As part
of the development of the MGW5100, we have implemented such features as
redundancy and scalability, no single point of failure, and the ability to meet
NEBS requirements. These features are required by Telcos (i.e. carriers) and
service providers in order to ensure a reliable service to their customers.

Video
preprocessing and quality enhancement technology.  New applications for MPEG-2, such as video
digital subscriber lines and video on demand for the cable market have
encouraged us to enhance the quality of our MPEG-2 video encoding at low bit
rates. We are developing tools for quality measurement, preprocessing modules
in DSP and field programmable gate array, or FPGA, and are researching more
advanced techniques like look-ahead and adaptive preprocessing for improved
compression of video content. The first implementations of this technology have
already yielded good results for the encoders in the MGW5100.

Research
and Development

We believe
that our innovative and versatile technology is at the core of our strength,
and that our ability to enhance our current products, to develop and to
introduce new products, to maintain technological competitiveness and to meet
customer requirements is essential to our future success.  Accordingly, we devote and intend to
continue to devote significant human and financial resources to research and
development.  For example, we are
currently investigating technologies for the encoding of High Definition video
to be incorporated into our products.  We continue to add new functionality to our
products. For instance, we recently added support for MXF. MXF is an open
standard that enables exchange of multimedia files prepared during the
production and post production workflow. 
We are also researching algorithms to improve the quality of our
encoders using advanced preprocessing.. 
As part of the process of product development, we work closely with
current and potential customers, dealers, distributors and leading companies in
relevant industries to identify market needs and define appropriate product
specifications. As of May 2004, our research and development department is comprised
of 39 employees all of whom are located in our headquarters in Israel. Our
research and development net expenses were $15.6 million in 2001, $8.1 million
in 2002 and $4.8 million in 2003. 
Research and development grants we received were $1.8 million in 2001,
$2.2 million in 2002, and $2.2 million in 2003.

Our
research and development efforts have been financed through internal resources
as well as through programs sponsored by the Office of the Chief Scientist, or
OCS, in the Israeli Ministry of Industry and Trade, and the European Union
Research and Development Program. 
Generally, grants from the OCS constitute up to 50% of qualifying
research and development expenditures for particular approved projects.  Under the terms of the OCS participation, a
royalty of 3% to 5% is due on revenues from sales of products and related
services that are developed from projects funded by the OCS.  Royalty obligations are varied between 100%
and 150% of the dollar-linked amount of the OCS grant. 
Royalties on grants recorded for programs beginning on or after
January 1, 1999 bear interest linked to the LIBOR.  The manufacture of products developed with
OCS grants must be performed in Israel, unless otherwise approved by the
OCS.  Such approvals will generally be
conditioned upon accelerating the rate of royalties and increasing the total
amount to be paid to as high as 300% of the grant.  Israeli government consent is also required for the transfer to
third parties of technologies developed under projects in which the government
participates.  Such consent is not
required for export from Israel of products developed with such
technologies.  Through December 31,
2003, we received grants from the OCS aggregating $4.8 million for certain of
our research and development projects. 
As of December 31, 2003, accrued and paid royalties to the OCS
totaled $3.1 million.

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In
addition to the general OCS grants, we have received OCS royalty-free grants
through our participation in consortium research programs supported by the MOST
Consortium and the STRIMM Consortium, which consortia participate in the OCS
Magnet royalty-free program.  One of the
goals of the MOST project was the creation and distribution of digital video
over networks for on-line services.  The
MOST consortium project was terminated on March 31, 2000.  The goals of the STRIMM project are to
provide seamless usage of internet-base video and audio mail messaging
services.  Various clients (using a PC,
PDA, cellular phone or similar terminals) on various access networks (broadband
and narrowband) would be able to receive and play video messages in stream mode
without the need to download the (large) video message to their device.  Video format and network protocols will be
transcoded without user intervention, according to the connection and device
capabilities of the terminal.  The
STRIMM project started in July 2000. During May 2003, we have applied for OCS
approval for an additional period, until July 2005.

Through
December 31, 2003, we recorded grants from the MAGNET, MOST and STRIMM
consortiums, aggregating $4 million.

We
are also involved in joint development projects with large European companies,
such as Philips research, Deutsche Telecom, TDF, Aerospatiale Matra, Beta
Research and THALES, conducted under the auspices of, and with financial
assistance from, the European Union Research and Development Program.  Among the goals of these projects are
providing solutions aimed at bridging between video streaming standards for the
broadband and narrowband Internet and the development of tools and applications
for the creation and secure distribution of digital video content.  We believe that participation in such
projects increases our exposure to new technologies, products and potential
customers.  These programs provide
royalty-free funding to consortia of industrial companies and academic
institutions aimed at improving the competitiveness of European industry
through technological research and development, partnerships and strategic
alliances.  Through December 31, 2003 we
have obtained approvals for grants for thirteen research and development
projects for a total amount of approximately $6.2 million (of which
approximately $3.9 million has already been offset against research and
development expenses). Through our participation in the European Union
projects, we are now widely recognized as a leader in advanced digital
multimedia technologies.

Service
and Support

We
believe that providing a high level of customer service and support is
essential to our success.  Our technical
support personnel provide world-wide services through each of our main offices
in Israel, United States, China and Japan. 
In the United States, we provide the first-line of support through our
wholly owned subsidiary, Optibase, Inc. 
Outside of the United States and Israel, our independent distributors
provide the first-line of support in their respective territories, while in
Israel, we provide a second-line of support to those customers.  We also support customer inquiries via a
unique web based Help Desk system to which all our customers are linked,
on-premises support, telephone and e-mail support, and provide additional
technical information on our Internet home page.  We provide a one-year warranty on our hardware products and a
three month free software upgrade on our software products.  We also organize technical seminars from
time to time to further enhance the technical knowledge of distributors and
resellers in the use of our products.

Manufacturing and Sources of Supply

Our
manufacturing facilities, located in Herzliya, Israel, perform procurement of
components, final assembly, testing and quality control of our products.  We out-source assembly of hardware modules
to multiple manufacturers in Israel who work in accordance with our designs and
specifications.  This outsourcing
strategy has improved product quality and our gross margins.  Quality control of our products is conducted
at various production stages, both at the subcontractors and our
facilities.  We have implemented a
supplier qualification program to ensure subcontractor quality standards.  We monitor printed circuit performance by
way of statistical survey and a reporting system that tracks boards from
initial inspection to shipment.

To
accommodate increased production levels, we have initiated a program of
subcontracting the manufacturing of high-volume products to manufacturers who
also procure the required components. 
Under this system, we purchase fully assembled and tested products at
predetermined prices.  We intend to
continue to outsource additional products as production levels increase and we
are satisfied as to the quality control of our subcontractors.  These types of arrangements will allow us to focus on the manufacture of
low-volume products, which are generally more complex in nature and require
more rigorous assembly, testing and quality control procedures.

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Key
components used in our VideoPlex Xpress,
MovieMaker 200, MovieMaker, MM200S, MM100S, MGW5100, MGW 2000e, MediaPump
and other products and systems are presently available from, or supplied by,
only one source and other components are available from limited sources.  These key components include, for example:

| |  | Video
  compression and decompression chips manufactured by LSI Logic which are used
  in our MPEG-1 and MPEG-2 encoders and decoders;                                                                                                                                                                                
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Processors
  compression chips manufactured by Equator Technologies Inc, which are used in
  our MGE400 and MM400 encoders;                                                                                                                                                                                           
| |  | SDI
  interface chips from Gennum;                                                                                                                                                                                                                                                                                    
| |  | Video A/D
  and D/A chips from Philips which are used in our encoders and decoders;                                                                                                                                                                                                                                   
| |  | Microprocessor
  and PCI bridge devices from Intel that are used in our MediaPump and MovieMaker
  boards;                                                                                                                                                                                                            
| |  | Decoder
  chips manufactured by Zoran Corporation, which are used in our decoders;                                                                                                                                                                                                                                    
| |  | Audio Analog
  to Digital Converters (A/D), Digital to Analog Converters (D/A) and
  decompression chips manufactured by Crystal, which are used in our encoders
  and decoders;                                                                                                                                      
| |  | Motorola,
  Inc.s DSPs , which are included in our decoders and encoders;                                                                                                                                                                                                                                            
| |  | The MP503
  manufactured by Cyclone, the suppliers of one of our MediaPump hardware
  platforms; and                                                                                                                                                                                                                  
| |  | Various
  modules, which are integrated in our new generation system, the MGW5100, as
  follows: Switch by PTI (PERFORMANCE Technologies, Inc), host by Motorola,
  backplane and alarm board by Kaparel Corporation, Pentium module by Jumptech
  Adastra ,and compact PCI platform by E.P.S. (Israel) TECH 1992 LTD.

Although
we generally do not have long term supply contracts with our suppliers, we
have, in the past, been able to obtain supplies of components and raw materials
in a timely manner and upon acceptable terms. 
We cannot assure you that we will not face in the future interruptions
or delays in supply of key components. 
The design of components to replace any of these limited source
components could require six months or more, and our results of operations could
be adversely affected in the event of an extended interruption or delay.

Competition

As
a provider of high quality MPEG-based video products, we face actual and
potential competition from numerous competitors.  Our most direct competitors offer MPEG based encoding and
decoding hardware and software development tools similar to those we offer with
varying feature sets and at varying price ranges.  Actual and potential competitors include Tut Systems, Tandberg
Television ASA, Harmonic Inc., Minerva Inc., VBrick Systems Inc., Amnis Systems
(formerly Optivision, Inc.), Winnov Inc., Pinnacle Systems Inc., Sigma Designs,
Inc., Matrox, Vela Research, Inc., Darim Vision Ltd., Canopus, SkyStream Inc.,
DVS, Viewcast Inc. and Vweb Inc. We also expect to see increasing indirect competition
from vendors of software encoders and decoders like Digital Rapids, Ligos and
Intervideo.

The
digital video products industry is undergoing a period of consolidation in
which companies, including some of our competitors, are participating in
business combinations.  These
combinations may result in the emergence of competitors who have greater market
share, customer base, sales force, product offering, and technology and
marketing expertise than we do.  To
compete effectively, we must continue to offer high-quality hardware platforms
and a robust, feature-rich software development kit.  We must also provide extensive technical support, allowing for
easy integration of our products with other systems, thereby reducing our sales
cycle time to system integrators.

We
expect price competition to escalate in the video networking industry.  We have consistently attempted to minimize
the effect of price reductions in the market by introducing more sophisticated
products at the top of our product line, and thereby maintain selling
prices.  However, anticipated
competition may force us in the future to lower product prices on a regular
basis and add new products and feature at lower prices.

We
must also continue to expand our product distribution channel, domestically and
internationally, by making sure that both video networking and content creation
products are covered by suitable and capable distributors.  We cannot assure you that we will be able to
compete effectively on these bases.

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Intellectual
Property

Our
future success and ability to compete are dependent, in part, upon our
proprietary technology.  We rely on
patent, trade secret, trademark and copyright law to protect our intellectual
property. Relating to technologies developed in Optibase Ltd., we hold six
issued patents, two granted in Israel and four granted in the United
States.  Also relating to these
technologies, we have four patent applications pending in the United States,
two of which concern MPEG-4 technologies. We have three PCT patent applications
pending in the WIPO, in the United States and in Israel, relating to the
MGW5100 and the other relating to MPEG-4.

We
also acquired one issued patent in connection with the Viewgraphics
transaction, relating to the DVB splicing technology. In addition, with that
transaction we acquired seven pending patent applications in the United States
concerning our DVB technology. One of those applications is also pending in
four patent offices around the world.

We
cannot assure you that any patents will be issued pursuant to our current or
future patent applications or that patents that have been or may be issued to
us will not be invalidated, circumvented, challenged or licensed to
others.  In addition, we cannot assure
you that the rights granted under any such patents will provide us with
competitive advantages.  We cannot
assure you that any patents issued to us will be adequate to stop unauthorized third
parties from copying our technology, designing around our patents or otherwise
obtaining and using our products, designs or other information.  In addition, we cannot assure you that
others will not develop technologies that are similar or superior to our
technology.  Furthermore, we believe
that factors such as the technological and creative skills of our personnel,
new product developments, product enhancements and marketing activities are
just as essential as the legal protection of proprietary rights to establishing
and maintaining a competitive position.

We
also rely on confidentiality agreements to protect our proprietary rights.  It is our policy to require employees and
consultants and, when possible, suppliers, to execute confidentiality
agreements with us.  We cannot assure
you that our efforts to protect our proprietary rights will be adequate.  Litigation may be necessary to enforce our
intellectual property rights and to protect our trade secrets, and we cannot
assure you that such efforts will be successful.  In addition, the laws of certain countries in which our products
are licensed or distributed do not protect our products and intellectual
property rights to the same extent as the laws of the United States or
Israel.  Accordingly, effective
trademark, copyright and patent protection may be unavailable in certain
foreign countries.  Our inability to
protect our proprietary rights effectively could have a material adverse effect
on our business, financial condition and results of operations.

Many
participants in the digital video market have a significant number of patents
and have frequently demonstrated a readiness to commence litigation based on
allegations of patent and other intellectual property infringement.  From time to time, we receive notices
relating to alleged infringement.  In
some cases, we have not received subsequent communications after responding to
the initial claim or we believe that the correspondence requires no further
action on our behalf.  In some other
cases, we have resolved the matters on commercially reasonable terms or
requested additional information in order to determine the merits of the
notice.  However, we cannot assure you
that future claims will be resolved on such terms, and failure to resolve such
claims on such terms could result in a material adverse effect on our business,
financial condition and results of operations. 
We expect that companies will increasingly be subject to infringement
claims as the number of products and competitors in our industry segment grows
and the functionality of products in different industry segments overlaps.  Responding to such claims, regardless of
merit, could cause product shipment delays or require us to enter into royalty
or licensing arrangements to settle such claims.  Any such claims could also lead to time-consuming, protracted and
costly litigation, which would require significant expenditures of time,
capital and other resources by our management. 
Moreover, we cannot assure you that any necessary royalty or licensing
agreement will be available or that, if available, such agreement could be
obtained on commercially reasonable terms.

Effect
of Government Regulation of our Business

Regulation
of our business by the Israeli government affects our business in several ways.
We benefit from certain tax incentives promulgated by the government of Israel,
including programs sponsored by the Office
of Chief Scientist, or OCS, in the Israeli Ministry of Industry and Trade, for
the support of research and development activities. We also obtained funding
from the MOST and STRIMM consortium, which is a part of the OCS Magnet
program.  We are subject to the Israeli
Companies Law, which regulates the activities of companies incorporated in
Israel. Please see the section entitled Risks Related to Operating in Israel  in ITEM 3.D. RISK FACTORS, as well
as ITEM 10. ADDITIONAL
INFORMATION, for more information on the effects of governmental
regulation of our business.

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4.C
Organizational Structure

Optibase
has one wholly owned subsidiary: Optibase Inc. in the United States.  Incorporated in 1991 and currently located
in Mountain View, California, Optibase Inc. manages our North American sales,
marketing and customer support activities. Optibase Europe Ltd. and Optibase
B.V., former subsidiaries of Optibase were dissolved in July 2002 and September
2003, respectively.  Immediately
following the acquisition of Viewgraphics in December 2000, Viewgraphics
operated as a wholly owned subsidiary of Optibase, Inc. under the name Optibase
U.S., Inc., which was merged into Optibase Inc. in June 2001. We currently
conduct our sales activities in Europe through local employees residing in
various European countries, which are also supported by our Israeli
office.  We also have an office in
France, while the activity in other countries is managed directly from
Israel.  In 1999 and 2000, we have
representative agents in Japan and in China, respectively, in order to
cultivate closer relationships with local sales forces and potential system
integrators and to expand our business development activities in the local
markets.

4.D
Property, plants and equipment

Our
headquarters are located in offices occupying approximately 25,385 square feet
in Herzliya Pituach, Israel, out of which 2,902 square feet are subleased.  Our lease on this space expires on December
31, 2008.

Optibase,
Inc.s headquarters occupy approximately 15,000 square feet in Mountain View,
California. The current lease expires on July 31, 2006.

At
the present time, we maintain small one-man office in France. We
also rent an office of approximately 1,496 square feet in Beijing, China
pursuant to a one-year lease that will expire in December 2004.

Item
5. Operating and Financial Review and Prospects

The
following discussion and analyses about our financial condition and results of
operations contain forward-looking statements that involve risks and
uncertainties.  Our actual results could
differ materially from the results discussed in the forward-looking
statements.  Factors that could cause or
contribute to such differences include, but are not limited to, those set forth
under ITEM 3.D RISK FACTORS ITEM 5.D
 TREND INFORMATION, as well as those discussed elsewhere in this
Annual Report.  You should read the
following discussion and analysis in conjunction with the Selected
Consolidated Financial Data and the Consolidated Financial Statements included
elsewhere in this Annual Report.

Overview

We
provide high-quality, cost-effective products that enable the preparation and
delivery of digital video based on MPEG and Windows MediaTM over
ATM, DVB, the Internet protocol (IP) and other packet-based networks.    We have created a breadth of product
offerings used in applications such as delivery of video over broadband
networks, digital video archiving, distance learning and business
television.  We have experienced a
decrease in our level of revenues in recent years, from $29.4 million in
revenues in 2001 to $20.4 million in revenues in 2002 and $19.4 million in
revenues in 2003.  However, our net loss
has decreased and we were able to return to a net profit of $1.8 million in
2003 from a net loss of $12.9 million in 2002 and a net loss of $39.1 millions
in 2001.  The recent decreases in our
net loss were mainly a result of the managements efforts to reduce operating expenses and improve
financial performance beginning in the third quarter of 2001 and a significant
increase in our financial income, net. As of December 31, 2003, we had
accumulated losses of $62.4 million.

Since
our commencement of operations in 1990, we have made significant investments in
research and development, focusing on MPEG-based digital video technology and
expanding into next generation of broadband networks.  We have periodically introduced new products and enhancements and
other modifications of our existing products.

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Most
recently, during 2003 we released the MGW2000e, which uses traffic smoothing
technology to improve network performance. The MGW2000e was released with the
Optibase Player providing a low latency, end-to-end streaming solution. In 2003
we also released Composer 3.7, which added CableLabs compliance and the
multiplexing of Dolby AC3 5.1 to the Movie Maker 200, enabling content creation
for cable head end video on demand servers. In the first quarter of 2004 we
released the Movie Maker 400. The Movie Maker 400 is a dual channel MPEG-4 PCI
encoder as part of our Movie Maker product line. It ships with an SDK very
similar to the one we provide for the Movie Maker 200, and, in addition,
supports ISMA compliant streaming of the audio and video data over IP networks.
The Movie Maker 400 is an enabler for surveillance, archiving and enterprise
streaming applications. Also in the quarter ended March 31, 2004, we released
the Videoplex HD, a new member of the Videoplex decoder product line that decoders
HD video content at all ATSC resolutions. The Videoplex HD uses technology
developed by Mikrom and is exclusively distributed worldwide by Optibase. It is
intended for use in Digital Cinema, Digital Signage and for content creation in
HD broadcast installations.

Critical
Accounting Policies

Our
consolidated financial statements are prepared in accordance with U.S. GAAP.
These accounting principles require management to make certain estimates,
judgments and assumptions based upon information available at the time that
they are made, historical experience and various other factors that are
believed to be reasonable under the circumstances. These estimates, judgments
and assumptions can affect the reported amounts of assets and liabilities as of
the date of the financial statements, as well as the reported amounts of
revenues and expenses during the periods presented.

In
many cases, the accounting treatment of a particular transaction is
specifically dictated by GAAP and does not require managements judgment in its
application. There are also areas in which managements judgment in selecting
among available alternatives would not produce a materially different result.
Our management reviewed these critical accounting policies and related
disclosures with the Audit Committee. See Note 2 to our Consolidated Financial
Statements, which contain additional information regarding our accounting
policies and other disclosures required by U.S. GAAP.

Our
management believes the significant accounting policies which affect
managements more significant judgments and estimates used in the preparation
of our consolidated financial statements and which are the most critical to aid
in fully understanding and evaluating our reported financial results include
the following:

| |  | Revenue
  recognition;                                                                                                               
| | - | -------------------------------------------------------------------------------------------------------------------------------------
| |  | Estimating
  valuation allowances and accrued liabilities, specifically the trade
  receivable allowances for doubtful debts;        
| |  | Inventories;                                                                                                                         
| |  | Review of
  goodwill, intellectual property and other intangible assets arising on
  capitalized purchased technology for impairment;
| |  | Review of
  equity investment for impairment;                                                                                        
| |  | Review of
  marketable securities investments for classifications and impairment; and                                                
| |  | Review for impairment
  of intangible assets;                                                                                        
| |  | Contingencies.                                                                                                                       

Revenue
recognition

We
generate revenues mainly from the sale of hardware products and to a lesser
extent from sales of software products. We sell our products worldwide through
distributors, systems integrators, VARs and OEMs who are considered
end-customers.

Revenues
from product sales are recognized in accordance with Staff Accounting Bulleting
No. 104, Revenue Recognition in Financial Statements (SAB No. 104), when
persuasive evidence of an agreement exists, delivery of the product has
occurred, the fee is fixed or determinable and collectibility is probable. Upon
delivery, titles and risks are transferred to the customer and no significant
obligations exist after delivery has occurred. Estimated warranty costs, which
are insignificant, are based on our past experience and are accrued in the
financial statements.

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Revenues
from software sales, which are insignificant, are recognized according to
Statement of Position No. 97-2, Software Revenue Recognition (SOP No. 97-2)
(as amended). Therefore, revenues from software sales are recognized when
delivery has occurred, persuasive evidence of an arrangement exists, the
vendors fee is fixed or determinable and collectibility is probable. Upon
delivery, titles and risks are transferred to the customer and no significant
obligations exist after delivery has occurred.

Deferred
revenues include amounts received from customers and goods shipped to
customers, for which revenue has not yet been recognized.

We
assess collection based on a number of factors, including past transaction
history, credit worthiness of the customer and in some instances a review of
the customers financial statements. We insure a substantial part of our
customers with credit insurance in cases of bankruptcy.

We
recognize maintenance over the contractual period for the maintenance, which is
generally one-year. Maintenance is available at multiple levels of support.
Quotes are optional and depend on whether a customer chooses to buy a
maintenance contract or not.

Our
arrangements do not generally include an acceptance requirement. However if
such an acceptance provision exists, then revenue recognition is deferred until
written acceptance of the product has been received from the customer. All of
our agreements in which revenues are recognized are non-refundable and
non-cancelable.

Estimating
valuation allowances and accrued liabilities, specifically the trade receivable
allowance for doubtful debts

We
review on a continuing basis the ability to collect on the trade accounts
receivable and the adequacy of the allowance for doubtful debts against the
trade receivables. We specifically analyze customer accounts, account
receivable aging reports, history of bad debts and the business or industry
sector to which they belong, customer concentrations, customer
credit-worthiness, current economic trends and any other pertinent factors that
come to light and to our attention. Generally a provision will be made when a
trade receivable becomes 90 days past due. In exceptional cases, a provision
after 90 days past due will be waived when, after due diligence with the
customer, we are confident that the receivable is still collectible and the
customer has demonstrated that payment is forthcoming. In addition, we provide
approximately 2% of the trade receivable amount as a general provision for
doubtful debts. As of December 31, 2003, our provision for doubtful debt was
approximately $517,000.

We
are able to make reasonably objective judgments on the adequacy of other
provisions relating to trade accruals. In the case of contingent liabilities,
no provision has been made. This has involved significant judgment that either
we will prevail in the case of litigation or have sufficient insurance to cover
an adverse outcome of any such material proceeding.

Inventories

Significant
judgment is required to determine the reserve for obsolete or excess inventory.
Inventory on hand may exceed future demand either because the product is
outdated or obsolete, or because the amount on hand is more than can be used to
meet future need, or excess. We provide for the total value of inventories that
we determine to be obsolete based on criteria such as customer demand and
changing technologies. On December 31, 2003, our inventory reserves were
approximately $768,000, or 17.4% of our $4.4 million gross inventories.

We
value our inventories at the lower of cost or market price.

Review
of goodwill, intellectual property and other intangible assets arising on
capitalized purchased technology for impairment

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We
assess the impairment of long-lived assets and related goodwill, intellectual
property and other intangibles whenever an event occurs that indicates that the
carrying value may not be recoverable. The factors we consider important in
this assessment include but are not limited to the following:

| |  | Significant
  changes in the manner of our use of the acquired assets or our strategy; and
| | - | ------------------------------------------------------------------------------------------
| |   |                                                                                           
| |  | Significant
  negative industry or economic trends.                                       

The
determination that the carrying value of intangibles, long-lived assets and
goodwill arising on the purchase of intellectual property may not be
recoverable is based upon the existence of one or more of the above factors. We
assess whether impairment exists by conducting an impairment review in which we
compare the carrying value of the assets to their fair value in accordance with
SFAS 142, which became effective in 2002.

During
2002 we implemented the impairment tests required by SFAS 142. Accordingly, a
transitional goodwill impairment loss of $854,000 as of January 1, 2002 was
recorded as the cumulative effect of a change in accounting principle in our
consolidated statement of operations.

In
August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, which is effective for fiscal years beginning
after December 15, 2001. As discussed in Note 2 to the Consolidated
Financial Statements, we adopted SFAS 144 in January 2002. In the second
quarter of 2002, we reassessed the technology acquired from Viewgraphics in
December 2000, and determined that it was unlikely that any future value would
be realized from such technology. As of June 30, 2002, the carrying value
of the technology, which was recorded as intangibles, was $6.8 million.
Based on SFAS No. 144, our intangible assets carrying value of
$6.8 million was in excess of its fair value of zero. Therefore, we
wrote-off the $6.8 million carrying value of our intangible assets as of
June 30, 2002. Net intangible assets at December 31, 2003 amounted to
$140,000.

Review
of Equity Investment for impairment

We
have made an equity investment in a company, which the management
believes is in our best interest and may promote our strategic objectives.
Before investments are executed, they are approved by our executive management
and our board of directors. Generally, management designates an executive staff
member to either serve on the board of directors of the investee as a voting
member or serve as an observer. This process assists management in monitoring
the investment and in determining when an impairment review of the investment
may be required. Our management performs a review of equity investments on a
quarterly basis to determine if a provision for impairment is required. This
process, while based on reasonably objective evidence supplied by the entity in
which we invest, is combined with due diligence sought from general economic
trends and indicators. Significant management judgment is made when conducting
these reviews and future developments in the entity invested in may result in
the impairment provision becoming a write-off or reversed to some extent.

Review
of marketable securities investments for impairment

As
of December 31, 2003 all marketable securities investments are classified as
available for sale and recorded at fair value, and unrealized investment gains
and losses are reflected in shareholders equity. Investment income is recorded
when earned. Investments are reviewed periodically to determine if they have
suffered an impairment of value that is considered other than temporary. If
investments are determined to be impaired, a capital loss is recognized at the
date of determination.

Testing
for impairment of investments also requires significant management judgment.
The identification of potentially impaired investments, the determination of their
fair value and the assessment of whether any decline in value is other than
temporary are the key judgment elements. The discovery of new information and
the passage of time can significantly change these judgments. Revisions of
impairment judgments are made when new information becomes known, and any
resulting impairment adjustments are made at that time. The current economic
environment and recent volatility of securities markets have increased the
difficulty of determining fair value and assessing investment impairment. The
same influences tend to increase the risk of potentially impaired assets.

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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
currently involved in certain legal proceedings and are required to assess the
likelihood of any adverse judgments or outcomes of these proceedings as well as
potential ranges of probable losses. A determination of the amount of accruals
required, if any, for these contingencies is made after careful analysis. 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.

5.A
Operating results

Revenue and Sales

The
following table sets forth, for the periods indicated, the percentage of total
consolidated sales derived from sales into each of the regions identified in
the table, regardless of the operating unit, which generated the sale.  For certain financial information presented
on the basis of geographic operating units, please see note 14a to our Consolidated
Financial Statements included elsewhere in this Annual Report.

|                                  |  | Year Ended December 31, |  
|--------------------------------- |  | ----------------------- | -
|                                  |  |                         |  
|Region                            |  | 2001                    |  
|                                  |  |                         |  
|North America                     |  | 52                      | %
|Europe                            |  | 15                      | %
|Eastern Asia                      |  | 25                      | %
|Other countries, including Israel |  | 8                       | %

The
percentage and the dollar amount of our revenues derived from sales into North
America decreased in 2003 compared to 2002. 
The decrease resulted primarily from the ongoing weakness in the
technology sector. Our sales into Europe increased in terms of absolute dollars
and as a percentage of our total revenues during this period, due to some
improvement in market conditions in Europe and the opening of new markets for
our MGW5100 product.  The percentage of revenues
derived from sales into Eastern Asia had increased in 2003 while the dollar
amount remained stable.  The decrease in
sales in other countries, including Israel, in 2003 primarily reflects slow
orders from local customers as well as the ongoing weakness in the technology
sector.

In
North America, we sell directly to system integrators, OEMs and value-added
resellers, or VARs.  Outside of North
America, we sell directly to system integrators, OEMs, VARs and other
distributors.  Sales of our products to
system integrators can involve a lengthy process and the timing of volume
orders from system integrators can be difficult to forecast.  As a result, revenues may fluctuate from
quarter to quarter depending on the timing and volume of orders.  Since these types of customers typically
request initial delivery within four to eight weeks of their placement of
orders, we have historically had a minimal backlog of orders.  Combined sales to our three leading system
integrators accounted for 23% of our revenues in 2001, 30% of our revenues in
2002 and 19% of our revenues in 2003. 
Combined sales by three leading distributors of our products accounted
for 13% of our revenues in 2001, 14% of our revenues in 2002 and 15% of our
revenues in 2003.

The
majority of our revenues are derived from sales of our standard product
offerings.  Additionally, from time to
time, we have the opportunity to develop customized products, which require
varying amounts of modifications to our standard products and existing
technology.  Except for those situations
that provide the potential for large orders or strategic relationships with
well-known market leaders, we attempt to limit our commitments for customized
products.  The percentage of revenues represented by
standard products and customized products, respectively, fluctuates from period
to period depending on a variety of factors, including the number, size and
timing of customized product activities. 
In each of 2002 and 2003, special engineering projects accounted for
less than 3% of revenues.

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Generally,
we recognize revenues when persuasive evidence of an agreement exists, delivery
of the product has occurred, the fee is fixed or determinable, collectibility
is probable and no significant future obligations exist.  Revenues from software sales are recognized
when delivery has occurred, persuasive evidence of an arrangement exists and
the vendors fee is fixed or determinable and collectibility is probable.  We recognize revenues from customized
project contracts according to the percentage of completion method of
accounting, based on the contractual value of the work performed up to the
balance sheet date, and the ratio of actual cost incurred to total contract
costs.

Research
and Development

We
participate in programs sponsored by the Office of Chief Scientist, or OCS, in
the Israeli Ministry of Industry and Trade, for the support of research and
development activities.  Through
December 31, 2003, we received grants from OCS aggregating $4.8 million
for certain of our research and development projects.  We are obligated to pay royalties to the OCS of 3% to 5% of the
sales of the products and other related revenues developed from such projects,
up to an amount equal to 100%-150% of the grants received linked to US dollar.  Royalties on grants recorded for programs
beginning on or after January 1, 1999 bear interest linked to the London
Interbank Offered Rate, or LIBOR. 
Through December 31, 2003, we accrued and paid royalties to the OCS
in the aggregate amount of $3.1 million. 
As of December 31, 2003, our aggregate contingent liability to the
OCS was $1.7 million.  We consider any
royalties paid in respect of these grants as a cost of revenues.  Please see Note 11b to the Consolidated
Financial Statements for a more complete discussion of these grants.

We
also obtained funding from the MOST and STRIMM consortia, which are part of the
OCS Magnet program.  The Magnet program
is a royalty-free program, encouraging cooperation among industrial companies
and research institutions.  Human
resources and funds are pooled to advance knowledge and technological
development in highly specialized fields. 
The MOST consortium project terminated on March 31, 2000.  The STRIMM consortium started in July 2000
and during May 2003 plans were submitted and approved by the OCS for additional
research periods that will last until July 2005.  Through December 31, 2003, we obtained grants from the MOST
and STRIMM consortium aggregating $4 million.

We
are taking part in non-royalty joint development projects with large European
companies, such as Philips research, Deutsche Telekom, TDF, Aerospatiale Matra,
Beta Research and THALES conducted under the auspices of, and with financial
assistance from, the European Union Research and Development Programs (the
Fourth and Fifth Framework Programs for Research and Technological Development,
or EU RTD).  Among the goals of these
projects are providing solutions aimed at bridging between video streaming
standards for the broadband and narrowband Internet and the development of
tools and applications for the creation and distribution of digital video
content.  We believe that participation
in such projects increases our exposure to new technologies, products and potential
customers.  The EU RTD provides
royalty-free funding to consortiums of industrial companies and academic
institutions.  These programs aim to
improve the competitiveness of European industry through technological research
and development, partnerships and strategic alliances.  We have obtained approval for grants for ten
research and development projects for a total amount of $6.2 million, of which
$3.9 million has been offset through December 31, 2003 against research
and development expenses.

Our
software development costs are charged to income as incurred until
technological feasibility is determined. 
Upon establishment of technological feasibility for the relevant
product, we capitalize software costs in accordance with Statement No. 86
Accounting for the Cost of Computer Software to Be Sold, Leased or Otherwise
Marketed, of the Financial Accounting Standards Board.  Under this policy, we capitalized research
and development expenditures equal to $160,000 in 2001, $120,000 in 2002, in
2003 we did not capitalize research and development expenditures.  We amortize capitalized software costs on a
product-by-product basis commencing with general product release by the greater
of the amount computed using:  (1)
the ratio that current gross revenues from sales of the software bear to
the total of current and anticipated future gross revenues from sales of that
software, or (2) the straight-line method over the estimated useful life
of the product (three to five years). 
We recognized amortization expenses on proprietary software equal
$60,000 in 2001, $54,000 in 2002 and $80,000 in 2003.  In the event that the software development
net costs exceed the net realizable value of the product, we will write down
the costs to net realizable value.

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We
cannot assure you that any of the types of research and development grants we
previously received will remain available in the future upon their current
terms or at all, or, if such types of grants are available, that we will qualify
to receive further grants.  Israeli
companies are generally subject to income tax at the corporate rate of
36%.  However, we are eligible for
certain tax benefits which should result in our income being taxed at a rate
which is significantly lower than the maximum rate for some time after we begin
to report taxable income and exhaust our net operating loss carry-forward.  Please see ITEM
10.E  TAXATION.

Compensation
Expenses

Through
the year 2000, we recorded deferred stock compensation of $6.5 million,
relating to share options and escrow held shares granted with an exercise price
below the deemed fair market value of our outstanding ordinary shares on the
date of the grant.  Deferred stock
compensation expense related to share options is allocated to expenses relating
to the employees who received those share options and is recognized as the
options vest.  Amortization of deferred
stock compensation and escrow held shares expense of $2.2 million, $1.4 million
and $(60,000) was recognized in the years 2001, 2002 and 2003
respectively.  Of the total deferred
stock compensation expenses in 2003, $(116,000) was recorded as research and
development expenses, $1,000 was recorded as general and administrative
expenses and $55,000 was recorded as selling and marketing expenses.  Please see Note 2t to the Consolidated
Financial Statements. To date we have no deferred stock compensation in our
balance sheet.

Statement
of Operations

Since
our inception in 1990 until December 31, 2003, we have accumulated losses of
$62.4 million.  We did not become
profitable on an annual basis until 1997. We were profitable starting from the
quarter ended September 30, 1997 until the quarter ended September 30,
2000 and again from the quarter ended June 30, 2003 until the quarter ended
December 31, 2003. We had a net profit of $1.8 million in fiscal year 2003
while incurring a net loss of $12.9 million in fiscal year 2002.  Our operating results for future periods
will continue to be subject to numerous uncertainties and we cannot assure you
that we will be able to return to profitability on a quarterly or annual basis
in the future.  Historical results are
not necessarily indicative of the results to be expected in the future and
results of interim periods are not necessarily indicative of results for the
entire year.  Please see ITEM 3.D RISK FACTORS and ITEM 5.D TREND INFORMATION.

The
following table sets forth, for the periods indicated, from our consolidated
statements of operations data as percentages of our revenues:

| |                                                                                                                     |  | Year Ended December 31, |   
| | ------------------------------------------------------------------------------------------------------------------- |  | ----------------------- | --
| |                                                                                                                     |  |                         |   
| |                                                                                                                     |  | 2001                    |   
| |                                                                                                                     |  |                         |   
| | Revenues                                                                                                            |  | 100.0                   | % 
| | Cost of revenues                                                                                                    |  | 51                      |   
| | Gross margin                                                                                                        |  | 49                      |   
| | Operating expenses:                                                                                                 |  |                         |   
| | Research and development, net                                                                                       |  | 52.9                    |   
| | Selling and marketing, net                                                                                          |  | 36.9                    |   
| | General and administrative                                                                                          |  | 16.7                    |   
| | Impairment of acquired intangibles                                                                                  |  | 71.1                    |   
| | Restructuring cost                                                                                                  |  | 7                       |   
| | Total
  operating expenses                                                                                          |  | 184.6                   |   
| | Operating (loss)                                                                                                    |  | (135.6                  | ) 
| | Other income (expenses), net                                                                                        |  | 0.01                    |   
| | Financial income, net                                                                                               |  | 3                       |   
| | Net
  income (loss) before tax                                                                                      |  | (132.6                  | ) 
| | Provision
  for tax                                                                                                 |  | 0.2                     |   
| | Net
  income (loss) before cumulative
                 effect
  of changes in accounting
                 principle |  | (132.8                  | ) 
| | Cumulative
  effect of changes in
                 accounting
  principle                                           |  |                         |   
| | Net
  income (loss)                                                                                                 |  | (132.8                  | )%
| |                                                                                                                     |  |                         |   

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Results of Operations
for the Years Ended 2003 and 2002

Revenues. 
Revenues consist of gross sales of products, less discounts, refunds and
returns.  Our revenues decreased by 5.1%
to $19.4 million in 2003 from $20.4 million in 2002.  The decrease resulted primarily from the overall ongoing weakness
in the technology market following the September 11, 2001 terrorist attacks in
the United States, and a decrease in the sales of our legacy products, which
was partially offset by sales of MGW5100 product line, which started in 2003.
Revenues in North America in 2003 were down both in absolute dollar amount and
as a percentage of total revenues. This decrease resulted primarily from better
market conditions in Europe and the Eastern Asia compared to those in North
America.

Cost
of Revenues. Cost
of revenues consists primarily of raw material costs, costs of subcontracting
manufacturing and assembly, labor expense, write-off of obsolescence inventory,
royalty payments made to the OCS, amortization of capitalized software
development costs, other acquisition related costs and allocated overhead
attributable to our production operations. 
Cost of revenues decreased by approximately 17.1% to $8.5 million in
2003 from $10.3 million in 2002.  Cost
of revenues as a percentage of revenues decreased to approximately 43.9% in
2003 compared to approximately 53% in 2002. The decrease was primarily due to the
lower cost of some of our new products, as well as the overall weakness in the
technology market, which led to reductions in prices of our raw materials and
in our manufacturing costs. During 2003, we continued manufacturing and selling
V.box products, which as a percentage of revenues have a higher cost compared
to the other product lines. We expect cost of revenues to fluctuate as a
percentage of revenues in the future depending, in part, on our product mix.

Research
and Development Expenses, Net. Research and development
expenses, net, consist primarily of labor expenses, development-related raw
materials, acquisition related costs and stock option compensation charges and
related overheard, offset by grants. 
Our net research and development expenses decreased by approximately
40.5% to $4.8 million in 2003 from $8.1 million in 2002.  As a percentage of revenues, net research
and development expenses decreased to approximately 25% in 2003 from approximately
39.8% in 2002.  Amortization of
intangible assets and deferred stock compensation expenses beginning in the
fourth quarter of 2000, as a result of the acquisitions of Viewgraphics and
HiTV, decreased to $(49,000) in 2003 from $1.5 million in 2002. In addition,
the decrease in research and development expenses can primarily be attributed
to the decrease in labor and subcontractors costs totaling approximately $4.3
million and $6.1 million in 2003 and 2002 respectively. Research and
development grants received from the OCS, including the OCS Magnet program, and
from the European Union remained stable at $2.2 million in 2003 as in 2002. We
expect our net research and development expenses to decrease in absolute
dollars in the future, primarily due to a reduction of personnel mainly in our Israeli
research and development center and managements ongoing efforts to reduce
operating expenses and improve financial performance.

Selling
and Marketing Expenses, Net.  Selling and marketing expenses,
net, consist primarily of compensation expenses, promotional expenses, travel
costs, royalties paid to the Marketing Fund and related overhead and
expenses.  Our net selling and marketing
expenses decreased approximately in 1% to $7.9 million in 2003 from $8 million
in 2002.  As a percentage of revenues,
net selling and marketing expenses increased to approximately 40.9% in 2003
from approximately 39.1% in 2002.  The
dollar amount decrease in selling and marketing expenses is primarily due to a
reduction in sales compensation expenses and a reduction in tradeshows and
marketing and communications activities. 
Selling and marketing expenses will fluctuate as a percentage of
revenues, depending, in part, on fluctuations in the level of revenues.

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General
and Administrative Expenses.  General and administrative
expenses consist primarily of compensation costs, fees to outside consultants,
legal and accounting fees, acquisition related costs and stock option
compensation charges and certain office maintenance
costs.  General and administrative
expenses decreased approximately 3.8% to $2 million in 2003 from $2.1 million
in 2002.  As a percentage of revenues,
general and administrative expenses remained stable at approximately 10% in
2003 as in 2002.  The decrease in dollar
amount is due primarily to a decrease in amortization of deferred stock
compensation expenses resulting from the purchase of Viewgraphics during the
forth quarter of 2000, reduced labor costs, decreasing usage of consultants and
experts and decreased provision for doubtful accounts.

Impairment
of Acquired Intangibles and Related Tangible Assets.  In
September 2001, following a continued decrease in our market capitalization we
implemented an impairment test on our acquired intangibles. As a result of the
analysis (conducted by an independent evaluator) we recorded expenses totaling
$20.9 million due to impairment of acquired intangibles. Under the new
accounting rules published in June 2001, by the Financial Accounting Standard
Board, SFAS 141 and SFAS No. 142 effective for fiscal years beginning after
December 15, 2001, goodwill and intangible assets will be subject to annual
impairment tests. In August 2001, the FASB issued SFAS 144, which is
effective for fiscal years beginning after December 15, 2001. SFAS 144
supersedes FASB Statement No. 121, Accounting for the Impairment or Disposal
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and the
accounting and reporting provisions relating to the disposal of a segment of a
business under Accounting Principles Board Opinion No. 30. Since in the second quarter of 2002 we lost SeaChange as
a customer of our MediaPump products, and due to the decrease in our market
value at that time, we have reassessed several assets, mainly intangibles, in
our financial statements. Impairment of these assets was required according to
the rules of SFAS 144. As a result, we recorded an impairment charge of
acquired intangibles totaling approximately $6.8 million during 2002. No
impairment of acquired intangibles and related tangible assets was charged in
fiscal year 2003.

Restructuring
Cost.  In the third quarter of 2002, due to the
loss of SeaChange as a customer of our MediaPump products and after assessing
markets conditions, we decided to cease additional research and development
efforts for the MediaPump, VideoPump and the MGW 3100. We also decided to shut
down the VideoPump and MGW 3100 product lines. As a result we incurred
restructuring costs totaling approximately $505,000, which costs were comprised
mainly of expenses related to the reduction in workforce and write-off of
assets related to that reduction. In September 2001, as part of the
managements aggressive efforts to tighten cost controls and improve financial
performance, we underwent a restructuring process. The restructuring costs,
totaling approximately $2.1 million, were comprised mainly of expenses related
to the reduction in workforce and write-off of assets related to that
reduction. No restructuring costs were charged in fiscal year 2003.

Operating
Income.  As a result of the foregoing, we recorded
operating loss of $3.9 million in 2003 compared with an operating loss of $15.3
million during 2002.

Other
Income (Expenses), Net.  We recorded other expenses of
$2.28 million in 2003, compared to other expenses of $339,000 in 2002.  Of the total expenses in 2003, $1.36 million
is related to the adjustment of the investment in Mobixell and $4,000 is
related to sales of fixed assets, as is the $14,000 in 2002.  In
respect of an investment we made in V.Box by way of convertible notes, we implemented the
hypothetical liquidation method. We recorded expenses totaling approximately $907,000 in
2003, compared with approximately $325,000 in 2002.

Financial
Income (Expenses), Net.  Financial expenses consist
primarily of interest we paid on bank credit lines.  Financial income consists mainly of interest received on deposits
and other financial assets held in our bank accounts and gains from realization
of securities. Our exchange differences occur primarily as a result of the
change of the NIS value relative to the U.S. dollar.  We recorded financial income, net of financial expenses, of $8
million in 2003, compared with $3.7 million in 2002.  The increase in 2003 resulted primarily from higher yields and
capital gains on certain investment grade financial investments made through
2003.

Net
Income (Loss) Before Tax.  We recorded net income before
tax of $1.8 million in 2003, compared with a net loss before tax of $11.9
million in 2002.

Provision
for Tax. We have
completed our tax assessments with the tax authorities in Israel for the fiscal
years 1997 through and including 2001. As a result, we have made supplemental
provisions for tax of approximately $124,000 in 2002, in addition to the
provision made in 2001 of approximately $67,000. No provision for tax was made
in fiscal year 2003.

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Net
Income (Loss) Before Cumulative Effect of Changes in Accounting Principles.  We
recorded net income of $1.8 million in 2003, as compared to a net loss of $12.1
million in 2002 before applying the cumulative effect of changes in accounting
principles which were implemented in that year.

Cumulative
Effect of Changes in Accounting Principles.  During
the second quarter, ended June 30, 2002 and according to the requirements of
SFAS 142, we completed our goodwill impairment analysis and recognized a
transitional goodwill impairment loss of $854,000 as of January 1, 2002, which
was recorded as the cumulative effect of a change in accounting principles in
our consolidated statement of operation. No cumulative effect of changes in
accounting principle was recorded in fiscal year 2003.

Net
Income (Loss).  We recorded net income of $1.8 million in
2003, compared with a net loss of $12.9 million in 2002.

Results
of Operations for the Years Ended 2002 and 2001

Revenues. 
Revenues consist of gross sales of products, less discounts, refunds and
returns.  Our revenues decreased by
30.6% to $20.4 million in 2002 from $29.4 million in 2001.  The decrease resulted primarily from the
overall weakness in the technology market following the September 11, 2001
terrorist attacks in the United States, and the loss of SeaChange as a customer
of our MediaPump products, which significantly reduced our revenues for the
second quarter of 2002 and affected us in the following quarters of 2002. We
also experienced a reduction in sales of our MGW 2000 product line to
approximately $2.7 million in 2002 from approximately $4.2 million in 2001,
which was partially offset by approximately $1.1 million sale of V.box
products, which started in 2002. Revenues in North America in 2002 were down in
absolute dollar amount, but were up as a percentage of total revenues. This
percentage increase resulted primarily from worse market conditions in Europe
and the Eastern Asia compared to those in North America.

Cost
of Revenues.  Cost of revenues consists primarily of raw
material costs, costs of subcontracting manufacturing and assembly, labor
expense, write-off of obsolescence inventory, royalty payments made to the OCS,
amortization of capitalized software development costs, other acquisition
related costs and allocated overhead attributable to our production
operations.  Cost of revenues decreased
by approximately 31.6% to $10.3 million in 2002 from $15 million in 2001.  Cost of revenues as a percentage of revenues
decreased to approximately 50.3% in 2002 compared to approximately 51% in 2001.
The decrease was primarily due to acquisition-related costs, which were
impaired during the quarter ended June 30, 2002 and were not charged to the cost
of revenues thereafter, as well as the overall weakness in the technology
market which led to reduction in prices of our raw materials and in our
manufacturing costs. During 2002, we started manufacturing and selling V.box
products, which as a percentage of revenues have a higher cost compared to the
other product lines.

Research
and Development Expenses, Net. Research and development
expenses, net, consist primarily of labor expenses, development-related raw
materials, acquisition related costs and stock option compensation charges and
related overheard, offset by grants. 
Our net research and development expenses decreased by approximately
47.8% to $8.1 million in 2002 from $15.6 million in 2001.  As a percentage of revenues, our net research
and development expenses decreased to approximately 39.8% in 2002 from
approximately 52.9% in 2001. 
Amortization of intangible assets and deferred stock compensation
expenses beginning in the fourth quarter of 2000, as a result of the
acquisitions of Viewgraphics and HiTV, decreased to $1.5 million in 2002 from
$4.4 million in 2001. In addition, the decrease in research and development
expenses can primarily be attributed to the decrease in labor and subcontractor
costs. Research and development grants received from the OCS, including the OCS
Magnet program, and the European Union increased to $2.2 million in 2002 from
$1.8 million in 2001.

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Selling
and Marketing Expenses, Net.  Selling and marketing expenses,
net, consist primarily of compensation expenses, promotional expenses, travel
costs, royalties paid to the Marketing Fund and related overhead and
expenses.  Our net selling and marketing
expenses decreased approximately in 26.3% to $8 million in 2002 from $10.8
million in 2001.  As a percentage of
revenues, our net selling and marketing expenses increased to approximately
39.1% in 2002 from approximately 36.9% in 2001.  The dollar decrease in selling and marketing expenses is
primarily due to a reduction in sales compensation expenses and reduction in
tradeshows and marketing and communications activities.

General
and Administrative Expenses.  General and administrative
expenses consist primarily of compensation costs, fees to outside consultants,
legal and accounting fees, acquisition related costs and stock option
compensation charges and certain office maintenance costs.  General and administrative expenses
decreased by approximately 58.4% to $2.1 million in 2002 from $4.9 million in
2001.  As a percentage of revenues,
general and administrative expenses decreased to approximately 10% in 2002 from
approximately 16.7% in 2001.  The
decrease is due primarily to a decrease in amortization of intangible assets
and deferred stock compensation expenses resulting from the purchase of
Viewgraphics and HiTV during the forth quarter of 2000, totaling $21,000 in
2002 compared to $1.5 million in 2001, reduced labor costs, decreasing usage of
consultants and experts, decreased provision for doubtful accounts partially offset
by an increase in insurance costs.

Impairment
of Acquired Intangibles and Related Tangible Assets.  In
September 2001, following a continued decrease in our market capitalization we
implemented an impairment test on our acquired intangibles. As a result of the
analysis (conducted by an independent evaluator) we recorded expenses totaling
$20.9 million due to impairment of acquired intangibles. Under the new
accounting rules published in June 2001, by the Financial Accounting Standard
Board, SFAS 141 and SFAS No. 142 effective for fiscal years beginning after
December 15, 2001, goodwill and intangible assets will be subjected to annual
impairment tests. In August 2001, the FASB issued SFAS 144, which is
effective for fiscal years beginning after December 15, 2001. SFAS 144
supersedes FASB Statement No. 121, Accounting for the Impairment or Disposal
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and the
accounting and reporting provisions relating to the disposal of a segment of a
business under Accounting Principles Board Opinion No. 30. Since in the second quarter of 2002 we lost SeaChange as
a customer of our MediaPump products, and due to the decrease in our market
value at that time, we have reassessed several assets, mainly intangibles, in
our financial statements. Impairment of these assets was required according to
the rules of SFAS 144. As a result, we recorded impairment charge of acquired
intangibles totaling approximately $6.8 million during 2002.

Restructuring
Cost.  In the third quarter of 2002, due to the
loss of SeaChange as a customer of our MediaPump products and after assessing
markets conditions, we decided to cease additional research and development
efforts for the MediaPump, VideoPump and the MGW 3100. We also decided to shut
down the VideoPump and MGW 3100 product lines. As a result we incurred
restructuring costs totaling approximately $505,000, which costs were comprised
mainly of expenses related to the reduction in workforce and write-off of
assets related to that reduction. In September 2001, as part of the
managements efforts to tighten cost controls and improve financial
performance, we underwent a restructuring process. The restructuring costs,
totaling approximately $2.1 million, were comprised mainly of expenses related
to the reduction in workforce and write-off of assets related to that
reduction.

Operating
Income.  As a result of the foregoing, we recorded
operating loss of $15.3 million in 2002 compared with an operating loss of
$39.9 million during 2001.

Other
Income (Expenses), Net.  We recorded other expenses of
$339,000 in 2002, compared to other income of $4,000 in 2001.  In
respect of an investment we made in V.Box by way of convertible notes, we implemented the hypothetical
liquidation method. We recorded expenses totaling approximately $325,000 in 2002.

Financial
Income (Expenses), Net.  Financial expenses consist
primarily of interest we paid on bank credit lines.  Financial income consists mainly of interest received on deposits
and other financial assets held in our bank accounts and gains from realization
of securities. Exchange differences occur as a result of the change of the NIS
value relative to the U.S. dollar.  We
recorded financial income, net of financial expenses, of $3.7 million in 2002,
compared with $875,000 million in 2001. 
The increase in 2002 resulted primarily from higher yields on certain
investment grade financial investments made through 2002.  Also our net financial income during 2001
suffered due to an other than temporary impairment of financial instruments of
approximately $1.8 million, which did not occur in 2002.

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Net
Loss Before Tax.  We recorded a net loss before tax of $11.9
million in 2002, compared with a net loss before tax of $39.0 million in 2001.

Provision
for Tax. We have
completed our tax assessments with the tax authorities in Israel for the fiscal
years 1997 through and including 2001. As a result we have made supplemental
provisions for tax of approximately $124,000 in 2002 in addition to the
provision made in 2001 of approximately $67,000.

Net
Loss Before Cumulative Effect of Changes in Accounting Principles.  We
recorded a net loss before giving cumulative effect of changes in accounting
principles of $12.1 million in 2002, compared to $39.1 million in 2001.

Cumulative
Effect of Changes in Accounting Principles.  During
the second quarter of 2002 and according to the requirements of SFAS 142, we
completed our goodwill impairment analysis and recognized a transitional
goodwill impairment loss of $854,000 as of January 1, 2002, which was recorded
as the cumulative effect of a change in accounting principle in our
consolidated statement of operation.

Net
Loss.  We recorded a net loss of $12.9 million in
2002, compared with a net loss of $39.1 million in 2001.  As a percentage of revenues, our net loss
decreased to approximately 63.2% of revenues in 2002 compared to approximately
132.9% of revenues in 2001.

Quarterly
Results of Operations

The
following tables set forth Consolidated Statement of Operations Data for each
of the eight quarters in the years 2002 and 2003, both in dollar amounts and as
a percentage of our revenues for the respective quarters.  This information has been derived from our
unaudited consolidated financial statements. 
The unaudited consolidated financial statements have been prepared on
the same basis as the audited consolidated financial statements contained
elsewhere in this Annual Report and include all adjustments, consisting only of
normal recurring adjustments, that we consider necessary for a fair
presentation of the information.  The
information should be read in conjunction with our Consolidated Financial
Statements and the related Notes appearing elsewhere in this Annual Report.

|                                                  |  | Fiscal 2002                 |   | Fiscal 2003       | 
|------------------------------------------------- |  | --------------------------- | - | ----------------- | 
|                                                  |  |                             |   |                   | 
|                                                  |  | Mar. 31,
  2002             |   | June
  30,
  2002 | 
|                                                  |  |                             |   |                   | 
|                                                  |  | (U.S. dollars in thousands) |  
|Consolidated Statement of
       Operations Data: |  |                             |   |                   | 
|Revenues                                          |  |                             | $ | 7,005             | 
|Cost
  of revenues                                |  |                             |   | 3,349             | 
|Gross
  profit                                    |  |                             |   | 3,656             | 
|Operating
  expenses:                             |  |                             |   |                   | 
|Research
  and development, net                   |  |                             |   | 2,486             | 
|Selling
  and marketing, net                      |  |                             |   | 1,960             | 
|General
  and administrative                      |  |                             |   | 461               | 
|Impairment
  of acquired intangibles              |  |                             |   |                   | 
|Restructuring
  cost                              |  |                             |   |                   | 

47

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|                                                                                    |  | Fiscal 2002                 |  | Fiscal 2003       |   
|----------------------------------------------------------------------------------- |  | --------------------------- |  | ----------------- | --
|                                                                                    |  |                             |  |                   |   
|                                                                                    |  | Mar. 31,
  2002             |  | June
  30,
  2002 |   
|                                                                                    |  |                             |  |                   |   
|                                                                                    |  | (U.S. dollars in thousands) | 
|Total
  operating expenses                                                          |  |                             |  | 4,907             |   
|Operating
  loss                                                                    |  |                             |  | (1,251            | ) 
|Other
  income (expenses), net                                                      |  |                             |  |                   |   
|Financial
  income (expenses), net                                                  |  |                             |  | 430               |   
|Net
  income (loss) before tax                                                      |  |                             |  | (821              | ) 
|Provision
  for tax                                                                 |  |                             |  |                   |   
|Net
  income (loss) before
  cumulative effect of changes in
  accounting principle |  |                             |  | (821              | ) 
|Cumulative
  effect of changes in
  accounting principle                            |  |                             |  | 854               |   
|Net
  income (loss)                                                                 |  |                             |  | (1,675            | ) 
|                                                                                    |  |                             |  |                   |   
|Percentage of Revenues:                                                             |  |                             |  |                   |   
|Revenues                                                                            |  |                             |  | 100               | % 
|Cost
  of revenues                                                                  |  |                             |  | 47.8              |   
|Gross
  margin                                                                      |  |                             |  | 52.2              |   
|Operating
  expenses:                                                               |  |                             |  |                   |   
|Research
  and development, net                                                     |  |                             |  | 35.5              |   
|Selling
  and marketing, net                                                        |  |                             |  | 28                |   
|General
  and administrative                                                        |  |                             |  | 6.6               |   
|Impairment
  of acquired intangibles                                                |  |                             |  |                   |   
|Restructuring
  cost                                                                |  |                             |  |                   |   
|Total
  operating expenses                                                          |  |                             |  | 70.1              |   
|Operating
  (loss)                                                                  |  |                             |  | (17.9             | ) 
|Other
  income, (expenses), net                                                     |  |                             |  |                   |   
|Financial
  income (expenses), net                                                  |  |                             |  | 6.1               |   
|Net
  income (loss) before tax                                                      |  |                             |  | (11.7             | ) 
|Provision
  for tax                                                                 |  |                             |  |                   |   
|Net
  income (loss) before
  cumulative effect of changes in
  accounting principle |  |                             |  | (11.7             | ) 
|Cumulative
  effect of changes in
  accounting principle                            |  |                             |  | 12.2              |   
|Net
  income (loss)                                                                 |  |                             |  | (23.9             | )%
|                                                                                    |  |                             |  |                   |   

In
September 2001, as part of our efforts to tighten cost controls and improve
financial performance, we underwent a restructuring process. The restructuring
costs, a total of approximately $2.1 million, were comprised mainly of expenses
related to the reduction in workforce and write-off of assets related to that
reduction. The decrease in operating expenses resulting from the restructuring
process is reflected in the quarterly results from the quarter ended December
31, 2001 onwards. In the fourth quarter of 2002, and the forth quarter of 2003
we decided to make additional reductions, mainly in research and development expenses. Those reductions were
reflected in our quarterly results during fiscal year 2003 and will continue to
affect our quarterly results in fiscal year 2004 and onwards.

48

---

---

Our
quarterly results of operations may fluctuate significantly due to several
factors, including, among other things, the following:

| |  | the size,
  timing and shipment of orders;                                                                                                     
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------
| |  | sales of
  products associated with large projects requiring customization;                                                                    
| |  | delay or
  cancellation of projects of our customers;                                                                                          
| |  | the timing
  of introductions of new products or product upgrades by us and our
  competitors and the rate of acceptance of those new products;
| |  | customer
  order deferrals in anticipation of new products or product upgrades;                                                                
| |  | the mix of
  product sales;                                                                                                                    
| |  | software and
  hardware development problems;                                                                                                  
| |  | product
  quality problems;                                                                                                                    
| |  | competitive
  pressures on product pricing, which can adversely affect gross profit;                                                           
| |  | the
  effective provision by us of customer support; and                                                                                       
| |  | efforts of
  third-party distributors and resellers.                                                                                           

Because
a large percentage of our operating expenses are fixed, variations in timing of
orders and recognition of revenue can cause significant variations in our operating
results from quarter to quarter.  For
the foregoing reasons, we believe that quarter to quarter comparisons of our
results of operations are not necessarily meaningful and that our results of
operations in any particular quarter should not be relied upon as an indication
of future performance.

Conditions
in Israel

We
are incorporated under the laws of the State of Israel, and our principal
offices and substantially all research and development and manufacturing
facilities are located in Israel. 
Accordingly, we are directly affected by political, economic and
military conditions in Israel.  Our
operations would be materially adversely affected if major hostilities
involving Israel will occur or if trade between Israel and its present trading
partners will be curtailed.

Political
Conditions.  Since the establishment of the State of
Israel in 1948, a number of armed conflicts have taken place between Israel and
its Arab neighbors and a state of hostility, varying from time to time in
intensity and degree, has led to security and economic problems for
Israel.  However, a peace agreement
between Israel and Egypt was signed in 1979, a peace agreement between Israel
and Jordan was signed in 1994 and, since 1993, several agreements between
Israel and Palestinian representatives have been signed. As of the date hereof,
Israel has not entered into any peace agreement with Syria or Lebanon.
Moreover, since October 2000, there has been a significant deterioration in the
relationship between Israel and the Palestinian Authority, which have resulted
in increased violence. Efforts to resolve the conflict have failed to result in
an agreeable solution.  The
violence includes terrorist acts in Israel and military operations in the West
Bank and Gaza.  We could be adversely
affected if these hostilities intensify or spread to additional areas in
Israel. Further deterioration of the
situation into a full scale armed conflict might require more widespread
military reserve service by some of our employees and officers, which may have
a material adverse effect on our business.

Certain
countries, companies and organizations continue to participate in a boycott of
Israeli firms.  We do not believe that
the boycott has had a material adverse effect on us, but restrictive laws,
policies or practices directed towards Israel or Israeli businesses may have an
adverse impact on the expansion of our business.

Generally,
all male adult citizens and permanent residents of Israel under the age of 51are obligated to perform up to 30 days, or
longer under certain circumstances, of military reserve duty annually.  Additionally, all such residents are subject
to being called to active duty at any time under emergency circumstances.  Currently, a majority of our officers and
employees are obligated to perform annual reserve duty.  While we have operated effectively under
these requirements since our inception, we cannot assess the full impact of
such requirements on our workforce or business if conditions should change, and
we cannot predict the effect of any expansion or reduction of such obligations
on us.

49

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Economic
Conditions.  Israels economy has been subject to
numerous destabilizing factors, including a period of rampant inflation in the
early to mid-1980s, low foreign exchange reserves, fluctuations in world
commodity prices, military conflicts and civil unrest.  The Israeli government has, for these and
other reasons, intervened in various sectors of the economy, employing, among
other means, fiscal and monetary policies, import duties, foreign currency
restrictions and controls of wages, prices and foreign currency exchange
rates.  In 1998, the Israeli currency
control regulations were liberalized significantly, as a result of which
Israeli residents generally may freely deal in foreign currency and
non-residents of Israel generally may freely purchase and sell Israeli currency
and assets.  There are currently no
Israeli currency control restrictions on remittances of dividends on the
ordinary shares or the proceeds from the sale of the shares; however,
legislation remains in effect pursuant to which currency controls can be
imposed by administrative action at any time. 
The Israeli government has periodically changed its policies in all
these areas.

Furthermore,
the Israeli economy is currently in recession. The rate of unemployment has
risen, consumer spending has decreased and many businesses have experienced
financial difficulties. A continuing deterioration in the economic conditions
in Israel may adversely affect usage patterns of our services and the ability
of our customers to pay for our services, which would adversely affect our
financial condition and results of operations. If the economic deterioration in
Israel continues, it may also affect the ability of Israeli banks to provide us
with financing on reasonable terms and conditions, should we need it in the
future.

Currency
and Inflation

A
substantial majority of our sales and expenses are incurred or determined in
U.S. dollars or are dollar-linked.  The
currency of the primary economic environment in which we operate is, therefore,
the dollar, which is our functional reporting currency.  Nevertheless, because certain of our
expenses are incurred in NIS and are affected by changes in the Israeli
consumer price index, the dollar cost of our operations is influenced by the
extent to which any increase in the rate of inflation in Israel is not offset,
or is offset on a lagging basis, by the devaluation of the NIS in relation to
the dollar.

As
of May 9, 2004, the inflation rate in Israel has increased at a rate of (0.1)%
while the NIS had devaluated against the dollar by approximately 4.7%. The
inflation rate in Israel was approximately 1.4% in 2001, approximately 6.5% in
2002 and a deflation rate of approximately 1.9% in 2003.  At the same time the devaluation of the NIS
against the dollar was approximately 9.3% in 2001 and approximately 7.3% in 2002.  In 2003, NIS had appreciated against the
dollar by approximately 7.6%.  As a
result of this differential, we experienced an increase in the dollar costs of
operations in Israel in 2003, and a decrease in 2001 and 2002, all of which did
not materially affect our results in such periods.  The fluctuations in the dollar costs of our operations in Israel
related primarily to the costs of salaries in Israel, which are paid in NIS and
constitute a significant portion of our expenses.  We cannot assure you that we will not be materially adversely affected
in the future if inflation in Israel exceeds the devaluation of NIS against the
dollar or if the timing of such devaluation lags behind increases in inflation
in Israel.

5.B
Liquidity and Capital Resources.

We
have funded our operations primarily through private and public sales of our
equity securities, borrowings from banks, research and development grants from,
among others, the EU RTD and the OCS, marketing grants from the Marketing Fund
and through cash generated from our operations.  As of December 31, 2003, we had cash, cash equivalents and
short - term investments of $54.9 million.

Our
operating activities used cash of $96,000 in 2003 and $21.2 million in 2001,
and in 2002 provided $23.4 million. 
Cash used by operating activities in 2001 was primarily the result of
our net loss for the period, as adjusted for impairment of other assets,
depreciation and amortization, amortization of deferred stock compensation,
other than temporary decrease in value of marketable securities, loss on
trading marketable securities, a significant decrease in trade receivables and
other receivables, partially offset by an increase in inventories, a
significant increase in trading marketable securities, a significant decrease
in trade payables, accrued expenses and other liabilities and deferred
revenues.   Cash provided by operating
activities in 2002 was primarily the result of our net loss for the period, as
adjusted for trading of marketable securities, net, impairment of other assets,
depreciation and amortization, amortization of deferred stock compensation, a
significant decrease in trade receivables, decrease in inventories, cumulative
effect of changes in accounting principle,  other expenses,
partially offset by gain on sale of available-for-sale marketable securities, a decrease in trade payables, accrued
expenses and other liabilities. Cash used by operating activities in 2003 was
primarily the result of our net income for the period, as adjusted for
impairment of long-term investment, depreciation and amortization,
other expenses, decrease in inventories, offset by gain on sale of
available-for-sale marketable securities, a decrease in trade payables, accrued
interest and amortization of premium and discount on available-for-sale
marketable securities.

50

---

---

Net
cash used in investing activities in each of 2003 and 2002 reflects primarily
the purchase of financial assets, fixed assets and primarily capital equipment.
Net cash provided by investing activities in 2001 reflects the maturity and
sale of marketable securities and short-term bank deposits, purchase of fixed
assets and capital equipment. In 2003, $53.6 million were used primarily for
the purchase of financial assets, $898,000 were used for investments in
companies, partially offset by $51.2 millions of proceeds from sale of
available-for-sale marketable securities. In 2002, $64.9 million were used
primarily for the purchase of financial assets, $946,000 were used for an
investment in a company, partially offset by $43 millions of proceeds from sale
of available-for-sale marketable securities, and redemption of matured
available-for-sale marketable securities. In 2001, $41.4 million were provided
from the maturity and sale of marketable securities and short-term bank
deposits, partially offset by investment of $17 millions in marketable
securities.

Net
cash provided by financing activities in 2003 reflects primarily the increase
in bank credit, net proceeds from the exercise of stock options and warrants
approximately in the amount of $2.1 million, partially offset by payments of
shareholders loans in the amount of approximately $129,000. Net cash provided
by financing activities in 2002 reflects primarily the net proceeds from the
issuance of ordinary shares and exercise of stock options and warrants
approximately in the amount of $342,000, and $35,000, respectively, partially
offset by principal payments of long-term capital lease obligations in the amount
of approximately $197,000.  Net cash
used in financial activities in 2001 reflects primarily the purchase of
treasury shares, partially offset by proceeds from the issuance of ordinary
shares and exercise of stock options and warrants in the amount of approximately
$442,000 and $702,000, respectively. During the last quarter of 2000 and the
first quarter of 2001, we repurchased some of our own shares in the amount
of  $65,000 and 1.1 million,
respectively.

As
of December 31, 2003, both our short-term and long-term indebtedness were
no longer affected by obligations undertaken during the acquisition of
Viewgraphics.  As of December 31, 2003,
we have an authorized unused line of credit in the amount of $20.5 million of
which $20 million are secured against financial securities.  We have an agreement with Clal Credit
Insurance Ltd. for the provision of insurance against default on outstanding
receivable balances.

In
the second quarter of 2003, we transferred approximately $39.3 million of our
monies and investments to Optibase, Inc. to achieve better net profit from the
investment. We manage our investment portfolio on a discretionary basis, within
the framework of an investment policy based upon an established set of
guidelines approved by our board of directors. The main terms of the investment
guidelines permit us to invest in the following securities: (i) U.S. Treasury
and Agency obligations; (ii) money market instruments of domestic and foreign
issues denominated in US dollars of commercial paper, bankers acceptances,
certificates of deposit, euro-dollar time deposits and variable rate issues;
(iii) corporate notes and bonds rated investment grade (BAA/BBB- and above),
provided that investments in any one corporation or entity will not exceed $3
million; (iv) hedge funds up to $10 million pursuant to the following
guidelines: (1) Volatility below 10%; (2) Minimum 5 years of positive
performance; (3) Low beta; (4) Positive sharp ratio; (5) Size of fund of at
least $1 BL; and (6) Multi manager and strategy; (vi) Investments in bonds and
notes with lower rating than BBB- and higher rating than B, provided that
investments in any one corporation or entity will not exceed $1 million. (vii)
Widely held funds that invests in corporate and sovereign debt.  We may also be engaged in hedging
transactions against the U.S. dollar only to protect anticipated exposure and
not for speculative purposes. Hedging transactions may be made against the
underlying assets only. In addition, 
investment in structured products is limited to a value equal to up to
40% of the our total portfolio. Our board acknowledged that our investment in
structured products exceeded the limit imposed. However, we are not required to
sell or dispose at this time of the structured products in order to meet the
limit. The investment guidelines are to be reviewed periodically by our board
of directors with the President and Chief Financial Officer.

As
of the date hereof, we do not have any material contractual commitments related
to capital expenditure.

51

---

---

We
believe that, considering the use of cash in our ongoing operations, together
with the existing sources of liquidity described above, our current cash, cash
equivalents and short term investments will be sufficient to meet our needs for
cash for at least the next 12 months. 
However, our liquidity and capital requirements are affected by many factors, some of which are based on the normal ongoing operations of
our businesses and some of which arise from uncertainties related to global
economies and the markets that we target for our services. In addition, we
routinely review potential acquisitions. 
If we grow more rapidly than currently anticipated, it is possible that
we would require more funds than anticipated. 
In that event, we would likely seek additional equity or debt financing,
although we cannot assure you that we would be successful in obtaining such
financing on favorable terms or at all.

On
February 5, 2002 we filed a statement of claim against Merrill Lynch &
Company and its subsidiary brokerage firm Merrill Lynch, Pearce, Fenner &
Smith, or collectively Merrill Lynch, claiming the sum of US$2,270,198 as
compensation and US$10 million as punitive damages due to alleged mismanagement
of our nostro funds by Merrill Lynch. Merrill Lynch, an international financial
management and advisory company, was in charge of investing our nostro
funds.   The lawsuit was referred to arbitration
and On December 24, 2003, the arbitrators panel issued an award in favor of
Optibase. The panel awarded Optibase $1,794,253.73 in damages inclusive of
interest, and assessed $33,850 in costs associated with the arbitration against
Merrill Lynch. We received the award payments during February 2004. As a
result, during the quarter ended March 31, 2004, we recorded other income at
the amount of $1,382,846 net of expenses.

5.C
Research and Development, Patents and Licenses, etc.

Research
and development expenses, net, consist primarily of labor expenses,
development-related raw materials, acquisition related costs and stock option
charges and related overhead, offset by grants.  Our net research and development expenses have continued to
decrease from $15.6 million in 2001 to $8.1
million in 2002, constituting a decrease of 47.8% from the previous year, and
to $4.8 million in 2003, constituting a decrease of 40.5% from 2002.  As a percentage of revenues, our net
research and development expenses decreased to approximately 25% in 2003 from approximately
39.8% in 2002 and approximately 52.9% in 2001.  The dollar decrease in research and development was primarily due
to the decrease in the amortization of tangible and intangible assets, and a
decrease in labor and subcontracting costs. 
Research and development grants remained stable at $2.2 million in 2003
as in 2002 after increasing from $1.8 million in 2001.  We expect research and development expenses
to decrease in absolute dollars and as a percentage of revenues during 2004
primarily due to a reduction of personnel
mainly in our Israeli research and development center and as a result of
the managements ongoing efforts to tighten
cost controls and improve financial performance while introducing
additional products and conducting ongoing improvements to our standard and
custom products.

5.D
Trend Information

The
digital media industry continues to be intensely competitive, and the industry
is continuing to undergo consolidation and contraction.  We will continue to focus on developing
technologies and new products, and research and development expenses might grow
in the future years.    We continue to
aggressively market our new products, while expanding markets for our existing
products.  However, as discussed
throughout this Annual Report, our operations have been subject, and will
continue to be subject, to pressure from weakness in the overall technology
sector as well as the digital media industry. 
We have been operating at a loss since the quarter ended December 31,
2000, and were able to return to profitability in the quarter ended June 30,
2003, but may not be able to sustain profitability in 2004, if the market
continues to be weak, our customers decrease their purchase orders or our sales
cycle will become longer due to the ongoing weakness in the economy. As
announced on June 20, 2002, as a result of the continued difficulties within
the technology sector in the beginning of 2002, we experienced a general
reduction in orders, including a significant order from one of our
customers.  We, therefore, announced
that we expect to report lower than anticipated revenues for the second quarter
of 2002. The loss of the customer orders has resulted in reduced revenues
throughout 2002 and 2003 and together with the decrease in sales of our legacy
products, may result in reduced revenues in further quarters.

5.E
Off-Balance Sheet Arrangements

There
are no off-balance sheet arrangements that have or are reasonably likely to
have a current or future effect on our financial condition, changes in
financial condition, revenues or expenses, results of operations, liquidity,
capital expenditures or capital resources that is material to investors.

52

---

---

5.F Tabular
Disclosure of Contractual Obligations

Set
forth below are our contractual obligations and other commercial commitments as
of December 31, 2003:

| |                                        |  | Payments Due by Period(USD in
  thousands) | 
| | -------------------------------------- |  | ------------------------------------------ | 
| |                                        |  |                                            | 
| | Contractual
  Obligations              |  | Total                                      | 
| |                                        |  |                                            | 
| | Long-Term
  Debt                       |  | 0                                          | 
| | Capital
  Lease Obligations            |  | 14                                         | 
| | Operating
  Leases                     |  | 4,305                                      | 
| | Purchase
  Obligations                 |  | 0                                          | 
| | Other
  Long-Term Obligations          |  | 0                                          | 
| | Total
  Contractual Cash
  Obligations |  | 4,319                                      | 

| |                                  |  | Amount of Commitment Expiration Per Period
  (USD in thousands) | 
| | -------------------------------- |  | --------------------------------------------------------------- | 
| |                                  |  |                                                                 | 
| | Other
  Commercial
  Commitments |  | Total                                                           | 
| |                                  |  |                                                                 | 
| | Lines of
  Credit                |  | 20,457                                                          | 
| | Standby
  Letters of Credit      |  | 0                                                               | 
| | Guarantees                       |  | 114                                                             | 
| | Standby
  Repurchase Obligations |  | 0                                                               | 
| | Other
  Commercial Commitments   |  | 0                                                               | 
| | Total
  Commercial Commitments   |  | 20,571                                                          | 

Item
6. Directors, Senior Management and Employees

6.A
Directors and senior management

The
following table sets forth information with respect to the individuals who are
currently our directors and executive officers.  All of these individuals are presently serving in the respective
capacities described below:

|Name                    |  | Age |  | Position                                                                 
|----------------------- |  | --- |  | -------------------------------------------------------------------------
|                        |  |     |  |                                                                          
|Tom Wyler(3)            |  | 52  |  | Chief Executive Officer and Chairman of the Board of Directors           
|Zvi Halperin            |  | 49  |  | President and Chief Financial Officer                                    
|Moshe Rousso            |  | 39  |  | General Manager, Broadband TV Division                                   
|Amir Goren              |  | 34  |  | Vice
  President of Corporate Marketing and Business Development         
|David Sackstein         |  | 38  |  | General Manager of Building Blocks Division.                             
|Orna Gil-Bar            |  | 39  |  | Vice President of Human Resources                                        
|Yaron Comarov           |  | 39  |  | Vice President of Operations                                             
|Rene Montsma            |  | 38  |  | Vice President of Strategic Sales                                        
|Adam Schadle            |  | 41  |  | Vice President of Sales North and South America                          
|Danny Lustiger          |  | 37  |  | President of Optibase Inc. and Vice President of Finance, Optibase
  Inc.
|Dana Tamir(2)           |  | 55  |  | Director                                                                 
|Chaim Labenski(1)(2)(3) |  | 56  |  | Director                                                                 
|Eddy Shalev(1)(2)       |  | 56  |  | Director                                                                 
|Alex Hilman(2)          |  | 52  |  | Director                                                                 

53

---

---

---

Tom
Wyler has served
as Chairman of the Board of Directors of Optibase since September 2001, and in
February 2002, Mr. Wyler also assumed the role of Chief Executive Officer in
charge of our operations. In June
2003, Wyler was appointed by our board of directors as chief executive officer,
subject to the approval of this appointment by our shareholders, as required
under Israeli law. Through the Festin
Group, of which he is a co-owner, Mr. Wyler has had substantial stakes in
several public companies in Switzerland. His other areas of involvement include
investment banking, foreign exchange and financial futures. In the early 1990s,
Mr Wyler turned his efforts to real estate interests in the U. S. More
recently, his attention has been directed toward the high-tech industry in
Israel. Mr. Wyler holds a Masters degree in Business Economics from the
University of Zurich.

Zvi
Halperin has served as Vice President and Chief
Financial Officer of Optibase since March 1994 and President since January
2002. He also served as the acting Chief Executive Officer of Optibase between
September 2001 and January 2002. From 1984 until 1994, Mr. Halperin held the
position of Group Controller and Financial Manager at Oshap Technologies Ltd.,
an Israeli holding company traded on Nasdaq. He is a Certified Public
Accountant in Israel and holds a B.A. degree in Accounting and Economics from
the Tel Aviv University.

Moshe
Rousso serves as
General Manager of Broadband TV Division at Optibase. Mr. Rousso joined
Optibase in October 2000. Prior to his present position, Mr. Rousso was Vice
President R&D in Optibase. Before joining Optibase, Mr. Rousso held a
number of R&D management positions at ECI Telecom. Mr. Rousso holds a B.Sc
E.E. degree from the Tel Aviv University.

Amir
Goren has served
as Vice President Marketing and Business Development since September 2002. In
the two years prior to his present position, Mr. Goren led strategic planning
and business development in Optibase. Before joining Optibase, Mr. Goren was a
team leader at P.O.C, a strategic and marketing planning consulting firm, where
he led strategic planning and fund raising projects for technological companies
at various stages of development in the fields of communications,
biotechnology, electronic control, Internet and services. Mr. Goren holds an
MBA degree and B.Sc degree in Industrial Engineering from the Tel Aviv
University

David
Sackstein, joined us in November 1994, Serves as the
General Manager of the Building Blocks division since November, 2003. Prior to
his present position Mr. Sackstein was the Senior Vice President of R&D.
Since joining the Company, Mr. Sackstein has held various technical and
managerial positions in the R&D department, including Vice President
Advanced Technologies. Prior to joining Optibase, Mr. Sackstein held the
position of Research Fellow at IBMs Research Center in Haifa. Mr. Sackstein
holds a B.Sc. in Electrical Engineering and a B.A. in Mathematics, both from
the Technion Israel Institute of Technology. Mr. Sackstein currently completing
his Executive MBA degree in Tel-Aviv University.

Orna
Gil-Bar, the Vice President of Human Resources, joined
us in September 2000. Prior to joining Optibase, Ms. Gil-Bar served as Human
Resource Manager for Computer Associates in Israel. During her tenure at
Computer Associates, Ms. Gil-Bar was involved with the human resource
implications resulting from CAs acquisition of Platinum Inc. From 1994 to
1996, Ms. Gil-Bar served as an organizational consultant for the Israeli
Defense Forces. Ms. Gil-Bar holds an MBA degree (Organizational and Consulting)
from the Tel-Aviv University.

Yaron
Comarov, currently our Vice President of Operations,
has been with Optibase since 1993. 
Prior to his present position, Mr. Comarov was our Director of
Operations.  Before joining Optibase,
Mr. Comarov worked as an Operations and Project Manager at Israel Aircraft
Industries.  Mr. Comarov holds a B.Sc.
degree in information systems and industrial engineering from the Technion
Israel Institute of Technology.  He is
currently completing his MBA at Boston University in Tel Aviv.

54

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Rene
Montsmaserves as of July 2003 as our Vice President
of Strategic Sales. Mr Montsma joined Optibase as Vice President International
Sales in January 2002. Before joining Optibase, Mr. Montsma served as Vice
President and General Manager Europe at Commtouch Inc. from 1999.  Prior to his appointments at Commtouch, Mr.
Montsma spent five years at British Telecom where he managed international
sales, distribution, and business development. Mr. Montsma holds an MBA degree
from INSEAD, Fontainebleau and a M.Sc. degree in Computer Sciences from Free
University, Amsterdam.

Adam
Schadle joined us at the time we acquired Viewgraphics
Inc. in December 2000. Serving as Vice President, Sales and Marketing at
Viewgraphics, Mr. Schadle managed the growth of the companys digital cable,
broadcast and postproduction products. Prior to joining Viewgraphics, Mr.
Schadle held management positions at Sony Electronics from 1986 to 1994.   Mr. Schadle holds a B.A in Radio,
television and film from the San Jose University.

Danny
Lustiger has served
as President of Optibase, Inc,.and Finance Vice President of Optibase, Inc
since November 2003. Prior to this appointment, Mr. Lustiger served as VP
finance of Optibase Inc., as of July 2001. From 1996 to 2001, Mr. Lustiger  held the position of Group Controller and
Financial Manager at Optibase Ltd. From 1993 to 1996 Mr. Lustiger held the
position of an accountant and auditor at Igal Brightman and Co., a member of
Deloitte & Touche Tomatsu International. 
Mr. Lustiger is a Certified Public Accountant in Israel. Mr. Lustiger
holds a B.A. degree in Accounting and Economics and an MBA in Finance and
International management from the Tel-Aviv University.

Dana
Tamirjoined our board of directors in September 2000. Dana is the owner and
establisher of PureWaters, a company that provides water treatment and wastewater
purification solutions for the Industrial, Agricultural and Marine markets. From January
1997 to May 2000, Ms. Tamir served as the Chief Executive Officer of Qronus, Inc., a
company that was spun off by Mercury. Prior to that Dana managed and executed large scale
Command Control & Communication real-time systems for the military industry in Israel
and Europe.

Chaim
Labenski joined our board of directors in January 2002. From 1977 to 1999, Mr.
Labenski held a number of positions at Securities Division of Bank Hapoalim BM, including
being First Vice President and Head of Foreign Securities and was involved in consulting,
securities research, trading and I.P.O coordination with global investment houses. Since
1999 he acts as a private investor. Mr. Labenski holds a B.Sc degree in Civil Engineering
from Aston University, U.K, a M.Sc degree in Engineering Management from Leeds University
and Dp.B.A degree in Business Administration from Manchester Business School.

Eddy
Shalevjoined our
board of directors in January 2002. Mr. Shalev is the Managing General Partner
of Genesis Partners, a leading Israeli Venture Capital Fund. Mr. Shalev has
participated in many private equity investments in emerging growth and
technology companies. He was an investor in many of the most successful
technology companies in Israel. From 1972 to 1983, Mr. Shalev held various
executive positions with IBM. Prior to joining IBM, Mr. Shalev worked in the
Computer Center of the Israeli Ministry of Defense. Mr. Shalev holds a M.Sc.
degree in Information System and a B.A. degree in Statistics from the Tel-Aviv
University.

Alex
Hilman joined our
board of directors in February 2002. Mr. Hilman is a partner in Hilman &
Co., which provides auditing, tax and business consulting services to
corporations. Mr. Hilman serves on the boards of various companies. Mr. Hilman
was the president of the Israeli institute of certified public accountants in
Israel, served in the board of IFAC, and is a member of the Small & Medium
Practices committee in IFAC. Mr. Hilman lectures taxation in Tel-Aviv
University, has published professional works on tax and accounting, among them,
The Israel Tax Guide. Mr. Hilman holds a B.A. degree in Accountancy and
Economics from the Tel Aviv University.

6.B
Compensation.

The
aggregate remuneration we paid to all persons as a group (16 persons) who
served in the capacity of director or executive officer in the year ended
December 31, 2003 was $1.75 million, including amounts paid to provide pension, retirement or
similar benefits pursuant to standard Israeli plans but excluding amounts
expended by us for automobiles made available to all of our officers, expenses
reimbursed to officers and other fringe benefits commonly reimbursed or paid by
companies in Israel.  In 2003, we set
aside $106,000 for the pension and severance fund benefits of our officers and
directors.  Our current directors and
executive officers (14 persons) held as of December 31, 2003 3,017,472 shares,
and share options to purchase an aggregate of 1,093,085 ordinary shares.

55

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Indemnification
of Directors and Officers. The Israeli Companies Law permits a company to insure its
directors and officers, provides them with indemnification, either in advance
or retroactively, and exempt its directors and officers  from liability resulting from their breach of their duty of care
towards the company, all in accordance with the terms and conditions specified
under Israeli law. Our articles of association include clauses allowing us to
provide our directors and officers with insurance, indemnification and to
exempt them from liability in accordance with the terms and conditions set
forth by the Companies Law, as described below.

Our
articles of association provide that, subject to statutory provisions, we may
enter into a contract for the insurance of the liability of our directors and
officers for an obligation imposed on a director and/or officer in consequence
of an act done in his or her capacity as a director and/or an officer, in any
of the following cases:

| |  | a breach of
  the duty of care vis-a-vis the Company or vis-a-vis another person;                                                                                                          
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | a breach of
  the fiduciary duty vis-a-vis the Company, provided that the officer acted in
  good faith and had a reasonable basis to believe that the act would not harm
  the Company; or
| |  | a monetary
  obligation imposed on the officer in favor of another person.                                                                                                                 

In
addition, our articles of association provide that we may give an advance
undertaking to indemnify a director and/or an officer, provided that the
undertaking is limited to types of events which in our board of directors
opinion are foreseeable at the time of giving the indemnity undertaking and in
such amount as the board of directors prescribes is reasonable in the
circumstances of the case.

Our
articles of association also provide that we can indemnify a director and/or an
officer for an obligation or expense imposed on him or her in consequence of an
act done in his or her capacity as an officer in the following events:

| |  | a monitory
  obligation imposed on the director and/or officer in favor of another person
  pursuant to a judgment, including a judgment given in a settlement or a court
  approved arbitrators award; and                                                                                                                                                                                                                                                                                                        
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | reasonable
  litigation costs, including advocates professional fees incurred by a
  director and/or officer or which he or she is ordered to pay by a court, in
  proceedings filed against the director and/or officer by the Company or on
  the Companys behalf or by another person, or in a criminal charge of which
  the director and/or officer is acquitted, or in a criminal charge of which
  the director and/or officer is convicted of an offence that does not require
  proof of criminal intent.

In addition,
our articles of association provide that we may exempt a director and/or an
officer in advance and retroactively for all or any of the directors and/or
officers liabilities for damages in consequence of a breach of the duty of
care vis-a-vis the Company.

Our
articles of association assert that we may not give insurance, indemnification
(including advance indemnification) nor may we exempt our directors and/or
officers from their liability in the following events:

| |  | a breach of
  the fiduciary duty vis-a-vis the Company, unless the officer acted in good
  faith and had a reasonable basis to believe that the act would not harm the
  Company;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | an
  intentional or reckless breach of the duty of care;                                                                                                                         
| |  | an act done
  with the intention of unduly deriving a personal profit; or                                                                                                        
| |  | a fine
  imposed on the officer.                                                                                                                                                 

Our
articles of association also provide, that the provisions pertaining to
insurance, exemption and indemnification of our directors and/or officers,
shall not limit us in entering into insurance contracts, if the insurance or
exemption or indemnification, is not expressly prohibited by any law.

We
have a directors and officers liability insurance policy. Our shareholders
approved indemnification of our directors and officers in connection with our
public offerings. We have undertaken to indemnify our directors and officers to
the fullest extent permitted by the Companies Law and our Articles of
Association and entered into an indemnity letter with each of our directors and
executive officers. The aggregate indemnification amount shall not exceed the
higher of: (i) 25% of our shareholders equity, as set forth in our financial
statements prior to such payment; or (ii) $7.5 million.

56

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Optibase,
Inc. has also undertaken to indemnify its directors and officers to the maximum
extent and in a manner permitted by the California Corporation Code and entered
into an indemnity letter with each of its directors and officers, subject to
similar limitations. The aggregate indemnification amount shall not exceed the
higher of: (i) 25% of the shareholders equity of Optibase, Inc., as set forth
in Optibase, Inc.s financial statements prior to such payment; or (ii) $7.5
million.

6.C
Board of Directors and Committees

Pursuant
to our articles of association, our board of directors is required to consist
of three to nine members. Directors are elected at the annual general meeting
of our shareholders by a vote of the holders of a majority of the voting power
represented at such meeting.  Each
director holds office until the annual general meeting of shareholders
following the annual general meeting at which the director was elected or until
his earlier resignation or removal. A director may be re-elected for subsequent
terms.   At present, our board of
directors consists of five members, including two external directors appointed
in accordance with the Israeli law requirements, as detailed herein. Our
articles of association provide that our directors may at any time and from
time to time, appoint any other person as a director, either to fill in a
vacancy or to increase the number of members of our board of directors.

Under
Israeli law, we are required to appoint two directors as members of our board
of directors who meet the requirements set out in the Companies Law for
external directors. External directors are elected by a special majority as
determined by the Companies Law, and serve for a three-year term. External
directors may be re-elected for one additional three-years term only. External
directors may not be dismissed during their term of service, unless one of the
events specified in the Companies Law occurs. Mr. Eddy Shalev and Mr. Chaim
Labenski were elected by our shareholders in the general meeting as of January
31, 2002 to serve as external directors.

Our
board of directors has established an audit committee, a compensation
committee, and an investment committee, as described below.

Audit
Committee.  The Companies Law requires publicly
traded companies to appoint an audit committee. 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 members, and include all of
the companys external directors. However, the chairman of the board of
directors, any director employed by the company or providing services to the
company on a regular basis, any controlling shareholder and any relative of a
controlling shareholder may not be a member of the audit committee. An audit
committee may not approve an action or a transaction with an officer or
director, a transaction in which an officer or director has a personal
interest, a transaction with a controlling shareholder and certain other transactions
specified in the Companies Law, 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.

In
accordance with the Sarbanes-Oxley Act of 2002 and Nasdaq requirements, our
audit committee reviews our internal accounting procedures and consults with
and reviews the services provided by our independent auditors.  In addition, the Audit Committee serves as a
review committee under Israeli law provisions and recommends approval of
transactions that are deemed interested party transactions, including
directors compensation.

Pursuant
to the Sarbanes-Oxley Act of 2002, the SEC has issued new rules, which would,
among other things, require Nasdaq to impose independence requirements on each
member of the audit committee. Nasdaq has proposed rules that would comply with
the SECs requirements and which are expected to be applicable to us in 2004.

The
proposed requirements would implement two basic criteria for determining
independence: (i) audit committee members would be barred from accepting any
consulting, advisory or other compensatory fee from the issuer or an affiliate
of the issuer, other than in the members capacity as a member of the board of
directors and any board committee, and (ii) audit committee members of an
issuer that is not an investment company may not be an affiliated person of
the issuer or any subsidiary of the issuer apart from his or her capacity as a
member of the board and any board committee.

57

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The
SEC has proposed to define affiliate for non-investment companies as a
person that directly, or indirectly through one or more intermediaries,
controls, or is controlled by, or is under common control with, the person
specified. The term control is proposed to be consistent with the other
definitions of this term under the Securities Exchange Act of 1934, as the
possession, direct or indirect, of the power to direct or cause the direction
of the management and policies of a person, whether through the ownership of
voting securities, by contract, or otherwise. A safe harbor has been proposed
by the SEC, under which a person who is not an executive officer, director or
10% shareholder of the issuer would be deemed not to have control of the
issuer.

Under
the final rules adopted by the SEC, an issuer is required to disclose in its
annual report, beginning with the annual report for 2003, whether or not such
issuer has at least one audit committee financial expert.  If it does, the issuer must disclose the
name of the expert.  If not, the issuer
must disclose why it does not have an audit committee financial expert.

The
members of the audit committee are Messrs. Shalev, Labenski and Hilman and Ms.
Tamir.  These include our two external
directors as required under the Companies Law, and we believe that all of the
members of the audit committee are independent of management. The rules of the
Nasdaq National Market also require that at least one member of the audit
committee be a financial expert. The board has determined that Alex Hilman is
an audit committee financial expert as defined by applicable SEC regulation.

Optibase
believes that the current composition of the audit committee satisfies the
requirements of Companies Law, the SECs rules and the proposed Nasdaq rules.

Compensation
Committee. The compensation committee, which is
comprised of Eddy Shalev and Chaim Labenski, reviews and recommends to the
board of directors and in certain cases, determines, the compensation and
benefits of our employees and reviews general policy relating to our
compensation and benefits.  The
compensation committee also administers our share option plans. Both of the
members of the compensation committee have been determined to be independent as
defined by the applicable Nasdaq and SEC rules.

Investment
Committee. Our investment committee, which is
comprised of Chaim Labenski and Tom Wyler manages our investments in accordance
with guidelines set by the board of directors.

The
Israeli Companies Law requires the board of a public company to appoint an
internal auditor pursuant to the audit committees proposal. The internal
auditor must satisfy certain independence requirements as required by the law.
The role of the internal auditor is to examine, among other things, the
compliance of the companys conduct with applicable law and orderly business
procedures. The service of Eyal Weizman, CPA, as our internal auditor was ended
during February 2004. Our audit committee is in the process of evaluating the
potential candidates for his replacement.

Independent
Directors.Pursuant to the current listing requirements of
the Nasdaq National Market, we are required to have at least two independent
directors on our board of directors. Under rules proposed by Nasdaq, the
majority of the members of the board directors will need to be independent as
of July 31, 2005.  An independent
director for these purposes has been proposed to mean a person other than an
officer or employee of a company or its subsidiaries or any other individual
having a relationship, which, in the opinion of the companys board of
directors, would interfere with the exercise of independent judgment in
carrying out the responsibilities of a director.

The
following persons are not considered independent under the proposed rules:

| |  | a director
  who is or was employed by the company or by any parent or subsidiary of the
  company within the last three years;                                                                                                                                                                                                                                                                                                                                                                                                                   
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| |  | a director
  who accepts or has family member (by blood, marriage or adoption or has the
  same residence) who accepts any payments from the company or any of its
  affiliates in excess of $60,000 during the current fiscal year or any of the
  past three fiscal years, other than compensation for board service,
  compensation paid to family members who are employees (other than executive
  officers of the company, its parent
  company or its subsidiaries) or benefits under a qualified plan or
  non-discretionary compensation;

58

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| |  | a director
  who is a family member of an individual who is, or within the past three
  years was, employed by the company or by any parent or subsidiary of the
  company as an executive officer;                                                                                                                                                                                                                                                        
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |  | a director
  who is a partner in, or a controlling shareholder or an executive officer of,
  any organization to which the company made, or from which the company
  received, payments (other than those arising solely from investments in the
  companys securities) that exceed 5% of the recipients consolidated gross
  revenues for that year, or $200,000, whichever is more, in the current fiscal
  year or any of the past three fiscal years;
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |  | a director
  of the listed company who is employed as an executive officer of another
  entity where any of the executive officers of the listed company serve on the
  compensation committee of such other entity, or if such relationship existed
  within the last three years; or                                                                                                                                                                     
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |  | a director
  who was a partner or employee of the companys outside auditor, and worked on
  the companys audit, within the last three years.                                                                                                                                                                                                                                                                                                             

This
independence requirement does not apply to a company of which more than 50% of
the voting power is held by an individual, a group or another company.

Based
on representations from our current directors, we believe that Eddy Shalev,
Chaim Labenski, Alex Hilman and Dana Tamir comply with the independence
standards set forth above.

Employment
Agreements

Each
of our executive officers entered into a written employment agreement with us
that provides, among other things, that such officers be paid a monthly
salary.  Each such agreement can be
terminated either by us, or by the employee, upon prior notice, which ranges
between 60 to 120 days for most of the management team.  In the event of a change of control,
termination of employment may result in acceleration of the vesting of options
by an additional 12 to 24 months. Vesting of options granted prior to August
2001 to most of our extended management team were fully accelerated. The
employment agreements also provide that each executive officer will maintain
confidentiality of matters relating to us and will not compete with us during
the period of the officers employment and for a certain period thereafter.

6.D
Employees

As
of May 2004, we had, including all of our subsidiaries and offices, 136
employees, as compared to 157 employees in December 2003, and 169 employees in
December 2002. This reduction is due mainly to our continued efforts to limit
our expenses. The largest percentage of staff reduction was in our research and
development department. We currently employ 16 part-time employees, and the
rest of the 120 employees are divided between the following : R&D  39
employees in Optibase Ltd.; Sales and Technical Marketing: 11 employees in
Optibase Ltd. and 16 employees in Optibase, Inc.; 1 in Europe and 3 in China.
Marketing: 13 employees in Optibase Ltd. and 1 employee in Optibase, Inc.,
Operations: 18 employees in Optibase Ltd. and 2 employees in Optibase, Inc.,
and general and Administrative, Finance and Human Resources: 10 employees in
Optibase Ltd and 6 employees in Optibase Inc. None of our employees, nor any of our subsidiaries employees, is a union
member, and we believe that our employer - employee relations are good.

Certain
provisions of Israeli law and of the collective bargaining agreements between
the Histadrut (General Federation of Labor in Israel) and the Coordination
Bureau of Economic Organizations (the Israeli federation of employers
organizations) apply to our Israeli employees directly or by an extension order
of the Israeli Ministry of Labor and Welfare. 
These provisions principally concern the maximum length of the work day
and the work week, minimum wages, recuperation payments, travel expenses,
determination of severance payment and other conditions of employment.  Furthermore, under these provisions, the
wages of most of our employees are automatically adjusted in accordance with
the cost of living adjustments, as determined on a nationwide basis and
pursuant to agreements with the Histadrut based on changes in the Israeli CPI, which was
extended by an extension order.  The
amounts and frequency of such adjustments are modified from time to time.

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Israeli
law generally requires the payment by Israeli employers of severance payment
upon the retirement or death of an employee or upon termination of employment
by the employer or, in certain circumstances, by the employee.  We currently fund our ongoing severance
obligations by making monthly payments for insurance policies.  In addition, according to the Israeli
National Insurance Law, Israeli employees and employers are required to pay
specified amounts to the National Insurance Institute, which is similar to the
United States Social Security Administration. 
These contributions entitle the employees to benefits in periods of
unemployment, work injury, maternity leave, disability, reserve military
service and bankruptcy or winding-up of the employer.  Since January 1, 1995, such amounts also include payments
for national health insurance payable by employees.  The payments to the National Insurance Institute are determined
progressively in accordance with wages. 
They currently range from 10.4% to 16.3% of wages, of which the
employees contribution ranges from 43% to 64% and the employers contribution
ranges from 57% to 36%.  A majority of
our full-time employees are covered by general and/or individual life and
pension insurance policies providing customary benefits to employees, including
retirement and severance benefits.

Recently
the Israeli employment courts have restricted substantially non-competition
provisions in employment agreements.

6.E
Share ownership

As
of May 1, 2004, our current directors and executive officers (14 persons) held
an aggregate of 3,017,472 ordinary shares of our Company and options to
purchase an aggregate of 1,093,085 ordinary shares, of which options to
purchase 708,233 shares are vested and exercisable within 60 days.

Option
plans

Since
1990, we have granted options to key employees and directors to purchase
ordinary shares at exercise prices ranging from $0.17 to $32.  As of May 1, 2004, options and warrants to
purchase 2,395,209 of our ordinary shares were outstanding, with exercise
prices ranging from $0.17 to $32 per share. 
Of these outstanding options, 66,783 ordinary shares are subject to
options under our 1994 Option Plan 1,846,302 shares are subject to options
under our 1999 Israeli Option Plan, the 1999 U.S. Option Plan and the 102 Plan,
and 482,124 shares are subject to options under the 2001 Non-statutory Share
Option Plan.  As of the date hereof,
1,536,283 of the options described above have vested. The expiration dates of
the aforementioned options range from 2003 to 2010.

1999
Israeli and U.S. Option Plans; 102 Plan.  In
January 1999, our shareholders approved the adoption of an Israeli option plan,
or the 1999 Israeli Option Plan, and a U.S. option plan, or the 1999 U.S.
Option Plan.  In November 1999, our
board of directors adopted an additional option plan entitling the grantees to
tax benefits under section 102 of the Israeli Income Tax Ordinance, or the 102
Plan.  The purposes of the 1999 Israeli Option
Plan, the 1999 U.S. Option Plan and the 102 Plan, or the Plans, are to attract
and retain the best available personnel, to provide additional incentive to
employees, directors and consultants and to promote the success of our
business. In December 1999, our board of directors adopted a resolution to
amend the Plans in a manner that as of April 1, 2000, the number of shares
made available for grant under the Plans will be automatically increased
annually, to equal 5% of our outstanding share capital at the relevant time.  As of May 1, 2004, an aggregate of 4,126,642
ordinary shares have been reserved for issuance under the Plans.  In May 2003 we amended our 102 Plan to
provide for the grant of options to Israeli optionees under the new capital
gains track provisions of the Israeli Tax Ordinance and issued, accordingly,
600,000 options to employees and officers of the Company, whose gain on which
will be taxed at the applicable capital gains tax rate..

Unless
specifically changed for a certain grantee, options vest over a period of four
years, starting one year after the grant of options, subject to the continued
employment of the grantee.  The exercise
price of the options is determined by our board of directors, subject to
limitations.  Generally, options granted
under each of the Plans will have a term of no more than ten years from the
date of grant.   All options are subject
to earlier termination upon termination of the grantees employment or other
relationship with us, generally no less than 30 days from termination.  We may make, from time to time, certain
exceptions in the vesting and expiration terms of options granted to certain
grantees.

60

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Options
Issued in Connection with the Acquisition of Viewgraphics.In
connection with the acquisition of Viewgraphics in December 2000, we assumed
all options to acquire Viewgraphics common stock outstanding prior to the
acquisition and issued in an aggregate options to acquire 753,384 ordinary shares at exercise prices
ranging from $0.17 to $12.03. As of May 1, 2004, 69,868 options are still
outstanding.

2001
Non-statutory Share Option Plans.  In April 2001, our board of
directors approved the adoption of the 2001 Non-statutory Share Option Plan,
the purposes of which are to attract and retain the best available personnel,
to provide additional incentive to employees, directors and consultants and to
promote the success of our business. 
The options to be granted under the plan are limited to non-statutory
options, thus there will be no incentive stock options.  In addition, we plan to use this plan to
grant options to employees only, thus excluding officers and directors from the
plan.  As such, we do not need
shareholder approval of this plan under U.S. laws or applicable Nasdaq
rules.  An aggregate of 670,000 ordinary
shares has been reserved for issuance under this plan, and 482,124 are
outstanding as of May 1, 2004.  The plan
otherwise has terms similar to those contained under the 1999 U.S. Option
Plan.

Item 7 Major Shareholders and Related Party Transactions

7.A Major Shareholders

The
following table sets forth certain information regarding the beneficial
ownership of the ordinary shares at May 1,
2004 of (i) each person or group known by us to own beneficially 5% or
more of the outstanding ordinary shares and (ii) the beneficial ownership of
all officers and directors as a group, in each case as reported to by such persons.

| | Name of Beneficial Owner                                                |  | Class of
  Security |                 | No. Of Shares
  Beneficially Held (1) |  | % of Class |    
| | ----------------------------------------------------------------------- |  | ------------------- | --------------- | ------------------------------------- |  | ---------- | ---
| |                                                                         |  |                     |                 |                                       |  |            |    
| | Festin Management Corp.                                                 |  |                     | Ordinary shares |                                       |  | 3,075,000  | (2)
| | Avraham and Moshe Namdar(4)                                             |  |                     | Ordinary shares |                                       |  | 1,024,076  | (5)
| | Shareholding of all directors and officers as a
     group (14 persons) |  |                     | Ordinary shares |                                       |  | 3,725,705  | (3)

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|1. | Number of shares and
  percentage ownership is based on 13,036,321 ordinary shares outstanding as of
  May 1, 2004. Such number excludes 531,023
  shares held by the Company, which have no rights in equity and no voting
  rights.  Beneficial ownership
  is determined in accordance with rules of the SEC and includes voting and
  investment power with respect to such shares.  Shares subject to options that are currently exercisable or
  exercisable within 60 days of May 1, 2004
  are deemed to be outstanding and to be beneficially owned by the person
  holding such options for the purpose of computing the percentage ownership of
  such person, but are not deemed to be outstanding and to be beneficially
  owned for the purpose of computing the percentage ownership of any other
  person.  All information with respect
  to the beneficial ownership of any principal shareholder has been furnished
  by such shareholder and, unless otherwise indicated below, we believe that
  persons named in the table have sole voting and sole investment power with
  respect to all the shares shown as beneficially owned, subject to community
  property laws, where applicable.  The
  shares beneficially owned by the directors include the ordinary shares owned
  by their family members to which such directors disclaim beneficial
  ownership.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|2. | The principal place of
  business is Road Town, Pasea Estate, P.O. Box 3149, Tortola, British Virgin
  Islands.  Festin Management Corp. was
  formed by Mr. Tom Wyler and Mr. Arthur Mayer-Sommer, each owning 50% of the
  capital stock of Festin. Each is principally engaged as a private investor.
  In June 2001, our board of directors appointed Wyler to serve as a director
  and in September 2001, the board of directors appointed Wyler to serve as the
  chairman of our board of directors. Wyler has also assumed the position of
  Chief Executive Officer in charge of our operations and in September 2003,
  Wyler was appointed as chief executive officer.  In December 2002, our shareholders approved a grant of 200,000
  options exercisable into 200,000 of our shares to Wyler, subject to certain
  adjustments. 75,000 of the aforementioned options are vested as of the period
  of 60 days after May 1, 2004.                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|3. | Includes 3,017,472 ordinary
  shares and 708,233 shares issuable upon exercise of options that may be
  exercisable within 60 days of the date hereof.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|4. | Avraham and Moshe Namdar
  are brothers.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|5. | Includes 761,914 shares
  held by Moshe Namdar, and 262,162 shares held by Avraham Namdar.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         

61

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Significant
changes in the ownership of our shares.

The
following table specifies significant changes in the ownership of our shares by
Festin Management Corp. This information is based on the forms 13D filed by
Festin Management Corp beginning March 3, 2001, regarding ownership of our
shares:

|Beneficial
  Owner 
  Festin Management Corp |  | Date |                  | No. Of Shares Beneficially Held | 
|--------------------------------------------- |  | ---- | ---------------- | ------------------------------- | 
|                                              |  |      |                  |                                 | 
|                                              |  |      |                  |                                 | 
|                                              |  |      | March 3 2001     |                                 | 
|                                              |  |      |                  |                                 | 
|                                              |  |      | April 24, 2001   |                                 | 
|                                              |  |      |                  |                                 | 
|                                              |  |      | May 17, 2001     |                                 | 
|                                              |  |      |                  |                                 | 
|                                              |  |      | June 19, 2001    |                                 | 
|                                              |  |      |                  |                                 | 
|                                              |  |      | July 15, 2001    |                                 | 
|                                              |  |      |                  |                                 | 
|                                              |  |      | November 25,2003 |                                 | 

The
following table specifies significant changes in the ownership of our shares by
Avraham and Moshe Namdar.   This
information is based on the forms 13D filed by Avraham and Moshe Namdar
beginning July 24, 2002, regarding ownership of our shares:

|Beneficial
  Owner 
  Avraham and Moshe
  Namdar |  | Date |                   | No. Of Shares Beneficially Held | 
|------------------------------------------------- |  | ---- | ----------------- | ------------------------------- | 
|                                                  |  |      |                   |                                 | 
|                                                  |  |      |                   |                                 | 
|                                                  |  |      | July 24, 2002     |                                 | 
|                                                  |  |      |                   |                                 | 
|                                                  |  |      | August 1, 2002    |                                 | 
|                                                  |  |      |                   |                                 | 
|                                                  |  |      | October3, 2002    |                                 | 
|                                                  |  |      |                   |                                 | 
|                                                  |  |      | November 25, 2002 |                                 | 
|                                                  |  |      |                   |                                 | 
|                                                  |  |      | December 30, 2002 |                                 | 
|                                                  |  |      |                   |                                 | 
|                                                  |  |      | February 27, 2003 |                                 | 
|                                                  |  |      |                   |                                 | 
|                                                  |  |      | October 10, 2003  |                                 | 
|                                                  |  |      |                   |                                 | 
|                                                  |  |      | December 10, 2003 |                                 | 
|                                                  |  |      |                   |                                 | 
|                                                  |  |      | January 6, 2004   |                                 | 
|                                                  |  |      |                   |                                 | 
|                                                  |  |      | February 11, 2004 |                                 | 

62

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On
May 10, 2004, there were approximately 74 shareholders of record of our
ordinary shares.  As of such date, 55
record holders in the United States hold approximately 96.476% of our ordinary
shares.

To
the best of our knowledge, except as described above, we are not owned or
controlled directly or indirectly by any government or by any other
corporation.  We are not aware of any
arrangement, the operation of which may at a subsequent date result in a change
in control of the company.

7.B Related Party Transactions

On
August 13, 2001, Mr. Ran Eisenberg, our former chief executive officer,
tendered his resignation. On August 30, 2001, we signed an agreement with Mr.
Eisenberg, according to which Mr. Eisenberg served as an advisor to our board
of directors from April 28, 2002 until the earlier of  (1) termination of the agreement by the Company as a result of
(i) a material breach of the agreement; (ii) willful misconduct or acts in bad
faith; or (iii) committal of a felony or a common law fraud, against us;
performed by Mr. Eisenberg; or (2) on August 30, 2002. In consideration for his
services, Mr. Eisenberg received $170,000 plus VAT, of which 50% was paid on
September 30, 2001 and the rest was paid in 2002. Mr. Eisenberg was also
reimbursed for reasonable business expenses incurred in connection with the
services and approved in advance by us.

In
connection with the separation of Mr. John Krooss employment with us effective
September 2001, we entered into a Separation Agreement and General Release
dated January 15, 2002, pursuant to which Mr. Krooss continues to serve on our
board of directors, and will, at his election and expense, receive certain
health insurance benefits. The Employment Agreement with Mr. Krooss dated
November 30, 2000 was terminated.  We
also agreed to indemnify Mr. Krooss in his capacity as a member of the board of
directors or officer for all periods commencing on or after December 4, 2000
and to recommend to the our board of directors that Mr. Krooss be granted
additional options in an amount determined by the board of directors.  In addition, we agreed to release certain of
Mr. Krooss shares in escrow in connection with a settlement between the
Company and the former shareholders of Viewgraphics (for details see ITEM 10.C  MATERIAL CONTRACTS
below). In July 2002 Mr. Krooss resigned from his position as a director of the
Company.

On
May 6, 2004 we announced that our president and chief financial officer, Mr.
Zvi Halperin, is resigning and will be replaced by Mr. Danny Lustiger, who
currently serves as the president and vice president of finance of Optibase
Inc. We have entered into a termination agreement with Mr. Halperin in which he
will resign from his positions as president and chief financial officer as of
May 17, 2004.  Mr. Halperin will
transfer his duties to Mr. Danny Lustiger during the coming months. The vesting
period for certain of the options to acquire shares which we have granted to
Mr. Halperin will be accelerated and fully vested as of the date on which he
ceases to be employed.

See
also the discussion regarding our relationships with Mobixell and V.Box under ITEM 4.A COMPANY OVERVIEW.

Loans to employees

In
February 2001, we lent to Hillel Gazit an amount of $100,000, which bears
interest at a rate of 6% per annum and is payable in full in February 2003. In connection with the release of
shares in escrow to the former shareholders of Viewgraphics in January 2001, we
received 8,878 shares otherwise releasable to Hillel Gazit as security under
the loan agreement with Hillel Gazit. In February 2003, Mr. Gazit paid the
accumulated interest on the loan. The parties are now discussing the repayment
of the loan principal itself.  To date,
we have made full provisions for the loan our financial reports in the event
the principal of the loan is not repaid.

Furthermore,
from time to time we lend unsubstantial amounts to our employees, who are not
officers, which are not deemed benefits by Israeli tax authorities.

7.C Interests of experts and
counsel

Not
applicable.

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Item 8. Financial Information

8.A Consolidated Statements and
Other Financial Information

The
following financial statements of the Company and the auditors report
appearing on pages F-1 through F-42 of this Annual Report for fiscal 2003 are
incorporated herein by reference:

| |  | Independent auditors report.                                                             
| | - | ------------------------------------------------------------------------------------------
| |  | Balance Sheets as of December 31, 2003 and 2002.                                          
| |  | Statements of Income for the years ended December
  31, 2003, 2002 and 2001.              
| |  | Statements of Shareholders Equity for the years
  ended December 31, 2003, 2002 and 2001.
| |  | Statements of Cash Flows for the years ended
  December 31, 2003, 2002 and 2001.          
| |  | Notes to financial statements.                                                            

Legal proceedings

Pursuant
to an arbitration with the New York Stock Exchange between us and Merrill
Lynch, we were awarded compensation in the amount of approximately $1.8 Million
of which we recorded other income totaling approximately $1.4 Million net of
expenses, for further details, see Item 5.B LIQUIDITY AND CAPITAL RESOURCES.

During
the first quarter of 2004, we were notifed of an alleged dispute with our
former distributor in France, Visualdis, claiming damages in the amount of
850,000 EUR for unfair termination of our distribution arrangement.  In addition, we have become aware of a
dispute between Visualdis and our new distributor in France, Imago, in connection
with the termination of the distribution relationship with us.  It is our assessment, based on the facts
presented by both parties to date, prima facie, that the claim for damages is
without merits.

There
are several legal proceedings initiated against us in the ordinary course of
business, and we do not believe that the outcome of these proceedings, if
adverse to us, individually or in the aggregate, will have a significant effect
on our financial position or profitability.

Dividends

We
have not declared or paid any cash dividends on our ordinary shares in the
past.  We do not expect to pay cash
dividends on our ordinary shares in the foreseeable future and intend to retain
our future earnings, if any, to finance the development of our business.

Our
future dividend policy will be determined by our board of directors and will
depend, among other factors, upon our earnings, financial condition, capital
requirements, the impact of the distribution of dividends on our financial
condition and tax liabilities, and such other conditions as our board of
directors may deem relevant.  Under
Israeli law, an Israeli company may pay dividends only out of its retained
earnings as determined for statutory purposes. Under our articles of
association the distribution of dividends will be made by a resolution of the
Companys board of directors.  The board
of directors may also distribute interim dividends on account of the final
dividend.  See Description of Share
Capital and Israeli Taxation and Investment Programs.

Cash
dividends paid by an Israeli company are normally subject to a withholding tax,
except for dividends paid to an Israeli company in which case no tax is withheld
unless the dividend is in respect of earnings from an Approved Enterprise.  In addition, because we have received
certain benefits under Israeli laws relating to Approved Enterprises, the
payment of dividends by us may be subject to certain Israeli taxes to which we
would not otherwise be subject.  The
tax-exempt income attributable to the Approved Enterprise can be distributed to
shareholders without subjecting us to taxes only upon our complete liquidation.  If we decide to distribute a cash dividend
out of income that has been exempted from tax, the income out of which the
dividend is distributed will be subject to corporate tax at a rate between 10%
and 25%.  See Israeli Taxation and
Investment Programs.

64

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In
the event that cash dividends are declared in the future, such dividends will
be paid in NIS or in foreign currency subject to any statutory
limitations.  Under current Israeli
regulations, any dividends or other distributions paid in respect of ordinary
shares will be freely repatriable in such non-Israeli currencies at the rate of
exchange prevailing at the time of conversion, provided that Israeli income tax
has been paid on, or withheld from, such payments.  Because exchange rates between the NIS and the dollar fluctuate
continuously, a United States shareholder will bear the risks of currency
fluctuations during the period between the date such dividend is declared and
paid by us in NIS and the date conversion is made by such shareholder into U.S.
dollars.

8.B
Significant Changes

Except
for as stated in this annual report, there are no significant financial changes
as of December 31, 2003.

Item 9. The Offer and Listing

9.A.4 and
9.C: Price History and Market

Our
ordinary shares are traded on the Nasdaq National Market under the symbol OBAS
since our initial public offering on April 7, 1999.  The following table sets forth, for the
periods indicated, the high and low close sale prices per share of our ordinary
shares as reported by the Nasdaq National Market.

|                           |  | High |        | Low |  
|-------------------------- |  | ---- | ------ | --- | -
|                           |  |      |        |     |  
|1999 (as of April 7, 1999) |  | $    | 35.25  |     | $
|2000                       |  | $    | 41.875 |     | $
|2001                       |  | $    | 9.25   |     | $
|2002                       |  |      |        |     |  
|First Quarter              |  | $    | 3.288  |     | $
|Second Quarter             |  | $    | 3.00   |     | $
|Third Quarter              |  | $    | 2.14   |     | $
|Fourth Quarter             |  | $    | 2.38   |     | $
|2003                       |  |      |        |     |  
|First Quarter              |  | $    | 2.12   |     | $
|Second Quarter             |  | $    | 3.4    |     | $
|Third Quarter              |  | $    | 7.18   |     | $
|Fourth Quarter             |  | $    | 8.83   |     | $
|2004                       |  |      |        |     |  
|January                    |  | $    | 8.32   |     | $
|February                   |  | $    | 7.19   |     | $
|March                      |  | $    | 7.12   |     | $
|April                      |  | $    | 7.25   |     | $
|May (through May 7, 2004)  |  | $    | 5.98   |     | $

On
May 7, 2004, the reported closing sale price of our ordinary shares on the
Nasdaq National Market was $5.56 per share.

Item 10. Additional Information

10.A Share capital

Not
applicable.

65

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10.B Articles of Incorporation

Purposes
and Objects of the Company

We
are a public company registered under the Israeli Companies Law as Optibase
Ltd., registration number 520037078.

Pursuant
to our articles of association, our objectives are to engage in any lawful
business and our purpose is to act pursuant to business considerations to make
profits.

Our
articles of association also state that we may contribute a reasonable amount
for an appropriate cause, even if the contribution is not within the framework
of our business considerations.

The
Powers of the Directors

The
power of our directors to vote on a proposal, arrangement or contract in which
the director is interested is limited by the relevant provisions of the
Companies Law.  In addition, the power
of our directors to vote on compensation to themselves or any members of their
body is limited in that such decision requires the approval of the audit
committee, the board of directors and the shareholders at a general
meeting.  Please see ITEM 6C. BOARD PRACTICES  APPROVAL OF
RELATED PARTY TRANSACTIONS.

The
powers of our directors to borrow are not limited, except in the same manner as
any other transaction by the company.

Rights
Attached to Shares

Our
registered share capital is NIS 2,500,004 divided into a single class of
19,230,800 ordinary shares, par value NIS 0.13 per share, of which 13,036,321  ordinary
shares were outstanding as of May 1, 2004. 
All outstanding ordinary shares are validly issued, fully paid and
non-assessable.  The rights attached to
the Ordinary Shares are as follows:

Dividend
rights

Holders
of Ordinary Shares are entitled to the full amount of any cash or share
dividend subsequently declared. The Board of Directors may propose a dividend
with respect to any fiscal year only out of profits, in accordance with the
provisions of the Companies Law. Declaration of a dividend requires the approval
of our board of directors. Please see ITEM
10E. ADDITIONAL INFORMATION  TAXATION.

One
year after a dividend has been declared and is still unclaimed, the board of
directors is entitled to invest or utilize the unclaimed amount of dividend in
any manner to our benefit until it is claimed. We are not obligated to pay
interest or linkage differentials on an unclaimed dividend.

Voting
rights

Holders
of ordinary shares have one vote for each ordinary share held on all matters
submitted to a vote of shareholders. 
Such voting rights may be affected by the grant of any special voting
rights to the holders of a class of shares with preferential rights that may be
authorized in the future. Currently there are no shares of capital stock
outstanding with special voting rights. The quorum required for an ordinary
meeting of shareholders consists of at least two shareholders present in person
or by proxy who hold or represent, in the aggregate, at least thirty three and
one third percent (33.3%) of our voting rights.  In the event that a quorum is not present within half an hour of
the scheduled time, the shareholders meeting will be adjourned to the same day
of the following week, at the same time and place, or such time and place as
the board of directors may determine by a notice to the shareholders.  If at such adjourned meeting a quorum is not
present at the time of opening of such meeting, two shareholders, at least,
present in person or by proxy, shall constitute a quorum.

66

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An
ordinary resolution, such as a resolution for the election of directors, or the
appointment of auditors, requires the approval by the holders of a majority of
the voting rights represented at the meeting, in person, by proxy or through a
voting instrument and voting thereon. 
Under our articles of association, if a resolution to amend the articles
of association is recommended by our board of directors, such recommended
resolutions adoption in a general meeting of the shareholders requires an
ordinary majority. In any other case, such a resolution requires approval of a
special majority of more than three quarters of the votes of the shareholders
entitled to vote themselves, by proxy or through a voting instrument.

The
directors are appointed by decision of an ordinary majority at a general
meeting.  The directors have the right
at any time, in a resolution approved by at least a majority of our directors,
to appoint any person as a director, subject to the maximum number of directors
specified in our articles of association, to fill in a place which has randomly
been vacated, or as an addition to the board of directors. Any such director so
appointed shall hold office until the next annual general meeting and may be
reelected.

Under
our articles of association our directors are elected by an ordinary majority
of the shareholders at each duly convened annual meeting, and they serve until
the next annual meeting, provided that external directors shall be elected in
accordance with applicable law and/or relevant stock exchange rules applicable
to us. In each annual meeting the directors that were elected at the previous
annual meeting are deemed to have resigned from their office. A resigning
director may be reelected.

Rights
in the Companys profits

All
of our ordinary shares have the rights to share in our profits distributed as a
dividend and any other permitted distribution.

Rights
in the event of liquidation

All
of our ordinary shares confer equal rights among them with respect to amounts
distributed to shareholders in the event of liquidation.

Changing
Rights Attached to Shares

According
to our articles of association, our share capital may be divided into different
classes of shares or alter the rights of such shares by an ordinary majority
resolution passed by the general meetings of the holders of each class of
shares separately, or after obtaining the written consent of the holders of all
of the classes of shares.

Annual
and Extraordinary Meetings

Our
board of directors must convene an annual meeting of shareholders every year by
no later than the end of fifteen months from the last annual meeting. Notice of
at least twenty-one days prior to the date of the meeting is required. An
extraordinary meeting may be convened by the board of directors, as it decides
or upon a demand of any two directors or 25% of the directors, whichever is
lower, or by one or more shareholders holding in the aggregate at least 5% of
the voting rights in the Company.  Where
the board of directors is requisitioned to call a special meeting, it shall do
so within twenty-one days, for a date that shall not be later than thirty-five
days from the date on which the notice of the special meeting is published.

Limitations
on the Rights to Own Securities in the U.S.

Our
memorandum and articles of association do not restrict in any way the ownership
of our shares by nonresidents of Israel, and neither the memorandum and
articles of association nor Israeli law restricts the voting rights of
nonresidents of Israel, except that under Israeli law, any transfer or issue of
shares of the Company to a resident of a country under a state of war with
Israel is prohibited and shall have no affect, unless authorized by the Israeli
Minister of Finance.

67

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Limitations
on Change in Control and Disclosure Duties

Our
memorandum and articles of association do not restrict the change of control
nor do they impose any disclosure duties beyond the requirements set out in
Israeli law. Please see ITEM
3D(B)--RISKS RELATING TO OPERATIONS IN ISRAEL  ANTI-TAKEOVER PROVISIONS.

Changes
in Our Capital

Changes
in our capital are subject to the approval of the shareholders at a general
meeting by an ordinary majority of shareholders participating and voting in the
general meeting.

10.C Material contracts

Separation
Agreement with Ran Eisenberg. 
On August 13, 2001, Mr. Ran Eisenberg, our former chief executive
officer, tendered his resignation. On August 30, 2001, we signed an agreement
with Mr. Eisenberg, according to which Mr. Eisenberg served as an advisor to
our board of directors from April 28, 2002 until the earlier of  (1) termination of the agreement by us as a
result of (i) a material breach of the agreement; (ii) willful misconduct or
acts in bad faith; or (iii) committal of a felony or a common law fraud,
against us; performed by Mr. Eisenberg; or (2) on August 30, 2002. In
consideration for his services, Mr. Eisenberg received $170,000 plus VAT, of
which 50% was paid on September 30, 2001 and the rest was paid in 2002. Mr.
Eisenberg was reimbursed for reasonable business expenditures incurred in
connection with the services and approved in advance by us.  This Agreement was filed under Form 6-K on
February 15, 2002.

Separation
Agreement with John Krooss. In connection with the separation of Mr. John Krooss employment
with us effective September 2001, we entered into a Separation Agreement and
General Release dated January 15, 2002, pursuant to which Mr. Krooss continues
to serve on our board of directors, and will, at his election and expense,
receive certain health insurance benefits. The Employment Agreement with Mr.
Krooss dated November 30, 2000 was terminated. 
We also agreed to indemnify Mr. Krooss in his capacity as a member of
the board of directors or officer for all periods commencing on or after
December 4, 2000 and to recommend to the our board of directors that Mr. Krooss
be granted additional options in an amount determined by the board of
directors.  In addition, as discussed
below, we agreed to release certain of Mr. Krooss shares in escrow in
connection with a settlement between us and the former shareholders of
Viewgraphics.  In July 2002, Mr. Krooss
resigned from his service as a director on our board of directors.

Settlement
with Former Shareholders of Viewgraphics. 
In connection with the acquisition of Viewgraphs and issuance of shares
to the former shareholders of Viewgraphics, we placed an aggregate of 716,933
shares into one-year escrow subject to such former shareholders
indemnification obligations under the merger agreement, and 319,488 shares into
a three-year escrow to provide for indemnification obligation of Mr. John
Krooss arising from representations related to the tax status of
Viewgraphics.  We entered into a
Settlement Agreement and Release dated December 1, 2001 with the former shareholders,
pursuant to which we settled our claims against the former shareholders arising
under the merger agreement.  As part of
the settlement, as of January 15, 2002, 251,285 shares in escrow attributable
to Mr. Krooss were returned to Optibase (with Mr. Krooss undertaking to pay a
specified amount of damages to us resulting from any breach of certain
representations under the merger agreement), 322,857 shares for Mr. Krooss and
104,968 shares for his childrens trust, or an aggregate of 427,825 escrow
shares were released from the escrow and 68,203 shares remain in escrow until
the third anniversary of the closing in connection with tax indemnification
obligations under the merger agreement.

Distribution
Agreement with BDX. On December 20, 2002, we entered into an agreement with BDX Beijing
Digital Express Center, or BDX our currently sole distributor in China for the
distribution of our open system, MGWXOO and information value systems in
China during 2003. Under the agreement BDX undertook to purchase from us
minimum quotas per each quarter of 2003. In the event BDX meets the target set
for 2003, BDX shall receive certain rebates, the total amount of which shall
not exceed $120,000, to be used by BDX for marketing activities. In addition,
we undertook to share with BDX other expenses incurred by BDX, such as
roadshows, CCBN and other marketing activities the total amount of which shall
not exceed $30,000.

68

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10.D Exchange controls

There
are no Israeli government laws, decrees or regulations that restrict or that
affect our export or import of capital or the remittance of dividends, interest
or other payments to non-resident holders of our securities, except or
otherwise as set forth under ITEM 10E. ADDITIONAL INFORMATION TAXATION.

Under
Israeli law (and our memorandum and articles of association), persons who are
neither residents nor nationals of Israel may freely hold, vote and transfer
ordinary shares in the same manner as Israeli residents or nationals.

10.E Taxation

Israeli
taxation

The
following is a discussion of Israeli and United States tax consequences
material to a U.S. shareholder.  To the
extent the discussion is based on new tax legislation, which has not been
subject to judicial or administrative interpretation, the views expressed in
the discussion might not be accepted by the tax authorities in question.  The discussion is not intended, and should
not be construed, as legal or professional tax advice and does not exhaust all
possible tax considerations.  Holders of
our ordinary shares should consult their own tax advisors as to the United
States, Israeli or other tax consequences of the purchase, ownership and
disposition of ordinary shares, including, in particular, the effect of any
non-U. S., state or local taxes.

Tax
reform.   On January
1, 2003 a comprehensive tax reform took effect in Israel. Pursuant to the
reform, resident companies are subject to Israeli tax on income accrued or
derived in Israel or abroad. In addition, the concept of controlled foreign
corporation was introduced according to which an Israeli company may become
subject to Israeli taxes on certain income of a non-Israeli subsidiary if the
subsidiarys primary source of income is passive income (such as interest,
dividends, royalties, rental income or capital gains). The tax reform also
substantially changed the system of taxation of capital gains.

General
Corporate Tax Structure in Israel.  The regular rate of corporate tax to which Israeli companies are
subject is 36%. However, the effective rate of tax of a company that is
qualified under Israeli law as an Industrial Company (as referred to below)
and that derives income from an Approved Enterprise (as referred to below)
may be considerably lower.

We
currently qualify as an Industrial Company pursuant to the Law for the
Encouragement of Industry (Taxes), 1969 (the Industry Law). A company
qualifies as an Industrial Company if it is resident in Israel and at least
90% of its income in a given tax year, determined in NIS (exclusive of income
from certain specified sources), is derived from Industrial Enterprises owned
by that company. An Industrial Enterprise is defined as an enterprise whose
major activity in a particular tax year is industrial manufacturing activity.
As an Industrial Company, we are entitled to certain tax benefits, including a
deduction of 12.5% per annum of the purchase of patents or certain other
intangible property rights. See Note (12) to our consolidated financial
statements.

Our
production facilities have been granted Approved Enterprise status under the
Law for Encouragement of Capital Investments, 1959 and consequently are
eligible for certain tax benefits for the first several years in which they
generate taxable income. We have elected to participate in the Alternative
Benefits Program with respect to our 
Approved Enterprises. The income derived from our facilities that were
granted Approved Enterprise status is exempt from income tax in Israel for
two years commencing in the year in which the specific Approved Enterprises
first generates taxable income. Following such two-year period, the Approved
Enterprises are subject to corporate tax at a reduced rate of 15-25% for an
additional period of five to eight years (subject to an adjustment based upon
the non-Israel investors ownership of us). Please see Note (12) to our
consolidated financial statements.

A
company owning an Approved Enterprise may elect to forego entitlement to grants
otherwise available as a result of an Approved Enterprise in return for an
alternative package of benefits. Under the alternative package of benefits, a
companys undistributed income derived from an Approved Enterprise will be
exempt from company tax for a period of between two and ten years from the
first year of taxable income, depending on the geographic location of the
Approved Enterprise within Israel, and the company will be eligible for a
reduced tax rate for the remainder of the benefits period.  The law also grants entitlement to claim
accelerated depreciation on equipment used by the Approved Enterprise during
five tax years. A foreign investors company, as defined in the Investment Law,
may enjoy benefits for an extended period of up to ten years, or twelve years,
if it complies with certain export criteria stipulated in the Investment Law.

69

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The period of tax
benefits detailed above is limited to the earlier of 12 years from the
commencement of production, or 14 years from receiving the approval. The tax benefits
are scheduled to gradually expire from 2003 through 2014.

The
Investment Center bases its decision whether or not to approve an application
on the criteria set forth in the Investment Law and regulations, the then
prevailing policy of the Investment Center, and the specific objectives and
financial criteria of the applicant. Therefore, we cannot assure you that any
applications we may make in the future will be approved. The entitlement to the
above benefits is conditional upon our fulfilling the conditions stipulated by
the above law, regulations published thereunder and the instruments 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 we may be required to refund the
amount of the benefits, in whole or in part, including interest.

Should
we 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 rates of 36%.               Subject
to applicable provisions concerning income under the alternative package of
benefits, all dividends are considered to be attributable to the entire
enterprise and their effective tax rate is the result of a weighted average of
the various applicable tax rates. Under the Investment Law, a company that has
elected the alternative package of benefits is not obliged to attribute part of
the dividend to exempt 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 programs and not to distribute the income
as a dividend.

In
the event a company is operating under more than one approval or its capital
investments are only partly approved, its effective tax rate is a weighted
combination of the various applicable tax rates.

Eligibility
for benefits under the Industry Law is not contingent upon the approval of any
Government agency. No assurance can be given that we will continue to qualify
as an Industrial Company, or will be able to avail us of any benefits under the
Industry Law in the future.

Tax
Benefits for Research and Development. Israeli tax law
allows, under specific conditions, a tax deduction in the year incurred for
expenditures, including capital expenditures, relating to scientific research
and development projects, if the expenditures are approved by the relevant
Israeli government ministry, determined by the field of research, and the
research and development is for the promotion of the company and is carried out
by or on behalf of the company seeking the deduction. Expenditures not so
approved are deductible over a three-year period. Expenditures made out of proceeds
made available to us through government grants are automatically deducted
during a one year period.

Special
Provisions Relating to Taxation under Inflationary Conditions.
The Income Tax Law (Inflationary Adjustments), 1985, generally referred to as
the Inflationary Adjustments Law, represents an attempt to overcome the
problems presented to a traditional tax system by an economy undergoing rapid
inflation. The Inflationary Adjustments Law is highly complex. Below we
describe those features which are material to us:

| |  | There is a special tax adjustment for the
  preservation of equity which classifies corporate assets into fixed assets
  and non-fixed assets. Where a companys equity, as defined in the law,
  exceeds the depreciated cost of fixed assets, a deduction from taxable income
  that takes into account the effect of the applicable annual rate of inflation
  on the excess is allowed up to a ceiling of 70% of taxable income in any
  single tax year, with the unused portion permitted to be carried forward on a
  linked basis. If the depreciated cost of fixed assets exceeds a companys
  equity, then the excess multiplied by the applicable annual rate of inflation
  is added to taxable income.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |  | Subject to specified limitations, depreciation
  deductions on fixed assets and losses carried forward are adjusted for
  inflation based on the increase in the consumer price index.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |  | In specified circumstances, gains on traded
  securities, which might otherwise be eligible for reduced rates of tax, will
  be subject to company tax at the rate of 36%.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          

70

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The
Israeli Law for the Encouragement of Capital Investment, 1959 and
regulations prescribe an expiry date for the grant of new benefits. The expiry
date has been extended several times in the past. The last expiry date that was
in effect was in June 2004, and no new benefits will be granted after that date
unless the expiry date is again extended. A government committee is reviewing
the benefits program under the law. There can be no assurance that new benefits
will be available after June 2004, however benefits already granted will stay
in effect throughout the plan period. We
have already been granted approved enterprise status under this Law, the
deadline does not have any affect on such status or on the benefits we receive.

Capital
Gains Tax on Sales of Our Ordinary Shares.  Israeli law generally imposes a capital
gains tax on the sale of capital assets located in Israel, including shares in
Israeli resident companies, by both residents and non-residents of Israel,
unless a specific exemption is available, or unless a treaty between Israel and
the country of the non-resident provides otherwise. Regulations promulgated
under the Israeli Income Tax Ordinance provided for an exemption from Israeli
capital gains tax for gains accrued before January 1, 2003 and derived from the
sale of shares of an Industrial Company, as defined by the Industry
Encouragement Law, that are traded on specified non-Israeli markets, including
The NASDAQ National Market, provided that the sellers purchased their shares
either in the companys initial public offering or in public market
transactions thereafter.  This exemption
does not apply to shareholders who are in the business of trading securities,
or to shareholders that are Israeli resident companies subject to the Income
Tax (Adjustments for Inflation) Law, 1985. We believe that we are currently an
Industrial Company, as defined by the Industry Encouragement Law. The status of
a company as an Industrial Company may be reviewed by the tax authorities from
time to time. There can be no assurance that the Israeli tax authorities will
not deny our status as an Industrial Company, possibly with retroactive effect.

On
January 1, 2003, the Law for Amendment of the Income Tax Ordinance (Amendment
No.132), 5762-2002, known as the tax reform, came into effect thus imposing
capital gains tax at a rate of 15% on gains derived on or after January 1, 2003
from the sale of shares of Israeli companies publicly traded on a recognized
stock exchange outside of Israel. This tax rate does not apply to: (1) dealers
in securities; (2) shareholders that report in accordance with the Income Tax
Law (Inflationary Adjustment), 1985; or (3) shareholders who acquired their
shares prior to an initial public offering. 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.
Non-Israeli residents shall be exempt from Israeli capital gains tax on any
gains derived from the sale of shares publicly traded on a stock exchange
recognized by the Israeli Ministry of Finance, provided such shareholders did
not acquire their shares prior to an initial public offering. In any event, the
provisions of the tax reform shall not affect the exemption from capital gains
tax for gains accrued before January 1, 2003, as described in the previous
paragraph and capital gains in respect of assets purchased prior to that date
will be subject to a blended tax rate calculated based on the relative time
periods before and after January 1, 2003. This is not true with respect to
traded securities, where post-2002 gains are measured based on the closing
prices at the end of 2002.

In
addition, 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, or the United States-Israel Tax Treaty, the sale, exchange or
disposition of ordinary shares by a person who qualifies as a resident of the
United States within the meaning of the United States-Israel Tax Treaty and who
is entitled to claim the benefits afforded to such person by the United
States-Israel Tax Treaty (or a Treaty United States Resident) generally will
not be subject to the Israeli capital gains tax unless such Treaty United
States Resident holds, directly or indirectly, shares representing 10% or more
of our voting power during any part of the twelve-month period preceding such
sale, exchange or disposition, subject to certain conditions. However, under
the United States-Israel Tax Treaty, such Treaty United States Resident would
be permitted to claim a credit for such taxes against the United States federal
income tax imposed with respect to such sale, exchange or disposition, subject
to the limitations in United States laws applicable to foreign tax credits. The
United States-Israel Tax Treaty does not relate to United States state or local
taxes.

71

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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. 
These sources of income include passive income, including dividends, royalties
and interest, as well as non-passive income from services provided in
Israel.  On distributions of dividends
other than bonus shares or stock dividends, income tax is withheld at
source.  Unless a different rate is
provided in a treaty between Israel and the shareholders country of residence,
the withholding rate is as follows:

|Dividends generated by an
  Approved Enterprise    |   | Dividends not generated by an
  Approved Enterprise | 
|-------------------------------------------------- | - | --------------------------------------------------- | 
|                                                   |   |                                                     | 
|U.S. company holding
  10% or more of our
  shares |   | Other
  non-resident                                | 
|                                                   |   |                                                     | 
|15                                                 | % |                                                     | 
|                                                   |   |                                                     | 

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

Foreign
Exchange Regulations. 
We are permitted to pay in Israeli and non-Israeli currency: -

| |  | dividends to holders of our ordinary shares; and                                                            
| | - | ------------------------------------------------------------------------------------------------------------
| |  | any amounts payable to the holders of our ordinary
  shares upon our dissolution, liquidation or winding up.

If
we make any payments in Israeli currency, the payments may be converted into
freely repatriable dollars at the rate of exchange prevailing at the time of
conversion.

United
States Federal Income Tax Consequences.  The following is a summary of certain
material U.S. federal income tax consequences that apply to U.S. Holders who
hold ordinary shares as capital assets. 
This summary is based on the United States Internal Revenue Code of
1986, as amended (the Code), Treasury regulations promulgated thereunder,
judicial and administrative interpretations thereof, and the U.S.-Israel Tax
Treaty, all as in effect on the date hereof and all of which are subject to
change either prospectively or retroactively. 
This summary does not address all tax considerations that may be
relevant with respect to an investment in ordinary shares.  This summary does not account for the
specific circumstances of any particular investor, such as:

| |  | broker-dealers,                                                                                  
| | - | -------------------------------------------------------------------------------------------------
| |  | financial institutions,                                                                          
| |  | certain insurance companies,                                                                     
| |  | investors liable for alternative minimum tax,                                                    
| |  | tax-exempt organizations,                                                                        
| |  | non-resident aliens of the U.S. or taxpayers whose
  functional currency is not the U.S. dollar, 
| |  | persons who hold the ordinary shares through
  partnerships or other pass-through entities,      
| |  | investors that actually or constructively own 10
  percent or more of our voting shares, and     
| |  | investors holding ordinary shares as part of a straddle
  or a hedging or conversion transaction.

This
summary does not address the effect of any U.S. Federal taxation other than
U.S. Federal income taxation.  In
addition, this summary does not include any discussion of state, local or
foreign taxation.  You are urged to
consult your tax advisors regarding the non-U. S. and United States federal,
state and local tax considerations of an investment in ordinary shares.

For
purposes of this summary, a U.S. Holder is:

| |  |  | an individual who is a citizen or, for U.S. federal
  income tax purposes, a resident of the United States;                                        
| |  | - | ---------------------------------------------------------------------------------------------------------------------------------------------------
| |  |  | a partnership, corporation or other entity created
  or organized in or under the laws of the United States or any political
  subdivision thereof;
| |  |  | an estate whose income is subject to U.S. federal
  income tax regardless of its source;                                                           

72

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| |  |  | a trust if: (a) a court within the United States is
  able to exercise primary supervision over administration of the trust, and
  (b) one or more United States persons have the authority to control all
  substantial decisions of the trust; or
| |  | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  |  | a trust, if the trust were in existence and
  qualified as a United States person, within the meaning of the Code, on
  August 20, 1996 under the law as then in effect and elected to continue to be
  so treated.                              

Taxation
of Dividends.  The
gross amount of any distributions received with respect to ordinary shares,
including the amount of any Israeli taxes withheld therefrom, will constitute
dividends for U.S. Federal income tax purposes, to the extent of our current
and accumulated earnings and profits as determined for U.S. federal income tax
principles.  You will be required to
include this amount of dividends in gross income as ordinary income.  Distributions in excess of our earnings and
profits will be treated as a non-taxable return of capital to the extent of
your tax basis in the ordinary shares and any amount in excess of your tax
basis, will be treated as gain from the sale of ordinary shares.  See --Disposition of Ordinary Shares below
for the discussion on the taxation of capital gains.  Dividends will not qualify for the dividends-received deduction
generally available to U.S. corporations under Section 243 of the Code.

Recently
enacted amendments to the Code, as amended, provide that dividend income may be
eligible for a reduced rate of taxation. Dividend income will be taxed at the
applicable long-term capital gains rate if the dividend is received from a
qualified foreign corporation, and the shareholder of such foreign
corporation holds such stock for more than 60 days during the 120-day period
that begins on the date that is 60 days before the ex-dividend date for the
stock. The holding period is tolled for any days on which the shareholder has reduced
his risk of loss. A qualified foreign corporation is one that is eligible for
the benefits of a comprehensive income tax treaty with the United States. A
foreign corporation will be treated as qualified with respect to any dividend
paid, if its stock is readily tradable on an established securities market.

Dividends
that we pay in NIS, including the amount of any Israeli taxes withheld
therefrom, will be included in your income in a U.S. dollar amount calculated
by reference to the exchange rate in effect on the day such dividends are
received.  A U.S. Holder who receives
payment in NIS and converts NIS into U.S. dollars at an exchange rate other
than the rate in effect on such day may have a foreign currency exchange gain
or loss that would be treated as U.S. source ordinary income or loss.  U.S. Holders should consult their own tax
advisors concerning the U.S. tax consequences of acquiring, holding and
disposing of NIS.

Any
Israeli withholding tax imposed on such dividends will be a foreign income tax
eligible for credit against a U.S. Holders U.S. federal income tax liability,
subject to certain limitations set out in the Code (or, alternatively, for
deduction against income in determining such tax liability).  The limitations set out in the Code include
computational rules under which non-U.S. tax credits allowable with respect to
specific classes of income cannot exceed the U.S. federal income taxes
otherwise payable with respect to each such class of income.  Dividends generally will be treated as
foreign-source passive income or financial services income for United States
foreign tax credit purposes.  Foreign
income taxes exceeding the credit limitation for the year of payment or accrual
may be carried back for two taxable years and forward for five taxable years in
order to reduce U.S. federal income taxes, subject to the credit limitation
applicable in each of such years.  Other
restrictions on the foreign tax credit include a prohibition on the use of the
credit to reduce liability for the U.S. individual and corporation alternative
minimum taxes by more than 90%.  A U.S.
Holder will be denied a foreign tax credit with respect to Israeli income tax
withheld from dividends received on the ordinary shares to the extent such U.S.
Holder has not held the ordinary shares for at least 16 days of the 30-day
period beginning on the date which is 15 days before the ex-dividend date or to
the extent such U.S. Holder is under an obligation to make related payments
with respect to substantially similar or related property.  Any days during which a U.S. Holder has
substantially diminished its risk of loss on the ordinary shares are not
counted toward meeting the 16-day holding period required by the statute.  The rules relating to the determination of
the foreign tax credit are complex, and you should consult with your personal
tax advisors to determine whether and to what extent you would be entitled to
this credit.

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

73

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

Passive
Foreign Investment Companies.There is a substantial risk that we are a passive
foreign investment company, or PFIC, for U.S. federal income tax purposes. 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 such shares.

For
U.S. federal income tax purposes, we will be classified as a PFIC for any
taxable year in which either (i) 75% or more of our gross income is passive
income, or (ii) at least 50% of the average value of all of our assets for the
taxable year produce or are held for the production of passive income. For this
purpose, 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 assets which produce
passive income. As a result of our substantial cash position and the decline in
the value of our stock, we are a PFIC under a literal application of the asset
test that looks solely to market value. If we are a PFIC for U.S. federal
income tax purposes, U.S. Holders of our ordinary shares would be required, in
certain circumstances, to pay an interest charge together with tax calculated
at maximum rates on certain excess distributions, including any gain on the
sale of ordinary shares.

The
consequences described above can be mitigated if the U.S. Holder makes an
election to treat us as a qualified electing fund, or QEF. A shareholder making
the QEF election is required for each taxable year to include in income a pro
rata share of the ordinary earnings and net capital gain of the QEF, subject to
a separate election to defer payment of taxes, which deferral is subject to an
interest charge. We have agreed to supply U.S. Holders with the information
needed to report income and gain pursuant to a QEF election. The QEF election
is made on a shareholder-by-shareholder basis and can be revoked only with the
consent of the Internal Revenue Service, or IRS.

As
an alternative to making the QEF election, the U.S. Holder of PFIC stock which
is publicly traded could mitigate the consequences of the PFIC rules by
electing to mark the stock to market annually, recognizing as ordinary income
or loss each year an amount equal to the difference as of the close of the
taxable year between the fair market value of the PFIC stock and the U.S.
Holders adjusted tax basis in the PFIC stock. Losses would be allowed only to
the extent of net mark-to-market gain previously included by the U.S. Holder
under the election for prior taxable years. 
All U.S. Holders are advised to consult their own tax advisers about the
PFIC rules generally and about the advisability, procedures and timing of their
making any of the available tax elections, including the QEF or mark-to-market
elections.

Backup
Withholding and Information Reporting. Payments in respect of
ordinary shares may be subject to information reporting to the U.S. Internal
Revenue Service and to a 28 percent U.S. backup withholding tax.  Backup withholding will not apply, however,
if you (i) are a corporation or come within certain exempt categories, and
demonstrate the fact when so required, or (ii) furnish a correct taxpayer
identification number and make any other required certification.  Any amount withheld under these rules may be
credited against your federal income tax liability. Backup withholding is not
an additional tax.  Amounts withheld
under the backup withholding rules may be credited against a U.S. Holders U.S.
tax liability, and a U.S. Holder may obtain a refund of any excess amounts
withheld under the backup withholding rules by filing the appropriate claim for
refund with the IRS.  Any U.S. holder
who holds 10% or more in vote or value of our ordinary shares may be subject to
certain additional United States information reporting requirements.

U.S.
Gift and Estate Tax. 
An individual U.S. Holder of ordinary shares will be subject to U.S.
gift and estate taxes with respect to ordinary shares in the same manner and to
the same extent as with respect to other types of personal property.

74

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10.F Dividend and paying agents.

Not
required.

10.G Statement by experts

Not
required.

10.H Documents on display

Reports
and other information of Optibase filed electronically with the U.S. Securities
and Exchange Commission may be found at www.sec.gov. They can also be inspected
without charge and copied at prescribed rates at the public reference
facilities maintained by the SEC in room 1024, 450 Fifth Avenue. N.W.
Washington, D.C. 20549. Copies of this material are also available by mail from
the Public Reference Section of the SEC, at 450 Fifth Street, N.W. Washington,
D.C. 20549, at prescribed rates.

10.I Subsidiary information

Not
required.

Item 11. Quantitative and Qualitative Disclosure About Market
Risk

Most
of our revenues are generated in U.S. dollars but a portion of our expenses are
incurred in NIS.  Therefore, our results
of operations may be seriously harmed by inflation in Israel and currency
fluctuations.  As a result, we are
exposed to risk to the extent that the rate of inflation in Israel exceeds the
rate of devaluation of the NIS in relation to the dollar or if the timing of
devaluation lags behind inflation in Israel. 
In that event, the dollar cost of our operations in Israel will increase
and our dollar-measured results of operations will be adversely affected.  Our operations also could be adversely
affected if we are unable to guard against currency fluctuations in the future.
 Accordingly, we may enter, but so far have not entered, into currency
hedging transactions to decrease the risk of financial exposure from
fluctuations in the exchange rate of the dollar against the NIS.  These measures, however, may not adequately
protect us from material adverse effects due to the impact of inflation in
Israel.

Interest
Rate and Rating Risks

Our
exposure to market risk for changes in interest rates in the U.S. relates
primarily to our investment in marketable securities.  Our marketable securities are comprised mainly of corporate bonds
and U.S. Government and Agencies bonds. The fair value of our long and
short-term securities is based upon their market values. Changes in U.S.
interest rates, as well as rating changes done by the leading rating agencies,
to the bonds issuers, could affect our financial results.

Investment
Portfolio Risks

In
the second quarter of 2003, we transferred approximately $39.3 million of our
monies and investments to Optibase, Inc. to achieve better net profit from the
investment. We manage our investment portfolio on a discretionary basis, within
the framework of an investment policy based upon an established set of
guidelines approved by our board of directors. The main terms of the investment
guidelines permit us to invest in the following securities: (i) U.S. Treasury
and Agency obligations; (ii) money market instruments of domestic and foreign
issues denominated in US dollars of commercial paper, bankers acceptances,
certificates of deposit, euro-dollar time deposits and variable rate issues;
(iii) corporate notes and bonds rated investment grade (BAA/BBB- and above),
provided that investments in any one corporation or entity will not exceed $3
million; (iv) hedge funds up to $10 million pursuant to the following
guidelines: (1) Volatility below 10%; (2) Minimum 5 years of positive
performance; (3) Low beta; (4) Positive sharp ratio; (5) Size of fund of at
least $1 BL; and (6) Multi manager and strategy; (vi) Investments in bonds and
notes with lower rating than BBB- and higher rating than B, provided that
investments in any one corporation or entity will not exceed $1 million. (vii)
Widely held funds that invests in corporate and sovereign debt.  It was also resolved to allow hedging transactions
against the U.S. dollars only to protect anticipated exposure and not for
speculative purposes. The hedging transactions will be made against the
underlying assets only, and to limit the investment in structured products to
up to 40% of the Corporations total portfolio (Investment Limitation).
Provided however, that if the structured products currently owned by the
Corporation constitute more than the Investment Limitation, the Corporation
shall not be required to sell or dispose any such structured products to meet
the Investment Limitation, but may not make any additional investments in
structured products until the Investment Limitation is met. The investment
guidelines are to be reviewed periodically by our board of directors with the
President and Chief Financial Officer.

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| | The
  securities in our investment portfolio are generally classified as available
  for sale and, consequently, are recorded on the Consolidated Balance Sheets
  at fair value with unrealized gains or losses reported as a separate
  component of accumulated other comprehensive income (loss). Changes in the
  current economic situation and other factors may adversely affect the value
  of our portfolio. As a result, we may recognize in earnings the decline in
  fair value of our portfolio investments when the decline is judged to be
  other- than- temporary.  Furthermore,
  our equity and other investments in private companies are subject to risk of
  loss of investment capital. These investments are inherently risky as the
  market for the technologies or products they have under development are
  typically in the early stages and may never materialize. We could lose our
  entire investment in these companies. At any time, a sharp rise in interest
  rates could have a material adverse impact on the fair value of our
  investment portfolio as well as on our results of operations. We do not
  currently hedge these interest rate exposures.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | The
  table set forth shows the construction of our portfolio classified as
  available for sale:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  

| |                                                 |  | December 31,  |  
| | ----------------------------------------------- |  | ------------- | -
| |                                                 |  |               |  
| |                                                 |  | 2002          |  
| |                                                 |  |               |  
| |                                                 |  | Amortizedcost |  
| |                                                 |  |               |  
| | Available-for-sale:                             |  |               |  
| |                                                 |  |               |  
| | Government and corporate debt                   |  |               | $
| | Government
  and corporate structured notes (*) |  |               |  
| |                                                 |  |               |  
| |                                                 |  |               |  
| | Total
  securities                              |  |               | $
| |                                                 |  |               |  

| | *) | The expected maturities may differ from the
  contractual maturities because debtors may have the right to call or prepay
  obligations without penalties.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------

Item 12. Description of Securities Other than Equity
Securities

Not
applicable.

Part
II

Item 13.    Defaults,
Dividend Arrearages and Delinquencies

Not
applicable.

76

---

---

Item 14.    Material
Modifications to the Rights of Security Holders and Use of Proceeds

Not
applicable.

Item 15.    Controls
and Procedures

Disclosure
controls and procedures.Our Chief Executive Officer and
Chief Financial Officer have evaluated the effectiveness of our disclosure
controls and procedures as of the end of the period covered by this Annual
Report on Form 20-F. Based upon such review, the Chief Executive Officer and
Chief Financial Officer have concluded that Optibase has in place appropriate
controls and procedures designed to ensure that information required to be
disclosed by Optibase in the reports it files or submits under the Securities
Exchange Act of 1934, as amended, and the rules thereunder, is recorded,
processed, summarized and reported within the time periods specified in the
SECs rules and forms.

Internal
controls. Since the date of the evaluation described above,
there have not been any significant changes in Optibases internal controls or
in other factors that could significantly affect those controls.

Item 16.

16.A Audit Committee Expert

Our
audit committee financial expert is Alex Hilman.

16.B Code of Business Conduct
and Ethics

We
have adopted a Code of Business Conduct and Ethics for our employees, including
our chief executive officer and senior financial officers. The Code of Business
Conduct and Ethics is attached as Exhibit 11 to this report.

16.C Fees to Auditors

Kost,
Forer Gabbay & Kasierer, a member of Earnst & Young International Ltd.,
or Earnst & Young has served as our independent public accountants for each
of the fiscal years in the three-year period ended December 31, 2003, for which
audited financial statements appear in this annual report on Form 20-F.

The
following table presents the aggregate fees for professional services and other
services rendered by Kost, Forer Gabbay & Kasierer to Optibase in 2003 and
2002.

|                       | 2003 USD in thousands | 2002 USD in thousands
|---------------------- | --------------------- | ---------------------
|Audit Fees (1)         | 26                    |                      
|Audit-related Fees (2) | 16                    |                      
|Tax Fees (3)           | 13                    |                      
|All Other Fees (4)     | 3                     |                      
|TOTAL                  | 58                    |                      

|(1) | Audit Fees consist of fees
  billed for the annual audit services engagement and other audit services,
  which are those services that only the external auditor can reasonably
  provide, and include the group audit; statutory audits; comfort letters and
  consents; attest services; and assistance with and review of documents filed
  with the SEC.                                                                                                                                                                                                                                                                                                                                                   
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|(2) | Audit-related Fees consist
  of fees billed for assurance and related services that are reasonably related
  to the performance of the audit or review of our financial statements or that
  are traditionally performed by the external auditor, and include
  consultations concerning financial accounting and reporting standards;
  internal control reviews of new systems, programs and projects; review of
  security controls and operational effectiveness of systems; review of plans
  and control for shared service centers, due diligence related to
  acquisitions; accounting assistance and audits in connection with proposed or
  completed acquisitions; and employee benefit plan audits.

77

---

---

|(3) | Tax Fees include fees
  billed for tax compliance services, including the preparation of original and
  amended tax returns and claims for refund; tax consultations, such as
  assistance and representation in connection with tax audits and appeals, tax
  advice related to mergers and acquisitions, transfer pricing, and requests
  for rulings or technical advice from taxing authority; tax planning services;
  and expatriate tax planning and services.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|(4) | All Other Fees include
  fees billed for training; forensic accounting; data security reviews;
  treasury control reviews and process improvement and advice; and
  environmental, sustainability and corporate social responsibility advisory
  services.                                                                                                                                                                                                           

Audit
Committee Pre-approval Policies and Procedures

Below
is a summary of the current Policies and Procedures.

Optibases
audit committees main role is to assist the Board of Directors in fulfilling its
responsibility for oversight of the quality and integrity of the accounting, auditing and
reporting practices of the Company. The Audit Committee oversees the appointment,
compensation, and oversight of the public accounting firm engaged to prepare or issue an
audit report on the financial statements of the Company. The audit committees
specific responsibilities in carrying out its oversight role include the approval of all
audit and non-audit services to be provided by the external auditor and quarterly review
the firms non-audit services and related fees. These services may include audit
services, audit-related services, tax services and other services, as described above. It
is the policy of our audit committee to approve in advance the particular services or
categories of services to be provided to the Company periodically. Additional services may
be pre-approved by the audit committee on an individual basis during the year.

Item 17.

Not
Applicable.

Part
III

Item 18.    Financial
Statements

| | The following financial statements of the Company
  and the auditors report are hereby attached. |        
| | ------------------------------------------------------------------------------------------------- | -------
| |                                                                                                   |        
| | Index to Consolidated Financial Statements                                                        | F-1    
| | Report of Independent Auditors                                                                    | F-2    
| | Consolidated Balance Sheets                                                                       | F-3F-4
| | Consolidated Statements of Operations                                                             | F-5    
| | Statements of Changes in Shareholders Equity                                                     | F-6-F-7
| | Consolidated Statements of Cash Flows                                                             | F-8-F9 
| | Notes to Consolidated Financial Statements                                                        | F10-F44

78

---

---

Item 19.    Exhibits
and financial statement schedules

(a)               Financial
Statement Schedules

Schedule
II          Schedule of
Valuation and Qualifying Accounts at December 31, 2003

SCHEDULE
II OPTIBASE LTD.

SCHEDULE
OF VALUATION AND QUALIFYING ACCOUNTS AT DECEMBER 31, 2003

|                             |                                 | Balance at 
  beginning of
  period |  | Provision for 
  doubtful 
  accounts |     | Write-off of 
  previously provided
  accounts |  | Balance at
  end of
  period |  
|---------------------------- | ------------------------------- | ----------------------------------- |  | ------------------------------------- | --- | ---------------------------------------------- |  | ---------------------------- | -
|                             |                                 |                                     |  |                                       |     |                                                |  |                              |  
|                             |                                 | (Dollars in thousands)              | 
|Year ended December 31, 2003 |                                 |                                     |  |                                       |     |                                                |  |                              |  
|                             | Allowance for doubtful accounts |                                     |  | $                                     | 814 |                                                |  |                              | $
|Year ended December 31, 2002 |                                 |                                     |  |                                       |     |                                                |  |                              |  
|                             | Allowance for doubtful accounts |                                     |  | $                                     | 739 |                                                |  |                              | $
|Year ended December 31, 2001 |                                 |                                     |  |                                       |     |                                                |  |                              |  
|                             | Allowance for doubtful accounts |                                     |  | $                                     | 453 |                                                |  |                              | $

Other schedules are
omitted because they are not required or the required information is shown in
the financial statements or notes thereto.

(b)          Exhibits

|Exhibit Number |  | Description
of Document
|-------------- |  | -----------------------

|1.1 |  | Amended
and  Restated  Memorandum  of  Association  of the Company  (incorporated  by  reference
to                       Exhibit 3.1 from the Company's Form 6K Dated February 15, 2002).
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|1.2 |  | Amended
 Articles of Association of the Company  (incorporated by reference to Exhibit 3.2 from
the                       Company's Form 6K dated February 15, 2002).
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

|2.1 |  | Escrow
 Agreement  dated December 4, 2000 by and among Optibase  Ltd.,  Viewgraphics
 Incorporated,                       American  Stock  Transfer  & Trust  Company  and
John  Krooss  as  Representative  of  Shareholders                       (incorporated by
reference to exhibits filed with the Form 6-K filed on December 7, 2000).
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.(a).1 |  | Agreement
and Plan of  Reorganization  dated  December 1, 2000 by and among  Optibase  Ltd.,  Vodka
                      Acquisition Corp., Viewgraphics Incorporated, John Krooss and the
Krooss 2000 Children's Trust
|------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Exhibit A Form Voting Agreement                            Exhibit B Form of Krooss Employment
Agreement (see Exhibit 10.1)                            Exhibit C Forms of Employment
Agreement                            Exhibit D Form of Individual Shareholder Agreement
                           Exhibit E Form Escrow Agreement (see Exhibit 2.3)
                           Exhibit F Form of Agreement of Merger
                           Exhibit G Form of Opinion from legal counsel to Viewgraphics
                           Exhibit H Forms of Opinion from legal counsels to Optibase
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | (incorporated by
reference to exhibits filed with the Form 6-K filed on December 7, 2000).
| |  | ------------------------------------------------------------------------------------------

|4.(a).2 |  | Asset
 Acquisition  Agreement  dated  December  1, 2000 by and among  Optibase  Ltd.,
 Viewgraphics                       Incorporated  and John Krooss  (incorporated by
reference to exhibits filed with the Form 6-K filed                       on December 7,
2000).
|------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

79

---

---

|Exhibit Number |  | Description
of Document
|-------------- |  | -----------------------

|4.(a).3 |  | Settlement
 Agreement and Release dated  December 1, 2001 by and among Optibase Ltd. and the former
                      shareholders  of  Viewgraphics,  John  Krooss as  shareholder
 representative  and  American  Stock                       Transfer & Trust  Company as
the escrow agent  (incorporated  by reference to Exhibits 4.3 and 4.4
                      filed with the  Registrant's  Annual  Report on Form 20-F for the
fiscal year ended  December  31,                       2001).
|------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.(a).4 |  | Agreement
and General  Release dated January 15, 2002 by and between  Optibase Ltd. and John Krooss
                      (incorporated  by reference to Exhibits 4.3 and 4.4 filed with the
 Registrant's  Annual Report on                       Form 20-F for the fiscal year ended
December 31, 2001).
|------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.(a).5 |  | Termination
 Agreement  Between  Optibase Ltd.,  Optibase Inc. and Optibase Europe Ltd. and Mr. Ran
                      Eisenberg,  dated August 29, 2001  (incorporated  by reference to
exhibits filed with the Form 6-K                       filed on February 15, 2002).
|------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.(b).1 |  | Consulting
 Agreement  between  Optibase  Ltd.  and  Mr.  Ran  Eisenberg,  dated  August  29,  2001
                      (incorporated by reference to exhibits filed with the Form 6-K
filed on February 15, 2002).
|------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.(b).2 |  | Distribution
 Agreement between Optibase Ltd. and Beijing Digital Express Center dated December 20,
                      2002  (incorporated by reference to Exhibit 4.7 filed with the
Registrant's  Annual Report on Form                       20-F for the fiscal year ended
December 31, 2002).
|------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.(c).1 |  | Form
of Letter of Indemnity between Optibase Ltd. and its directors and officers
 (incorporated by                       reference  to Exhibit 4.8 filed with the
 Registrant's  Annual  Report on Form 20-F for the fiscal                       year
ended December 31, 2002).
|------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.(c).2 |  | Form
of Letter of Indemnity between Optibase, Inc. and its directors and officers
(incorporated by                       reference  to Exhibit 4.9 filed with the
 Registrant's  Annual  Report on Form 20-F for the fiscal                       year
ended December 31, 2002).
|------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.(c).3 |  | 1999
Israel Share Option Plan,  as amended  (incorporated  by reference to exhibits  filed
with the                       Registrant's Annual Report on Form 20-F for the fiscal
year ended December 31, 1999).
|------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.(c).4 |  | 1999
U.S.  Share  Option Plan,  as amended  (incorporated  by reference to exhibits  filed
with the                       Registrant's Annual Report on Form 20-F for the fiscal
year ended December 31, 1999)
|------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.(c).5 |  | 102
Plan  (incorporated by reference to exhibits filed with the Registrant's  Annual Report
on Form                       20-F for the fiscal year ended December 31, 1999)
|------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.(c).6 |  | Employee
Stock  Purchase Plan  (incorporated  by reference to exhibits filed with the
 Registrant's                       Annual Report on Form 20-F for the fiscal year ended
December 31, 1999)
|------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.(c).7 |  | 2001
 Non-statutory  Share  Option  Plan as amended  and Form Option  Agreement  (incorporated
 by                       reference to Exhibit 10.5 filed with the  Registrant's  Annual
 Report on Form 20-F for the fiscal                       year ended December 31, 2000,
and with respect to the amendment,  Exhibit 99.7 filed with the Form
                      6-K filed on February 15, 2002).
|------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.(c).8 |  | Employment
 Agreement  with John Krooss  dated  November  30, 2000  (incorporated  by  reference to
                      exhibits filed with the Form 6-K filed on December 7, 2000).
|------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.(c).9 |  | 2003
Amendment to the 1999 Israel Share Option Plan.
|------- |  | ----------------------------------------------------

|8.1 |  | List
of the subsidiaries of the Company
|--- |  | ---------------------------------------

|10.1 |  | Consent
of Kost, Forer Gabbay & Kasierer, a member of Ernst & Young Global.
|---- |  | ---------------------------------------------------------------------------

|11 |  | Code
of Business Conduct and Ethics.
|-- |  | ------------------------------------

|12.(a).1 |  | Certification
 by Chief  Executive  Officer  pursuant to Rule  13a-14(a)  or Rule  15d-14(a) of the
                      Securities  Exchange Act of 1934, as adopted pursuant to Section
302 of the  Sarbanes-Oxley  Act of                       2002.
|-------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|12.(a).2 |  | Certification
 by Chief  Financial  Officer  pursuant to Rule  13a-14(a)  or Rule  15d-14(a) of the
                      Securities  Exchange Act of 1934, as adopted pursuant to Section
302 of the  Sarbanes-Oxley  Act of                       2002.
|-------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|32.1 |  | Certification
by Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|---- |  | ---------------------------------------------------------------------------------------------------

|32.2 |  | Certification
by Principal  Financial Officer pursuant to Section 906 of the  Sarbanes-Oxley Act of
                      2002.
|---- |  | -------------------------------------------------------------------------------------------------------------------------------

80

---

---

OPTIBASE LTD. AND ITS
SUBSIDIARIES

CONSOLIDATED
FINANCIAL STATEMENTS

AS OF DECEMBER 31,
2003

IN U.S. DOLLARS

INDEX

|                                                | Page       
|----------------------------------------------- | -----------
|                                                |            
|                                                |            
|Report of Independent Auditors                  | F-2        
|                                                |            
|Consolidated Balance Sheets                     | F-3 - F-4  
|                                                |            
|Consolidated Statements of Operations           | F-5        
|                                                |            
|Statements of Changes in Shareholders
  Equity | F-6 - F-7  
|                                                |            
|Consolidated Statements of Cash Flows           | F-8 - F-9  
|                                                |            
|Notes to Consolidated Financial Statements      | F-10 - F-44

- - - - - - - - - - -

---

---



REPORT
OF INDEPENDENT AUDITORS

To the Shareholders
of

OPTIBASE LTD.

We have
audited the accompanying consolidated balance sheets of Optibase Ltd. (the
Company) and its subsidiaries as of December 31, 2002 and 2003, and the
related consolidated statements of operations, changes in shareholders equity
and cash flows for each of the three years in the period ended December 31,
2003. Our audits also included the financial statement schedule listed at Item
19(a). These financial statements are the responsibility of the Companys
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

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

In our
opinion, the consolidated financial statements referred to above, present
fairly, in all material respects, the consolidated financial position of
Optibase Ltd. and its subsidiaries as of December 31, 2002 and 2003, and the
consolidated results of their operations and cash flows for each of the three
years in the period ended December 31, 2003, in conformity with accounting
principles generally accepted in the United States. Also, in our opinion, the
related financial statement schedule, when considered in relation to the basic
financial statements taken as a whole, present fairly in all material respects
the information set forth therein.

As discussed in Note 1c to the
consolidated financial statements, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 141, Business Combinations and No. 142,
Goodwill and Other Intangible Assets, effective July 1, 2001 and January 1,
2002, respectively.

|Tel-Aviv, Israel | KOST
  FORER GABBAY & KASIERER  
|---------------- | --------------------------------
|January 26, 2004 | A Member of Ernst & Young Global

F - 2

---

---

OPTIBASE LTD. AND ITS
SUBSIDIARIES

|CONSOLIDATED BALANCE SHEETS
|---------------------------
|                           
|U.S. dollars in thousands  

|                                                                                                                                                        |  | December
  31, |       
|------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------- | ------
|                                                                                                                                                        |  |                |       
|                                                                                                                                                        |  | 2002           |       
|                                                                                                                                                        |  |                |       
|ASSETS                                                                                                                                                  |  |                |       
|                                                                                                                                                        |  |                |       
|CURRENT
  ASSETS:                                                                                                                                       |  |                |       
|Cash
  and cash equivalents                                                                                                                             |  | $              | 6,002 
|Marketable
  securities (Note 3)                                                                                                                        |  |                | 39,318
|Trade
  receivables (net of allowance for doubtful accounts of $ 814 and
            $ 517 as of
  December 31, 2002 and 2003, respectively) (Note 15a) |  |                | 2,650 
|Other
  accounts receivable and prepaid expenses (Note 4)                                                                                               |  |                | 1,577 
|Inventories
  (Note 5)                                                                                                                                  |  |                | 4,237 
|                                                                                                                                                        |  |                |       
|                                                                                                                                                        |  |                |       
|Total
  current assets                                                                                                                                  |  |                | 53,784
|                                                                                                                                                        |  |                |       
|                                                                                                                                                        |  |                |       
|LONG-TERM
  INVESTMENTS:                                                                                                                                |  |                |       
|Long-term
  lease deposits (Note 11a)                                                                                                                   |  |                | 239   
|Severance
  pay fund                                                                                                                                    |  |                | 1,057 
|Investments
  in companies (Note 6)                                                                                                                     |  |                | 2,235 
|                                                                                                                                                        |  |                |       
|                                                                                                                                                        |  |                |       
|Total
  long-term investments                                                                                                                           |  |                | 3,531 
|                                                                                                                                                        |  |                |       
|                                                                                                                                                        |  |                |       
|PROPERTY AND
  EQUIPMENT, NET (Note 7)                                                                                                                  |  |                | 2,173 
|                                                                                                                                                        |  |                |       
|                                                                                                                                                        |  |                |       
|OTHER
  ASSETS, NET (Note 8)                                                                                                                            |  |                | 220   
|                                                                                                                                                        |  |                |       
|                                                                                                                                                        |  |                |       
|Total
  assets                                                                                                                                          |  | $              | 59,708
|                                                                                                                                                        |  |                |       

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

F - 3

---

---

OPTIBASE LTD. AND ITS
SUBSIDIARIES

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

|                                                                                                                                                                                                                                                                                                                               |  | December
  31, |        
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | -------------- | -------
|                                                                                                                                                                                                                                                                                                                               |  |                |        
|                                                                                                                                                                                                                                                                                                                               |  | 2002           |        
|                                                                                                                                                                                                                                                                                                                               |  |                |        
|LIABILITIES
  AND SHAREHOLDERS EQUITY                                                                                                                                                                                                                                                                                         |  |                |        
|                                                                                                                                                                                                                                                                                                                               |  |                |        
|CURRENT
  LIABILITIES:                                                                                                                                                                                                                                                                                                         |  |                |        
|Short-term
  bank credit (Note 10)                                                                                                                                                                                                                                                                                             |  | $              | -      
|Current
  maturities of long-term capital lease obligations                                                                                                                                                                                                                                                                    |  |                | 129    
|Trade
  payables                                                                                                                                                                                                                                                                                                               |  |                | 2,064  
|Deferred
  revenues                                                                                                                                                                                                                                                                                                            |  |                | 309    
|Other
  accounts payable and accrued expenses (Note 9)                                                                                                                                                                                                                                                                         |  |                | 6,051  
|                                                                                                                                                                                                                                                                                                                               |  |                |        
|                                                                                                                                                                                                                                                                                                                               |  |                |        
|Total
  current liabilities                                                                                                                                                                                                                                                                                                    |  |                | 8,553  
|                                                                                                                                                                                                                                                                                                                               |  |                |        
|                                                                                                                                                                                                                                                                                                                               |  |                |        
|LONG-TERM
  LIABILITIES:                                                                                                                                                                                                                                                                                                       |  |                |        
|Long-term
  capital lease obligations, net of current maturities                                                                                                                                                                                                                                                               |  |                | 14     
|Accrued
  severance pay                                                                                                                                                                                                                                                                                                        |  |                | 1,646  
|                                                                                                                                                                                                                                                                                                                               |  |                |        
|                                                                                                                                                                                                                                                                                                                               |  |                |        
|Total
  long-term liabilities                                                                                                                                                                                                                                                                                                  |  |                | 1,660  
|                                                                                                                                                                                                                                                                                                                               |  |                |        
|                                                                                                                                                                                                                                                                                                                               |  |                |        
|COMMITMENTS
  AND CONTINGENT LIABILITIES (Note 11)                                                                                                                                                                                                                                                                             |  |                |        
|                                                                                                                                                                                                                                                                                                                               |  |                |        
|SHAREHOLDERS
  EQUITY (Note 13):                                                                                                                                                                                                                                                                                              |  |                |        
|Share
  capital:                                                                                                                                                                                                                                                                                                               |  |                |        
|Ordinary
  shares of NIS 0.13 par value -                                                                                                                                                                                                                                                                                      |  |                |        
|Authorized:
  19,230,800 shares as of December 31, 2002 and 2003;
                 Issued:
  12,872,411 shares and 13,523,531 shares as of December 31,
                 2002
  and 2003, respectively; Outstanding: 12,341,388 shares and
                 12,992,508
  shares as of December 31, 2002 and 2003, respectively |  |                | 505    
|Additional
  paid-in capital                                                                                                                                                                                                                                                                                                   |  |                | 115,507
|Treasury
  shares                                                                                                                                                                                                                                                                                                              |  |                | (2,278 
|Deferred
  stock compensation                                                                                                                                                                                                                                                                                                  |  |                | (509   
|Accumulated
  other comprehensive income                                                                                                                                                                                                                                                                                       |  |                | 467    
|Accumulated
  deficit                                                                                                                                                                                                                                                                                                          |  |                | (64,197
|                                                                                                                                                                                                                                                                                                                               |  |                |        
|                                                                                                                                                                                                                                                                                                                               |  |                |        
|Total
  shareholders equity                                                                                                                                                                                                                                                                                                   |  |                | 49,495 
|                                                                                                                                                                                                                                                                                                                               |  |                |        
|                                                                                                                                                                                                                                                                                                                               |  |                |        
|Total
  liabilities and shareholders equity                                                                                                                                                                                                                                                                                   |  | $              | 59,708 
|                                                                                                                                                                                                                                                                                                                               |  |                |        

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

F - 4

---

---

OPTIBASE LTD. AND ITS
SUBSIDIARIES

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

|                                                                                                                    |  | Year ended December 31, |        
|------------------------------------------------------------------------------------------------------------------- |  | ----------------------- | -------
|                                                                                                                    |  |                         |        
|                                                                                                                    |  | 2001                    |        
|                                                                                                                    |  |                         |        
|                                                                                                                    |  |                         |        
|Revenues
  (Notes 14 and 15b)                                                                                       |  | $                       | 29,432 
|Cost of  revenues (Note 15d)                                                                                        |  |                         | 15,016 
|                                                                                                                    |  |                         |        
|                                                                                                                    |  |                         |        
|Gross profit                                                                                                        |  |                         | 14,416 
|                                                                                                                    |  |                         |        
|                                                                                                                    |  |                         |        
|Operating
  expenses:                                                                                               |  |                         |        
|Research
  and development, net (Note 16a)                                                                          |  |                         | 15,562 
|Selling
  and marketing                                                                                             |  |                         | 10,843 
|General
  and administrative                                                                                        |  |                         | 4,927  
|Impairment
  of other assets (Note 1c)                                                                              |  |                         | 20,933 
|Restructuring
  charges (Note 1d)                                                                                   |  |                         | 2,064  
|                                                                                                                    |  |                         |        
|                                                                                                                    |  |                         |        
|Total
  operating expenses                                                                                          |  |                         | 54,329 
|                                                                                                                    |  |                         |        
|                                                                                                                    |  |                         |        
|Operating
  loss                                                                                                    |  |                         | (39,913
|Other income
  (expenses), net                                                                                      |  |                         | 4      
|Financial
  income, net (Note 16b)                                                                                  |  |                         | 875    
|                                                                                                                    |  |                         |        
|                                                                                                                    |  |                         |        
|Income
  (loss) before provision for tax                                                                            |  |                         | (39,034
|Provision
  for tax (Note 12)                                                                                       |  |                         | 67     
|                                                                                                                    |  |                         |        
|                                                                                                                    |  |                         |        
|                                                                                                                    |  |                         |        
|Net income
  (loss) before cumulative effect of accounting
       change                                            |  |                         | (39,101
|Cumulative
  effect of accounting change (Note 1c)                                                                  |  |                         | -      
|                                                                                                                    |  |                         |        
|                                                                                                                    |  |                         |        
|Net income
  (loss)                                                                                                 |  | $                       | (39,101
|                                                                                                                    |  |                         |        
|                                                                                                                    |  |                         |        
|Net earnings
  (loss) per share:                                                                                    |  |                         |        
|Before
  cumulative effect of accounting change - basic                                                             |  | $                       | (3.24  
|                                                                                                                    |  |                         |        
|                                                                                                                    |  |                         |        
|Cumulative
  effect of accounting change - basic                                                                    |  | $                       | -      
|                                                                                                                    |  |                         |        
|                                                                                                                    |  |                         |        
|Basic                                                                                                               |  | $                       | (3.24  
|                                                                                                                    |  |                         |        
|                                                                                                                    |  |                         |        
|Diluted                                                                                                             |  | $                       | (3.24  
|                                                                                                                    |  |                         |        
|                                                                                                                    |  |                         |        
|Weighted
  average number of shares used in computing basic
       net earnings (loss) per share (in thousands)     |  |                         | 12,059 
|                                                                                                                    |  |                         |        
|                                                                                                                    |  |                         |        
|Weighted
  average number of shares used in computing
       diluted net earnings (loss) per share (in
  thousands) |  |                         | 12,059 
|                                                                                                                    |  |                         |        

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

F - 5

---

---

OPTIBASE LTD. AND ITS
SUBSIDIARIES

|STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY
|---------------------------------------------
|                                             
|U.S. dollars in thousands                    

|                                                                                                           |                                                                                                                                                                  | Ordinary
  shares |     | Additional
  paid-in
  capital |   | Treasury
  shares |   | Deferred
  stock
  compensation |        | Accumulated
  other
  comprehensive
  income (loss) |  | Accumulated
  deficit |        | Total
  comprehensive
  loss |  | Total
  shareholders
  equity |  
|---------------------------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------- | ----------------- | --- | ------------------------------ | - | ----------------- | - | ------------------------------- | ------ | --------------------------------------------------- |  | --------------------- | ------ | ---------------------------- |  | ------------------------------ | -
|                                                                                                           |                                                                                                                                                                  |                   |     |                                |   |                   |   |                                 |        |                                                     |  |                       |        |                              |  |                                |  
|                                                                                                           |                                                                                                                                                                  |                   |     |                                |   |                   |   |                                 |        |                                                     |  |                       |        |                              |  |                                |  
|Balance as of January 1,
  2001                                                                            |                                                                                                                                                                  | $                 | 486 |                                | $ | 115,507           |   | $                               | (65    | )                                                   |  | $                     | (5,605 | )                            |  |                                | $
|                                                                                                           |                                                                                                                                                                  |                   |     |                                |   |                   |   |                                 |        |                                                     |  |                       |        |                              |  |                                |  
|Issuance of shares under
  employee share purchase plan,
       net                                        |                                                                                                                                                                  |                   | 4   |                                |   | 438               |   |                                 | -      |                                                     |  |                       | -      |                              |  |                                |  
|Exercise of stock options                                                                                  |                                                                                                                                                                  |                   | 5   |                                |   | 697               |   |                                 | -      |                                                     |  |                       | -      |                              |  |                                |  
|Cancellation of deferred
  stock compensation                                                              |                                                                                                                                                                  |                   | -   |                                |   | (290              | ) |                                 | -      |                                                     |  |                       | 290    |                              |  |                                |  
|Cancellation of deferred
  stock compensation related to
       issuance of shares that are held in escrow |                                                                                                                                                                  |                   | -   |                                |   | (403              | ) |                                 | -      |                                                     |  |                       | 403    |                              |  |                                |  
|Amortization of deferred
  stock compensation                                                              |                                                                                                                                                                  |                   | -   |                                |   | -                 |   |                                 | -      |                                                     |  |                       | 1,911  |                              |  |                                |  
|Amortization of deferred
  stock compensation related
       to shares that are held in escrow             |                                                                                                                                                                  |                   | -   |                                |   | -                 |   |                                 | -      |                                                     |  |                       | 302    |                              |  |                                |  
|Purchase of treasury shares                                                                                |                                                                                                                                                                  |                   | -   |                                |   | -                 |   |                                 | (1,094 | )                                                   |  |                       | -      |                              |  |                                |  
|Receipt of treasury shares
  related to ViewGraphics
       acquisition (see Note 13b2)                    |                                                                                                                                                                  |                   | -   |                                |   | -                 |   |                                 | (1,119 | )                                                   |  |                       | -      |                              |  |                                |  
|Other comprehensive income:                                                                                |                                                                                                                                                                  |                   |     |                                |   |                   |   |                                 |        |                                                     |  |                       |        |                              |  |                                |  
|                                                                                                           | Unrealized loss on
  available-for-sale marketable
       securities                                                                                             |                   |     | -                              |   |                   | - |                                 |        | -                                                   |  |                       |        | -                            |  |                                |  
|                                                                                                           |                                                                                                                                                                  |                   |     |                                |   |                   |   |                                 |        |                                                     |  |                       |        |                              |  |                                |  
|                                                                                                           | Less - reclassification
  adjustment for other than
       temporary decrease in value of
  available-for-sale
       marketable securities included in net loss |                   |     | -                              |   |                   | - |                                 |        | -                                                   |  |                       |        | -                            |  |                                |  
|                                                                                                           |                                                                                                                                                                  |                   |     |                                |   |                   |   |                                 |        |                                                     |  |                       |        |                              |  |                                |  
|                                                                                                           |                                                                                                                                                                  |                   |     |                                |   |                   |   |                                 |        |                                                     |  |                       |        |                              |  |                                |  
|                                                                                                           | Other comprehensive income                                                                                                                                       |                   |     | -                              |   |                   | - |                                 |        | -                                                   |  |                       |        | -                            |  |                                |  
|                                                                                                           | Net loss                                                                                                                                                         |                   |     | -                              |   |                   | - |                                 |        | -                                                   |  |                       |        | -                            |  |                                |  
|                                                                                                           |                                                                                                                                                                  |                   |     |                                |   |                   |   |                                 |        |                                                     |  |                       |        |                              |  |                                |  
|                                                                                                           | Total comprehensive loss                                                                                                                                         |                   |     |                                |   |                   |   |                                 |        |                                                     |  |                       |        |                              |  |                                |  
|                                                                                                           |                                                                                                                                                                  |                   |     |                                |   |                   |   |                                 |        |                                                     |  |                       |        |                              |  |                                |  
|                                                                                                           |                                                                                                                                                                  |                   |     |                                |   |                   |   |                                 |        |                                                     |  |                       |        |                              |  |                                |  
|Balance as of December 31,
  2001                                                                          |                                                                                                                                                                  | $                 | 495 |                                | $ | 115,949           |   | $                               | (2,278 | )                                                   |  | $                     | (2,699 | )                            |  |                                | $
|                                                                                                           |                                                                                                                                                                  |                   |     |                                |   |                   |   |                                 |        |                                                     |  |                       |        |                              |  |                                |  

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

F - 6

---

---

OPTIBASE LTD. AND ITS
SUBSIDIARIES

|STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY
|---------------------------------------------
|                                             
|U.S. dollars in thousands                    

|                                                                                               |  | Ordinaryshares |     | Additional
  paid-in
  capital |   | Treasury
  shares |   | Deferred
  stock
  compensation |        | Accumulated
  other
  comprehensive
  income |  | Accumulated
  deficit |        | Total
  comprehensive
  income (loss) |  | Total
  shareholders
  equity |  
|---------------------------------------------------------------------------------------------- |  | -------------- | --- | ------------------------------ | - | ----------------- | - | ------------------------------- | ------ | -------------------------------------------- |  | --------------------- | ------ | ------------------------------------- |  | ------------------------------ | -
|                                                                                               |  |                |     |                                |   |                   |   |                                 |        |                                              |  |                       |        |                                       |  |                                |  
|                                                                                               |  |                |     |                                |   |                   |   |                                 |        |                                              |  |                       |        |                                       |  |                                |  
|Balance as of January 1,
  2002                                                                |  | $              | 495 |                                | $ | 115,949           |   | $                               | (2,278 | )                                            |  | $                     | (2,699 | )                                     |  |                                | $
|                                                                                               |  |                |     |                                |   |                   |   |                                 |        |                                              |  |                       |        |                                       |  |                                |  
|Issuance of shares under
  employee share purchase
       plan, net                            |  |                | 5   |                                |   | 337               |   |                                 | -      |                                              |  |                       | -      |                                       |  |                                |  
|Exercise of stock options                                                                      |  |                | 5   |                                |   | 30                |   |                                 | -      |                                              |  |                       | -      |                                       |  |                                |  
|Cancellation of deferred
  stock compensation                                                  |  |                | -   |                                |   | (809              | ) |                                 | -      |                                              |  |                       | 809    |                                       |  |                                |  
|Amortization of deferred
  stock compensation                                                  |  |                | -   |                                |   | -                 |   |                                 | -      |                                              |  |                       | 1,156  |                                       |  |                                |  
|Amortization of deferred
  stock compensation related to
       shares that are held in escrow |  |                | -   |                                |   | -                 |   |                                 | -      |                                              |  |                       | 225    |                                       |  |                                |  
|Other comprehensive income:                                                                    |  |                |     |                                |   |                   |   |                                 |        |                                              |  |                       |        |                                       |  |                                |  
|Unrealized
  income on available-for-sale marketable
            securities                    |  |                | -   |                                |   | -                 |   |                                 | -      |                                              |  |                       | -      |                                       |  |                                |  
|Net
  loss                                                                                     |  |                | -   |                                |   | -                 |   |                                 | -      |                                              |  |                       | -      |                                       |  |                                |  
|                                                                                               |  |                |     |                                |   |                   |   |                                 |        |                                              |  |                       |        |                                       |  |                                |  
|Total
  comprehensive loss                                                                     |  |                |     |                                |   |                   |   |                                 |        |                                              |  |                       |        |                                       |  |                                |  
|                                                                                               |  |                |     |                                |   |                   |   |                                 |        |                                              |  |                       |        |                                       |  |                                |  
|                                                                                               |  |                |     |                                |   |                   |   |                                 |        |                                              |  |                       |        |                                       |  |                                |  
|Balance as of December 31,
  2002                                                              |  |                | 505 |                                |   | 115,507           |   |                                 | (2,278 | )                                            |  |                       | (509   | )                                     |  |                                |  
|                                                                                               |  |                |     |                                |   |                   |   |                                 |        |                                              |  |                       |        |                                       |  |                                |  
|Exercise of warrants and
  employees stock options                                             |  |                | 19  |                                |   | 2,048             |   |                                 | -      |                                              |  |                       | -      |                                       |  |                                |  
|Cancellation of deferred
  stock compensation                                                  |  |                | -   |                                |   | (263              | ) |                                 | -      |                                              |  |                       | 263    |                                       |  |                                |  
|Amortization of deferred
  stock compensation                                                  |  |                | -   |                                |   | -                 |   |                                 | -      |                                              |  |                       | 246    |                                       |  |                                |  
|Reversal of stock
  compensation due to forfeiture of
       stock options                     |  |                | -   |                                |   | (306              | ) |                                 | -      |                                              |  |                       | -      |                                       |  |                                |  
|Other comprehensive income:                                                                    |  |                |     |                                |   |                   |   |                                 |        |                                              |  |                       |        |                                       |  |                                |  
|Unrealized
  income on available-for-sale marketable
            securities                    |  |                | -   |                                |   | -                 |   |                                 | -      |                                              |  |                       | -      |                                       |  |                                |  
|Net
  income                                                                                   |  |                | -   |                                |   | -                 |   |                                 | -      |                                              |  |                       | -      |                                       |  |                                |  
|                                                                                               |  |                |     |                                |   |                   |   |                                 |        |                                              |  |                       |        |                                       |  |                                |  
|Total
  comprehensive income                                                                   |  |                |     |                                |   |                   |   |                                 |        |                                              |  |                       |        |                                       |  |                                |  
|                                                                                               |  |                |     |                                |   |                   |   |                                 |        |                                              |  |                       |        |                                       |  |                                |  
|                                                                                               |  |                |     |                                |   |                   |   |                                 |        |                                              |  |                       |        |                                       |  |                                |  
|Balance as of December 31,
  2003                                                              |  | $              | 524 |                                | $ | 116,986           |   | $                               | (2,278 | )                                            |  | $                     | -      |                                       |  |                                | $
|                                                                                               |  |                |     |                                |   |                   |   |                                 |        |                                              |  |                       |        |                                       |  |                                |  

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

F - 7

---

---

OPTIBASE LTD. AND ITS
SUBSIDIARIES

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

|                                                                                                                                      |  | Year ended December 31, |        
|------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------- | -------
|                                                                                                                                      |  |                         |        
|                                                                                                                                      |  | 2001                    |        
|                                                                                                                                      |  |                         |        
|Cash flows from operating
  activities:                                                                                               |  |                         |        
|Net
  income (loss)                                                                                                                   |  | $                       | (39,101
|Adjustments
  required to reconcile net income (loss) to net cash provided by
            (used in)
  operating activities:           |  |                         |        
|Depreciation
  and amortization                                                                                                       |  |                         | 6,107  
|Impairment
  of property and equipment and capitalized computer software
                 costs
  - included in restructuring charges |  |                         | 728    
|Impairment
  of other assets                                                                                                          |  |                         | 20,933 
|Impairment
  of long-term investment                                                                                                  |  |                         | -      
|Other expenses                                                                                                                        |  |                         | -      
|Cumulative
  effect of accounting change                                                                                              |  |                         | -      
|Proceeds
  from (investment in) trading marketable securities, net                                                                    |  |                         | (9,732 
|Other
  than temporary decrease in value of available-for-sale marketable
                 securities                                 |  |                         | 1,791  
|Accrued
  interest and amortization of premium and discount on available-
                 for-sale
  marketable securities           |  |                         | 248    
|Gain
  on sale of available-for-sale marketable securities                                                                            |  |                         | (5     
|Loss
  (gain) on sale of property and equipment                                                                                       |  |                         | (4     
|Accrued
  severance pay, net                                                                                                          |  |                         | 229    
|Amortization
  of deferred stock compensation                                                                                         |  |                         | 2,213  
|Decrease
  (increase) in trade receivables, net                                                                                       |  |                         | 2,052  
|Decrease
  (increase) in other accounts receivable and prepaid expenses                                                               |  |                         | 1,721  
|Decrease
  (increase) in inventories                                                                                                  |  |                         | (1,352 
|Decrease
  in trade payables                                                                                                          |  |                         | (4,563 
|Increase
  (decrease) in deferred revenues                                                                                            |  |                         | (373   
|Increase
  (decrease) in accrued expenses and other accounts payable                                                                  |  |                         | (2,117 
|                                                                                                                                      |  |                         |        
|                                                                                                                                      |  |                         |        
|Net cash provided by (used
  in) operating activities                                                                                 |  |                         | (21,225
|                                                                                                                                      |  |                         |        
|                                                                                                                                      |  |                         |        
|Cash flows from investing
  activities:                                                                                               |  |                         |        
|Capitalization
  of computer software costs                                                                                           |  |                         | (160   
|Proceeds
  from sale of property and equipment                                                                                        |  |                         | 34     
|Purchase
  of property and equipment                                                                                                  |  |                         | (1,037 
|Investments
  in available-for-sale marketable securities                                                                             |  |                         | (17,042
|Proceeds
  from sale of available-for-sale marketable securities                                                                      |  |                         | 1,871  
|Proceeds
  from redemption of matured available-for-sale marketable securities                                                        |  |                         | 12,000 
|Proceeds
  from maturity of short-term bank deposits                                                                                  |  |                         | 27,569 
|Redemption
  of (investment in) long-term lease deposits                                                                              |  |                         | (26    
|Investment
  in companies                                                                                                             |  |                         | (250   
|Payment
  for the acquisition of ViewGraphics Inc.                                                                                    |  |                         | (850   
|                                                                                                                                      |  |                         |        
|                                                                                                                                      |  |                         |        
|Net cash provided by (used
  in) investing activities                                                                                 |  |                         | 22,109 
|                                                                                                                                      |  |                         |        
|                                                                                                                                      |  |                         |        
|Cash flows from financing
  activities:                                                                                               |  |                         |        
|Short-term
  bank credit                                                                                                              |  |                         | -      
|Proceeds
  from issuance of Ordinary shares, net                                                                                      |  |                         | 442    
|Proceeds
  from exercise of stock options                                                                                             |  |                         | 702    
|Purchase
  of treasury shares                                                                                                         |  |                         | (1,094 
|Payments
  of shareholders loans                                                                                                     |  |                         | (285   
|Payments
  of long-term capital lease obligations                                                                                     |  |                         | (111   
|                                                                                                                                      |  |                         |        
|                                                                                                                                      |  |                         |        
|Net cash provided by (used
  in) financing activities                                                                                 |  |                         | (346   
|                                                                                                                                      |  |                         |        
|                                                                                                                                      |  |                         |        
|Increase in cash and cash
  equivalents                                                                                               |  |                         | 538    
|Cash and cash equivalents
  at the beginning of the year                                                                              |  |                         | 5,226  
|                                                                                                                                      |  |                         |        
|                                                                                                                                      |  |                         |        
|Cash and cash equivalents
  at the end of the year                                                                                    |  | $                       | 5,764  
|                                                                                                                                      |  |                         |        

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

F - 8

---

---

OPTIBASE LTD. AND ITS
SUBSIDIARIES

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

|                                                                                                                     |  | Year ended December 31, |        
|-------------------------------------------------------------------------------------------------------------------- |  | ----------------------- | -------
|                                                                                                                     |  |                         |        
|                                                                                                                     |  | 2001                    |        
|                                                                                                                     |  |                         |        
|Supplemental disclosure of
  cash flow activities:                                                                   |  |                         |        
|                                                                                                                     |  |                         |        
|(a)   Non-cash
  transactions:                                                                                       |  |                         |        
|                                                                                                                     |  |                         |        
|Treasury
  shares received from ViewGraphics Inc. former shareholders                                                |  | $                       | (269   
|Reclassification
  of inventories into property and equipment                                                        |  |                         | 192    
|Reclassification
  of available-for-sale marketable securities into trading
                 marketable
  securities |  |                         | (13,528
|                                                                                                                     |  |                         |        
|                                                                                                                     |  |                         |        
|                                                                                                                     |  | $                       | (13,605
|                                                                                                                     |  |                         |        
|(b)   Cash
  paid during the year for:                                                                               |  |                         |        
|                                                                                                                     |  |                         |        
|Interest                                                                                                             |  | $                       | 90     
|                                                                                                                     |  |                         |        
|                                                                                                                     |  |                         |        
|Taxes                                                                                                                |  | $                       | -      
|                                                                                                                     |  |                         |        

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

F - 9

---

---

OPTIBASE LTD. AND ITS
SUBSIDIARIES

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

NOTE 1:-    GENERAL

| | a. | Optibase
  Ltd. (the Company) was incorporated and commenced operations in 1990.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    | Optibase
  Ltd. has one wholly-owned subsidiary: Optibase Inc. in the United States
  which was incorporated in 1991. Other two previously wholly-owned
  subsidiaries, Optibase Europe Ltd. in the United Kingdom and Optibase B.V. in
  the Netherlands, were dissolved in July 2002 and in September 2003,
  respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    | The Company
  and its subsidiaries (collectively, the Group) provide constraints-free
  streaming of rich media over broadband networks and enable interconnectivity
  between Digital Video Broadcasting and IP networks. The Company and its
  subsidiaries products have been deployed in applications such as TV
  broadcasts over IP networks, video-on-demand, corporate communications,
  distance learning and business TV.                                                                                                                                                                                                                                                                                                                                                                     
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    | The Company
  and its subsidiaries sell their products worldwide through distributors,
  Value Added Resellers (VARs), system integrators and Original Equipment
  Manufacturers (OEMs), who are considered end-customers.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    | The majority
  of the Company and its subsidiaries sales is made in North America, Europe
  and the Far East (see Note 14a).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    | The Company
  and its subsidiary depend on third parties to distribute and market their
  products. If the Company and its subsidiary are unable to effectively manage
  and maintain relationships with their system integrators, VARs, OEMs, and
  distributors, or to develop new relationships with other system integrators
  and distributors, their ability to market and sell their products in certain
  markets will be affected. Furthermore, a loss of one or more of the Company
  and its subsidiaries major system integrators and/or major distributors, or
  any event negatively effecting such system integrators and/or distributors
  financial condition, could cause a material adverse effect on the Company and
  its subsidiarys results of operations and financial position.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    | The Company
  and its subsidiary are dependent upon sole source suppliers for certain key
  components used in their products, including certain compression chips.
  Although there are a limited number of manufacturers of the particular
  components, management believes that other suppliers could provide similar
  components on comparable terms. A change in suppliers, however, could cause a
  delay in manufacturing and possible loss of sales, which would adversely
  affect the operating results and financial position.                                                                                                                                                                                                                                                                
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | b. | Acquisitions
  of ViewGraphics, Inc. (ViewGraphics) and ECI Telecom Ltd. HiTV unit (HiTV
  unit):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    | 1.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         

F - 10

---

---

OPTIBASE LTD. AND ITS
SUBSIDIARIES

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

NOTE 1:-    GENERAL
(Cont.)

| | Under the
  agreement, 936,421 Ordinary shares were placed in escrow for a period of one
  year as set forth in the agreement to cover against future contingencies. The
  fair value of these escrowed shares was recorded as part of the purchase
  price (see Note 13.b.2). An additional 100,000 shares, which relate to the
  employment of two ViewGraphics executives, were placed into escrow for a
  period of up to 24 months. The fair value of the shares was recorded as
  deferred stock compensation (see Note 13.b.1). The Company also granted
  753,384 options in exchange for the options held by employees of ViewGraphics
  as of the acquisition date. The Company recorded a deferred stock
  compensation in respect for these options (see Note 13d). The operations of
  ViewGraphics are included in the consolidated statements from the date of
  acquisition.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | Prior to the
  acquisition, ViewGraphics was a provider of hardware and software solutions
  used for the manipulations and transmission of broadcast-quality digital
  video over broadband networks. These solutions are used for applications such
  as interactive TV, video-on-demand and databasing.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | The
  acquisition was treated on the basis of the purchase method of accounting in
  accordance with Accounting Principles Board Opinion No. 16 Business
  Combinations (APB 16). Accordingly, the purchase price has been allocated
  according to the fair value of the assets acquired and liabilities assumed at
  the date of acquisition.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | Other
  intangible assets acquired had a fair value of $ 47,074 as shown below:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

| | Technology                                |  | $ | 16,130 | 
| | ----------------------------------------- |  | - | ------ | 
| | Goodwill                                  |  |   | 14,669 | 
| | Assembled
  workforce                     |  |   | 1,000  | 
| | Customer
  base                           |  |   | 845    | 
| | In process
  research and development (*) |  |   | 14,430 | 
| |                                           |  |   |        | 
| |                                           |  |   |        | 
| |                                           |  | $ | 47,074 | 
| |                                           |  |   |        | 

| |    | (*)                                                                                                                                                                                                                                                                      | Write-off of
  in process research and development, for which technological feasibility has
  not yet been established and no alternative future use exists.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                         
| | 2. | In October
  2000, the Company purchased the HiTV unit, in consideration of $ 3,750, which
  was paid in cash. Prior to the acquisition, the HiTV unit was a developer of
  a carrier-grade networking solution optimized for TV distribution networking
  applications.

F - 11

---

---

OPTIBASE LTD. AND ITS
SUBSIDIARIES

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

NOTE 1:-    GENERAL
(Cont.)

| | The
  acquisition was treated on the basis of the purchase method of accounting and
  accordingly, the allocation of the purchase price of HiTV unit is based on
  the fair value of assets acquired at the date of acquisition as follows:
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Property and
  equipment |  | $ | 770   | 
| | ------------------------ |  | - | ----- | 
| | Assembled
  workforce    |  |   | 259   | 
| | Patents                  |  |   | 1,710 | 
| | Technology               |  |   | 1,011 | 
| |                          |  |   |       | 
| |                          |  |   |       | 
| |                          |  | $ | 3,750 | 
| |                          |  |   |       | 

| | c. | Impairment
  of other assets:
| | -- | -----------------------------
| |    |                              
| |    | 1.                           
| |    |                              
| |    |                              
| |    |                              
| |    |                              

| | Acquired
  technology (1) |  | $ | 5,160  | 
| | ------------------------- |  | - | ------ | 
| | Acquired
  technology (2) |  |   | 813    | 
| | Goodwill (1)              |  |   | 12,872 | 
| | Patents (2)               |  |   | 1,397  | 
| | Customer
  base (1)       |  |   | 688    | 
| | Assembled
  workforce (1) |  |   | 3      | 
| |                           |  |   |        | 
| |                           |  |   |        | 
| |                           |  | $ | 20,933 | 
| |                           |  |   |        | 

| | (1)                                                                                                   | Related to
  the purchase of ViewGraphics, and based on an independent valuation, as of
  September 30, 2001.
| | ----------------------------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------------------------------
| |                                                                                                       |                                                                                                              
| | (2)                                                                                                   | Related to
  the purchase of HiTV unit and based on an independent valuation, as of
  September 30, 2001.    
| |                                                                                                       |                                                                                                              
| | The
  impairment charge is reflected as impairment of other assets in the
  statements of operations.

F - 12

---

---

OPTIBASE LTD. AND ITS
SUBSIDIARIES

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

NOTE 1:-    GENERAL
(Cont.)

| | 2. | Impairment
  of other assets in 2002 (see also Note 2j and 2k):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    | Due to loss
  of a major customer, recurring operating losses and downward adjustment to
  the Companys projections, the Company performed a recoverability test on its
  long-lived assets. In conjunction with this analysis, the Company recorded a non-cash charge of
  $ 6,791 in accordance with Statement of Financial Accounting Standard
  No. 144 Accounting for the Impairment or Disposal of Long-Lived Assets
  (SFAS 144) in respect to one
  group of assets. This charge is included in the impairment of intangible
  assets in the consolidated statements of operations.                                                                                                                    
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    | The Company
  reviewed assets on a component-level basis, which is the lowest level of
  assets for which there are identifiable cash flows that can be distinguished
  operationally and for financial reporting purposes. The carrying amount of
  the asset group was compared to the related expected undiscounted future cash
  flows to be generated by those assets over the estimated remaining useful
  life of the primary asset. In cases where the expected future cash flows were
  less than the carrying amounts of the assets, those assets were considered
  impaired and written down to their fair values. Fair value was established
  based on discounted cash flows.                          
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | 3. | Impairment
  of goodwill due to the adoption of Statement of Financial Accounting Standard
  No.142, Goodwill and Other Intangible Assets (SFAS 142) (as of
  January 1, 2002).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    | SFAS 142
  requires goodwill to be tested for impairment upon adoption and at least
  annually thereafter or between annual tests in certain circumstances, and
  written down when impaired, rather than being amortized as previous
  accounting standards required. Goodwill attributable to the reporting unit is
  tested for impairment by comparing the fair value of each reporting unit with
  its carrying value. Fair value is determined using discounted cash flows and
  market capitalization. Significant estimates used in the methodologies
  include estimates of future cash flows, future short-term and long-term
  growth rates and weighted average cost of capital for the reportable unit.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    | The Company
  and its subsidiaries reclassified certain intangible assets, acquired from
  ViewGraphics and HiTV Unit, to goodwill in accordance with Statement of
  Financial Accounting Standard No.141, Business Combinations
  (SFAS 141) (as of January 1, 2002).                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    | Based on steps the Company has taken
for the adoption of SFAS 142, goodwill amounting to $ 854, was impaired using the
impairment test required by SFAS 142. The impairment, required to be recognized when
adopting SFAS 142, is reflected as a cumulative effect of accounting change as of January
1, 2002. The goodwill composed of reclassification of the following intangible assets:                                                                                                                                                                                                                                                                                                                        

| | Customer
  base - ViewGraphics       |  | $ | 66  | 
| | ------------------------------------ |  | - | --- | 
| | Assembled
  workforce - ViewGraphics |  |   | 636 | 
| | Assembled
  workforce - HiTV         |  |   | 152 | 
| |                                      |  |   |     | 
| |                                      |  |   |     | 
| |                                      |  | $ | 854 | 
| |                                      |  |   |     | 

F - 13

---

---

OPTIBASE LTD. AND ITS SUBSIDIARIES

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

NOTE 1:-    GENERAL
(Cont.)

| | The results
  of operations presented below for the two years ended December 31, 2001 and
  2002, reflect the operations had the Company adopted the non-amortization
  provisions of SFAS 142 effective as of January 1, 2000:
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                                 |  | Year ended December 31, |        
| | ----------------------------------------------- |  | ----------------------- | -------
| |                                                 |  |                         |        
| |                                                 |  | 2001                    |        
| |                                                 |  |                         |        
| |                                                 |  |                         |        
| | Reported net
  income (loss)                    |  | $                       | (39,101
| | Cumulative
  effect of accounting change        |  |                         | -      
| | Goodwill
  amortization                         |  |                         | 2,145  
| |                                                 |  |                         |        
| |                                                 |  |                         |        
| | Adjusted net
  loss                             |  | $                       | (36,956
| |                                                 |  |                         |        
| |                                                 |  |                         |        
| | Basic and
  diluted net loss-per-share:         |  |                         |        
| | Reported net
  loss                             |  | $                       | (3.24  
| | Cumulative
  effect of accounting change        |  |                         | -      
| | Goodwill
  amortization                         |  |                         | 0.18   
| |                                                 |  |                         |        
| |                                                 |  |                         |        
| | Adjusted
  basic and diluted net loss-per-share |  | $                       | (3.06  
| |                                                 |  |                         |        

| | d. | Restructuring:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    | During the
  third quarter of 2001, the Company announced that it was implementing a
  restructuring plan (the 2001 Plan) intended to further reduce costs. The
  2001 Plan consisted of employee termination benefits associated with the
  involuntary termination of 38 employees. Through the third quarter of 2001,
  the 2001 Plan and the benefit arrangement were communicated to employees. The
  restructuring charges amounted to $ 2,064 and were utilized during 2001 and
  2002 (see also Notes 2h and 2n).
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    | During the
  third quarter of 2002, and with respect to the conditions that led to the
  abovementioned impairment of intangible assets, the Company announced that it
  was implementing a restructuring plan (the Plan) intended to further reduce
  costs. The Plan consisted of employee termination benefits associated with
  the involuntary termination of 10 employees. Through the third quarter of
  2002, the Plan and the benefit arrangement were communicated to employees.                               
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    | The
  following table summarizes the restructuring accruals status as of December
  31, 2002:                                                                                                                                                                                                                                                                                                                                                                                                                              

| |                                                                  |  | Restructuring
  charge |      | Utilized |          | Balance at
  December 31,
  2002 |  
| | ---------------------------------------------------------------- |  | ---------------------- | ---- | -------- | -------- | -------------------------------- | -
| |                                                                  |  |                        |      |          |         
| |                                                                  |  |                        | Cash |          | Non-cash |                                  |  
| |                                                                  |  |                        |      |          |          |                                  |  
| | Employee
  termination benefits and
       related costs         |  |                        | $    | 186      |          |                                  | $
| | Impairment
  of property and
       equipment (see also Note 2h) |  |                        |      | 319      |          |                                  |  
| |                                                                  |  |                        |      |          |          |                                  |  
| |                                                                  |  |                        |      |          |          |                                  |  
| |                                                                  |  |                        | $    | 505      |          |                                  | $
| |                                                                  |  |                        |      |          |          |                                  |  

| | The
  restructuring accruals as of December 31, 2002, were utilized during 2003.
| | --------------------------------------------------------------------------------

F - 14

---

---

OPTIBASE LTD. AND ITS
SUBSIDIARIES

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

NOTE 1:-    GENERAL
(Cont.)

| | The
  restructuring was accounted for in accordance with EITF No. 94-3 Liability
  Recognition for Certain Employee Termination Benefits and Costs of Exit and
  Activity (Including Certain Costs Incurred in a Restructuring) (EITF
  94-3), and in accordance with Staff
  Accounting Bulletins No. 100, Restructuring and Impairment Charges (SAB 100). The impairment of property and equipment was accounted for
  in accordance with SFAS 144.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

NOTE 2:-    SIGNIFICANT
ACCOUNTING POLICIES

| | The
  consolidated financial statements have been prepared in accordance with
  generally accepted accounting principles in the United States (U.S. GAAP).
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------
| |                                                                                                                                                             
| | a.                                                                                                                                                          
| |                                                                                                                                                             
| |                                                                                                                                                             
| |                                                                                                                                                             
| | b.                                                                                                                                                          
| |                                                                                                                                                             
| |                                                                                                                                                             
| |                                                                                                                                                             
| | c.                                                                                                                                                          
| |                                                                                                                                                             
| |                                                                                                                                                             
| |                                                                                                                                                             
| | d.                                                                                                                                                          
| |                                                                                                                                                             
| |                                                                                                                                                             

F - 15

---

---

OPTIBASE LTD. AND ITS
SUBSIDIARIES

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

NOTE 2:-    SIGNIFICANT
ACCOUNTING POLICIES (Cont.)

| | e. | Short-term
  bank deposits:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    | Bank
  deposits with maturities of more than three months, but less than one year,
  are included in short-term bank deposits and presented at cost. All of the
  short-term bank deposits are in U.S. dollars.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | f. | Marketable
  securities:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    | The Group
  accounts for its investments in marketable securities in accordance with
  Statement of Financial Accounting Standard No. 115, Accounting for Certain
  Investments in Debt and Equity Securities (SFAS 115). Management
  determines the appropriate classification of its investments in marketable
  debt at the time of purchase, and reevaluates such determinations at each
  balance sheet date.                                                                                                                                                                                                                                                                                                                                                                                                                                   
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    | As of
  December 31, 2003, all marketable securities covered by SFAS 115 were
  classified as available-for-sale. Available-for-sale marketable securities
  are stated at fair value, with unrealized gains and losses reported in a
  separate component of shareholders equity, Accumulated other comprehensive
  income (loss). Realized gains and losses on sales of investments, as determined on a
  specific identification basis, and interest income, including amortization of
  the premium and discount on debt securities, are included in the consolidated
  statement of operations, as financial income or expense as appropriate (see Note
  16b).                                                                                                                                                                                   
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    | During 2001,
  the Company reclassified into the trading category some of its then-existing
  available-for-sale marketable securities, and classified into the trading
  category some newly purchased debt securities. As such, as of December 31, 2001
  all marketable securities were classified as available-for-sale or trading.
  Trading securities were held for resale in anticipation of short-term market
  movements. Under SFAS 115, marketable securities classified as trading
  securities are stated according to the quoted market prices as of each
  balance sheet date. Gains and losses (realized and unrealized) related to
  trading securities as well as interest on such securities are included as
  financial income or expenses as appropriate (see Note 3 and 16b).                                                      
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    | According to
  the Staff Accounting Bulletin No. 59 (SAB 59), management is required to
  evaluate each period whether the decline in value for securities is other
  than temporary. The Companys policy in evaluating the fair value of its
  investments in marketable securities is based on the following factors: (i)
  whether there is a significant decline in value of the securities suspected
  to be other than temporary,(ii) the ability to hold the security until
  recovery and (iii) the intention to hold the security until recovery. As
  such, in 2001 the Company experienced a significant decline in value of
  certain available-for-sale securities in the amount of $ 1,791, which was
  considered other than temporary, and recorded a loss in the statement of
  operations as financial expenses (see Note 3 and 16b).

F - 16

---

---

OPTIBASE LTD. AND ITS
SUBSIDIARIES

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

NOTE 2:-    SIGNIFICANT
ACCOUNTING POLICIES (Cont.)

| | g. | Inventories:                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    | Inventories
  are stated at the lower of cost or market value. Inventory write-offs are
  provided to cover risks arising from slow-moving items or technological
  obsolescence. In 2002 and 2003 the Company and its subsidiaries recorded
  write-off expenses in a total amount of $ 608 and $ 460, respectively, of
  obsolete inventory and slow-moving items, which are included in the statement
  of operations under cost of revenues.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    | Cost is
  determined as follows:                                                                                                                                                                                                                                                                                                                                                                                                                
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    | Raw
  materials and components - by the average cost method.                                                                                                                                                                                                                                                                                                                                                                                  
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    | Work in
  progress and finished goods - on the basis of calculated manufacturing costs
  and related overhead.                                                                                                                                                                                                                                                                                                                                  
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | h. | Property and
  equipment:                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    | Property and
  equipment is stated at cost net of accumulated depreciation.                                                                                                                                                                                                                                                                                                                                                                     
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    | Depreciation
  is computed by the straight-line method over the estimated useful lives of
  the assets, at the following annual rates:                                                                                                                                                                                                                                                                                                          

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

| |    | In 2001 and
  2002, as part of the restructuring plans, the Company and its subsidiaries
  recognized an impairment loss in the amount of $ 588 and $ 319, respectively,
  (see Notes 1d, 2k). Based on its most recent analysis, management believes
  that no further impairment exists as of December 31, 2003.                                                               
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                                                                                                                                  
| | i. | Goodwill:                                                                                                                                                                                                                                                                                                                                                                        
| |    |                                                                                                                                                                                                                                                                                                                                                                                  
| |    | Goodwill
  represents excess of the costs over the net assets of businesses acquired.
  Under SFAS 142, goodwill acquired in a business combination on or after July
  1, 2001, is not amortized. Goodwill arose from acquisitions prior July 1,
  2001, was amortized until December 31, 2001, on a straight-line basis over
  the estimated useful life, which was eight years.
| |    |                                                                                                                                                                                                                                                                                                                                                                                  
| |    | Through
  2001, the Company and its subsidiaries periodically assessed the
  recoverability of the carrying amount of goodwill in accordance with SFAS 121
  and APB 17.                                                                                                                                                                                                         

F - 17

---

---

OPTIBASE LTD. AND ITS
SUBSIDIARIES

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

NOTE 2:-    SIGNIFICANT
ACCOUNTING POLICIES (Cont.)

| | j. | Other
  assets, net:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    | Intangible
  assets including assembled workforce, acquired technology, patents and
  customer base subject to amortization arose from acquisition prior July 1,
  2001, were amortized on a straight-line method over their useful lives, which
  are three, five, five and eight years, respectively in accordance with  SFAS 121.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    | As for
  impairments, see Notes 1c1, 1c2, 1c3 and 2k.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | k. | Impairment
  of long-lived assets:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    | Through
  2001, the Company and its subsidiaries periodically assessed the
  recoverability of the carrying amount of long-lived assets and provided for
  any possible impairment loss based upon the difference between the carrying
  amount and fair value of such assets in accordance with SFAS 121.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    | Subsequent
  to January 1, 2002, the Company and its subsidiaries long-lived assets are
  reviewed for impairment in accordance with SFAS 144 whenever events or
  changes in circumstances indicate that the carrying amount of an asset may
  not be recoverable. Recoverability of assets to be held and used is measured
  by a comparison of the carrying amount of an asset to the future undiscounted
  cash flows expected to be generated by the asset. If 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. Assets to be disposed of are reported at the lower of the
  carrying amount or fair value less costs to sell.                                                                                                                                                                                  
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | l. | Investment
  in companies:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    | Investment in companies represents
investments in: (i) Preferred shares of a privately held company which is recorded at the
lower of cost or estimated fair value, since the Company does not have the ability to
exercise significant influence over operating and financial policies of the investee and
holds an equity stake of less than 20%, (ii) a privately held company by a way of
convertible loans. The value of the investment is reviewed under the hypothetical
liquidation method, since the Company has the ability to exercise significant influence
over operating and financial policies of the entity. The company recorded losses in the
amount of $ 0, $ 325 and $ 907 in the years ended December 31, 2001, 2002 and 2003,
respectively, which are included in the statement of operations under other expenses
(income), net, and (iii) Common stock of a public company that is recorded at fair value,
in accordance with SFAS 115.

F - 18

---

---

OPTIBASE LTD. AND ITS
SUBSIDIARIES

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

NOTE 2:-    SIGNIFICANT
ACCOUNTING POLICIES (Cont.)

| |    | The
  Companys investment in company (i) is reviewed for impairment
  whenever events or changes in circumstances indicate that the carrying amount
  of an investment may not be recoverable, in accordance with Accounting
  Principles Board Opinion No. 18 The Equity Method of Accounting for
  Investments in Common Stock, (APB 18). In 2003, the Company reassessed the
  fair value of an investment in a company and recorded a loss in the amount of
  $ 1,364 in the statement of operations as other expenses. As of December 31,
  2003, based on managements most recent analyses, no further impairment
  losses have been identified (see also Note 6).
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | m. | Revenue
  recognition:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    | The Company
  and its subsidiaries generate revenues mainly from the sale of hardware
  products (products) and to a lesser extent from sales of software products.
  The Company and its subsidiaries sell their products worldwide through system
  integrators, VARs, distributors and OEMs who are considered end-customers.                                                                                                                                                                                                                                                                                                                                            
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    | Revenues
  from product sales are recognized in accordance with Staff Accounting
  Bulletin No. 104, Revenue Recognition in Financial Statements (SAB 104),
  when delivery has occurred, persuasive evidence of an agreement exists, the
  vendors fee is fixed or determinable, no further obligation exist and
  collectibility is probable. Estimated warranty costs, which are
  insignificant, are based on the Company and its subsidiaries past experience
  and are accrued in the financial statements. The Company and its subsidiaries
  do not grant a right of return.                                                                                     
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    | Revenues
  from software sales, which are insignificant, are recognized according to
  Statement Of Position No. 97-2, Software Revenue Recognition (SOP 97-2)
  (as amended). Therefore, revenues from software sales are recognized when
  delivery has occurred, persuasive evidence of an arrangement exists, the
  vendors fee is fixed or determinable and collectibility is probable. Upon
  delivery, titles and risks are transferred to the customer and no further
  significant obligations exist.                                                                                                                                                           
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    | Amounts
  received from customers for whom revenue has not yet been recognized, are
  presented as deferred revenues.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | n. | Research and
  development costs:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    | Research and
  development costs incurred in the process of developing product improvements
  or new products, are generally charged to expenses as incurred, net of
  participation of the Office of the Chief Scientist in the Israeli Ministry of
  Industry and Trade and the European Union Research and Development Program.                                                                                                                                                                                                                                                                                                                                            
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    | Statement of
  Financial Accounting Standard No. 86 Accounting for the Costs of Computer
  Software to be Sold, Leased or Otherwise Marketed, (SFAS 86) requires
  capitalization of certain software development costs subsequent to the
  establishment of technological feasibility. Based on the Company product
  development process, technological feasibility is established upon completion
  of a working model.                                                                                                                                                                                                                                                

F - 19

---

---

OPTIBASE LTD. AND ITS
SUBSIDIARIES

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

NOTE 2:-    SIGNIFICANT
ACCOUNTING POLICIES (Cont.)

| |    | Costs
  incurred by the Company between completion of the working model and the point
  at which the product is ready for general release, have been capitalized.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    | Capitalized
  software costs are amortized by the greater of the amount calculated using
  the: (i) ratio that current gross revenues from sales of the software to the
  total of current and anticipated future gross revenues from sales of that
  software, or (ii) the straight-line method over the estimated useful life of
  the product (three years).                                                                                                                                                                                                                                                                                                                                            
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    | The Company
  assesses the recoverability of this intangible asset on a regular basis by
  determining whether the amortization of the asset over its remaining life can
  be recovered through undiscounted future operating cash flows from the
  specific software product sold. As of December 31, 2001, as part of the
  restructuring plan, the Company and its subsidiaries wrote off an amount of
  $ 140 of capitalized computer software costs (see Note 1d). Based on its most
  recent analyses, management believes that no further impairment of
  capitalized software development costs exists as of December 31, 2003.                                                                    
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | o. | Income
  taxes:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    | The Company
  and its subsidiaries account for income taxes in accordance with Statement of
  Financial Accounting Standard No. 109, Accounting for Income Taxes (SFAS
  No. 109). This Statement prescribes the use of the liability method, whereby
  deferred tax asset and liability account balances are determined based on
  differences between financial reporting and tax bases of assets and
  liabilities and are measured using the enacted tax rates and laws that will
  be in effect when the differences are expected to reverse. The Company and
  its subsidiaries provide a valuation allowance, if necessary, to reduce
  deferred tax assets to their estimated realizable value.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | p. | Royalty-bearing
  grants:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    | Royalty-bearing
  grants from the Government of Israel for research and development are recognized
  at the time the Company is entitled to such grants on the basis of the
  related costs incurred, and are recorded as a reduction of research and
  development costs.                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | q. | Non-royalty-bearing
  grants:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    | The Company
  receives non-royalty-bearing grants from the European Union Research and
  Development Program, and from the MOST and STRIMM consortiums, which are part
  of the Office of the Chief Scientist Magnet program. These grants are
  recognized at the time the Company is entitled to such grants on the basis of
  the costs incurred and are recorded as a reduction of research and
  development costs.                                                                                                                                                                                                                                                                                   

F - 20

---

---

OPTIBASE LTD. AND ITS
SUBSIDIARIES

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

NOTE
2:-    SIGNIFICANT ACCOUNTING POLICIES (Cont.)

| | r. | Concentrations
  of credit risk:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    | Financial instruments that potentially
  subject the Company and its subsidiaries to concentrations of credit risk
  consist principally of cash and cash equivalents, marketable securities,
  trade receivables and long-term lease deposits.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    | Cash and
  cash equivalents, are invested in U.S. dollar deposits with major banks in
  Israel and the United States. Such deposits in the United States may be in
  excess of insured limits and are not insured in other jurisdictions.
  Management believes that the financial institutions that hold the Groups
  cash and cash equivalents are financially sound and, accordingly, minimal
  credit risk exists with respect to these financial instrument.                                                                                                                                                                                                                                                                                                                                                                                                                             
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    | Investments in marketable securities are
  done via major investment banks in the United States. These investments
  include corporate bonds and Government and Corporate structured notes.
  Management believes that the financial institutions are financially sound,
  the portfolio is well diversified, and accordingly minimal credit risk exists
  with respect to these marketable securities, all in accordance with the
  Companys investment policy.                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    | The trade receivables of the Company and
  its subsidiaries are geographically diversified and derived from sales to
  customers mainly in North America, Europe and the Far East. The Company and
  its subsidiaries generally do not require collateral; however, in certain
  circumstances, the Company and its subsidiaries may require letters of
  credit, advanced payments, insurance, other collateral or additional
  guarantees. An allowance for doubtful accounts is determined with respect to
  those amounts that the Company and its subsidiaries have determined to be
  doubtful of collection in addition to a general allowance for the remaining
  accounts. The Company and its subsidiaries perform ongoing credit evaluations
  of their customers. The allowance for doubtful accounts amounted to $ 814 and
  $ 517 as of December 31, 2002 and 2003, respectively.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | s. | Basic and
  diluted net earnings (loss) per share:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    | Basic net earnings (loss) per share are
  computed based on the weighted average number of Ordinary shares outstanding
  during each year. Diluted net earnings (loss) per share are computed based on
  the weighted average number of Ordinary shares outstanding during each year,
  plus the dilutive potential equivalent Ordinary shares considered outstanding
  during the year, in accordance with Statement of Financial Accounting
  Standard No. 128, Earnings Per Share (SFAS 128).                                                                                                                                                                                                                                                                                                                                                                                           

F - 21

---

---

OPTIBASE LTD. AND ITS
SUBSIDIARIES

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

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

F - 22

---

---

OPTIBASE LTD. AND ITS
SUBSIDIARIES

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

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

| |                                                                    |  | Year ended
  December 31, |        
| | ------------------------------------------------------------------ |  | ------------------------- | -------
| |                                                                    |  |                           |        
| |                                                                    |  | 2001                      |        
| |                                                                    |  |                           |        
| | Net income (loss) - as reported                                    |  | $                         | (39,101
| | Add - stock-based
  employee compensation 
      - intrinsic value |  |                           | 1,911  
| | Deduct -
  stock-based employee 
      compensation - fair value   |  |                           | (10,619
| |                                                                    |  |                           |        
| | Net income (loss) - pro forma                                      |  | $                         | (47,809
| |                                                                    |  |                           |        
| | Basic net earnings (loss) per share - as 
      reported           |  | $                         | (3.24  
| |                                                                    |  |                           |        
| | Basic net earnings (loss) per share - pro 
      forma             |  | $                         | (3.96  
| |                                                                    |  |                           |        
| | Diluted net earnings (loss) per share - as 
      reported         |  | $                         | (3.24  
| |                                                                    |  |                           |        
| | Diluted net earnings (loss) per share - 
      pro forma           |  | $                         | (3.96  
| |                                                                    |  |                           |        

| |    | The Company
  applies SFAS 123 and Emergency Issue Task Force No. 96-18 Accounting for
  Equity Instruments that are Issued to Other than Employees for Acquiring, or
  in Conjunction with Selling, Goods or Services (EITF 96-18) with respect
  to options issued to non-employees. SFAS 123 requires use of an option
  valuation model to measure the fair value of these options at the measurement
  date, as defined in EITF 96-18.                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | u. | Severance pay:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |    | The Companys liability for severance pay
  is calculated pursuant to Israels severance pay law, based on the most
  recent salary of the employees, multiplied by the number of years of
  employment as of balance sheet date. Israeli employees are entitled to
  severance equal to one months salary for each year of employment, or a
  portion thereof. In the event of decrease in an employee salary, severance
  pay is calculated as follows: the severance pay with respect to the period
  prior to the decrease is based on the most recent salary of the employee
  prior to such decrease multiplied by the number of years of the employment
  until the date of the decrease. The severance pay with respect to the period
  following such decrease is based on the actual recent salary of such employee
  multiplied by the number of years of employment following such decrease.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |    | The Companys liability is fully provided
  by monthly deposits with severance pay funds, insurance policies and by an
  accrual. The value of these funds and policies is recorded as an asset in the
  Companys balance sheet.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        

F - 23

---

---

OPTIBASE LTD. AND ITS
SUBSIDIARIES

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

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

F - 24

---

---

OPTIBASE LTD. AND ITS
SUBSIDIARIES

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

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

F - 25

---

---

OPTIBASE LTD. AND ITS
SUBSIDIARIES

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

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

F - 26

---

---

OPTIBASE LTD. AND ITS
SUBSIDIARIES

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

|NOTE 3:-    MARKETABLE SECURITIES
|---------------------------------

| |                                                 |  | December 31,     |       
| | ----------------------------------------------- |  | ---------------- | ------
| |                                                 |  |                  |       
| |                                                 |  | 2002             |       
| |                                                 |  |                  |       
| |                                                 |  | Amortized
  cost |       
| |                                                 |  |                  |       
| | Available-for-sale:                             |  |                  |       
| |                                                 |  |                  |       
| | Government and corporate 
  debt                |  | $                | 36,851
| | Government and corporate
  structured notes (*) |  |                  | 2,000 
| |                                                 |  |                  |       
| |                                                 |  |                  |       
| | Total securities                                |  | $                | 38,851
| |                                                 |  |                  |       

| | *)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        | The expected
  maturities may differ from the contractual maturities because debtors may
  have the right to call or prepay obligations without penalties.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |                                                                                                                                                           
| | During 2001, the Companys management determined that the declines in
  the fair value of the Companys investment in the shares of the mutual fund
  are other than temporary. As such, the cost basis of these securities was
  written down to fair value as a new cost basis, and the Company recognized a
  related loss in the amount of $ 1,791 in its statement of operations.
  Thereafter, the Company reclassified its investment in the shares of the
  mutual fund from available-for-sale securities to trading securities. Also,
  during 2001 the Company classified some newly purchased U.S. corporate bonds
  as trading securities. As of December 31, 2003, the Company classified all
  the marketable securities as available-for-sale securities.
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | Realized gains on sales of available-for-sale securities totaled $ 5,
  $ 852 and $ 4,536 in 2001, 2002 and 2003, respectively. The net adjustment to
  unrealized holding gains (losses) on available-for-sale securities, included
  as a separate component of shareholders equity - Accumulated other
  comprehensive gains (losses), amounted to $ (990), $ 389 and $ 1,143 in 2001,
  2002 and 2003, respectively.                                                                                                                                                                                                                                                                                                                                              
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | Included in the Companys portfolio investments are structured notes
  with an estimated fair value of approximately $ 19,336 as of December 31,
  2003. Such investments are used by management to enhance yields, diversify
  the portfolio investments, and manage the Companys exposure to interest rate
  fluctuations.  The notes
  were acquired from several banks and were categorized as available for sale
  under the arrangements with the banks, whether or not, the notes bear
  interest based upon the rate of the LIBOR.                                                                                                                                                                                                                              
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | The notes
  were accounted for as separate notes in accordance with the provisions of
  FASB Emerging Issues Task Force (EITF) Issue No. 96-12, Recognition of
  Interest Income and Balance Sheet Classification of Structured Notes. For
  each day in which the relevant LIBOR rate is below an agreed annual fixed
  rate, which ranges from 7% to 8%, the deposits bear interest at the rate of
  10% to 10.5% per annum. On all other days, the deposits do not bear any
  interest. As of December 31, 2003, investments in structured notes securities
  approximate their market value.                                                                                                                                                                       
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | The Company recorded losses of $ 0, $ 359 and $ 0 on trading securities
  in 2001, 2002 and 2003, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          

F - 27

---

---

OPTIBASE LTD. AND ITS
SUBSIDIARIES

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

|NOTE 3:-    MARKETABLE SECURITIES (Cont.)
|-----------------------------------------
|                                         
|                                         

| |                                |  | December 31, 2003 |       
| | ------------------------------ |  | ----------------- | ------
| |                                |  |                   |       
| |                                |  | Amortized
  cost  |       
| |                                |  |                   |       
| |                                |  |                   |       
| | Available-for-sale securities: |  |                   |       
| | Matures in one year            |  | $                 | 3,317 
| | Matures from 1 to 5
  years    |  |                   | 8,523 
| | Matures from 6 to
  10 years   |  |                   | 35,053
| |                                |  |                   |       
| |                                |  |                   |       
| | Total                          |  | $                 | 46,893
| |                                |  |                   |       

NOTE
4:-    OTHER ACCOUNTS RECEIVABLE AND PREPAID EXPENSES

| |                        |  | December
  31, |      
| | ---------------------- |  | -------------- | -----
| |                        |  |                |      
| |                        |  | 2002           |      
| |                        |  |                |      
| |                        |  |                |      
| | Employees              |  | $              | 122  
| | Government authorities |  |                | 193  
| | Prepaid expenses       |  |                | 311  
| | Interest receivable    |  |                | 887  
| | Others                 |  |                | 64   
| |                        |  |                |      
| |                        |  |                |      
| |                        |  | $              | 1,577
| |                        |  |                |      

NOTE
5:-    INVENTORIES

| |                              |  | December
  31, |      
| | ---------------------------- |  | -------------- | -----
| |                              |  |                |      
| |                              |  | 2002           |      
| |                              |  |                |      
| |                              |  |                |      
| | Raw materials and components |  | $              | 2,135
| | Work in progress             |  |                | 410  
| | Finished goods               |  |                | 1,692
| |                              |  |                |      
| |                              |  |                |      
| |                              |  | $              | 4,237
| |                              |  |                |      
| |                              |  |                |      
| | See also
  Note 2g.          |  |                |      

F - 28

---

---

OPTIBASE LTD. AND ITS
SUBSIDIARIES

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

|NOTE 6:-    INVESTMENT IN COMPANIES
|-----------------------------------
|                                   
|                                   
|                                   
|                                   
|                                   
|                                   
|                                   
|                                   
|                                   
|                                   

F - 29

---

---

OPTIBASE LTD. AND ITS
SUBSIDIARIES

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

NOTE 7:-    PROPERTY AND
EQUIPMENT, NET

| |                                    |  | December
  31, |      
| | ---------------------------------- |  | -------------- | -----
| |                                    |  |                |      
| |                                    |  | 2002           |      
| |                                    |  |                |      
| | Cost:                              |  |                |      
| | Computers and peripheral equipment |  | $              | 7,885
| | Office furniture and equipment     |  |                | 591  
| | Motor vehicles                     |  |                | 46   
| | Leasehold improvements             |  |                | 1,302
| |                                    |  |                |      
| |                                    |  |                |      
| |                                    |  |                | 9,824
| |                                    |  |                |      
| |                                    |  |                |      
| | Accumulated depreciation           |  |                | 7,651
| |                                    |  |                |      
| |                                    |  |                |      
| | Depreciated cost                   |  | $              | 2,173
| |                                    |  |                |      

|                              | As for
  charges, see Note 11d.                                                                                                     
|----------------------------- | ------------------------------------------------------------------------------------------------------------------------------------
|                              |                                                                                                                                     
|                              | Depreciation
  expenses amounted to $ 893, $ 1,576 and $ 1,276 for the years ended December 31,
  2001, 2002 and 2003, respectively.
|                              |                                                                                                                                     
|                              | As for
  impairment charges in 2001 and 2002, see Note 1d.                                                                          
|                              |                                                                                                                                     
|NOTE 8:-    OTHER ASSETS, NET

| |                                     |  | December
  31, |      
| | ----------------------------------- |  | -------------- | -----
| |                                     |  |                |      
| |                                     |  | 2002           |      
| |                                     |  |                |      
| | Intangible assets:                  |  |                |      
| | Original amounts:                   |  |                |      
| | Capitalized computer software costs |  | $              | 1,238
| |                                     |  |                |      
| | Accumulated amortization:           |  |                |      
| | Capitalized computer software costs |  |                | 1,018
| |                                     |  |                |      
| |                                     |  |                |      
| | Amortized cost                      |  | $              | 220  
| |                                     |  |                |      

| | Amortization
  expenses amounted to $ 5,214, $ 1,047 and $ 80 for the years ended December 31,
  2001, 2002 and 2003, respectively. The amortization expenses for the year
  2001 included amortization of assembled workforce, customer base and acquired
  technology. The amortization expenses for the year 2002 included amortization
  of acquired technology. During 2001 and 2002 the assembled
  workforce, customer base and acquired technology were impaired (see Note 1c).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | As for
  impairment charges for other assets in 2001, 2002 and 2003, see Note 1c.                                                                                                                                                                                                                                                                                                                                                                                                      
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | As for
  charges, see Note 11d.                                                                                                                                                                                                                                                                                                                                                                                                                                                        

F - 30

---

---

OPTIBASE LTD. AND ITS
SUBSIDIARIES

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

NOTE 9:-    OTHER
ACCOUNTS PAYABLE AND ACCRUED EXPENSES

| |                                      |  | December 31, |      
| | ------------------------------------ |  | ------------ | -----
| |                                      |  |              |      
| |                                      |  | 2002         |      
| |                                      |  |              |      
| |                                      |  |              |      
| | Employees and payroll accruals       |  | $            | 1,619
| | Royalties (see Note 11b)             |  |              | 1,987
| | Accrued expenses                     |  |              | 1,556
| | Restructuring accruals (see Note 1d) |  |              | 51   
| | Others                               |  |              | 838  
| |                                      |  |              |      
| |                                      |  |              |      
| |                                      |  | $            | 6,051
| |                                      |  |              |      

NOTE 10:-  FINANCIAL ARRANGEMENTS

|                                                  | As of
  December 31, 2002 and 2003, the Company and its subsidiary had authorized
  lines of credit in the amount of $ 10,844 and $ 20,457, respectively, out of
  which $ 844 and $ 457, respectively, are linked to the NIS and bear an annual
  bank interest rate of Prime plus 1%-1.25%, and $ 10,000 an $ 20,000,
  respectively, bear an annual interest rate of LIBOR plus 0.5%. The amount of
  $ 20,000 is secured against marketable securities of the Company and its subsidiary.
|------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|                                                  | The Company
  and its subsidiary had an utilized line of credit in the amount of $ 2,151 as
  of December 31, 2003 for marketable securities purposes only (there is no
  material fee for the unused portion of the line of credit).                                                                                                                                                                                                                                                        
|                                                  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|NOTE 11:-  COMMITMENTS AND CONTINGENT LIABILITIES
|                                                 
|                                                  | a.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|                                                  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|                                                  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|                                                  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              

| | Year ended December 31, |  |   |       | 
| | ----------------------- |  | - | ----- | 
| |                         |  |   |       | 
| | 2004                    |  | $ | 1,207 | 
| | 2005                    |  |   | 1,128 | 
| | 2006                    |  |   | 807   | 
| | 2007                    |  |   | 582   | 
| | 2008                    |  |   | 581   | 
| |                         |  |   |       | 
| |                         |  |   |       | 
| |                         |  | $ | 4,305 | 
| |                         |  |   |       | 

| | As of December 31, 2003, the Company and its subsidiary provided
  for long-term deposits amounting to $ 255 as collateral, in accordance with
  the lease agreements (see also Note 11c).
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 31

---

---

OPTIBASE LTD. AND ITS
SUBSIDIARIES

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

|NOTE 11:-  COMMITMENTS AND CONTINGENT LIABILITIES (Cont.)
|---------------------------------------------------------
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         

F - 32

---

---

OPTIBASE LTD. AND ITS
SUBSIDIARIES

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

|NOTE 11:-  COMMITMENTS AND CONTINGENT LIABILITIES (Cont.)
|---------------------------------------------------------
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|NOTE 12:-  TAXES ON INCOME                               
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         
|                                                         

F - 33

---

---

OPTIBASE LTD. AND ITS
SUBSIDIARIES

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

|NOTE 12:-  TAXES ON INCOME (Cont.)
|----------------------------------
|                                  
|                                  
|                                  
|                                  
|                                  
|                                  
|                                  
|                                  
|                                  
|                                  
|                                  
|                                  
|                                  
|                                  
|                                  
|                                  
|                                  
|                                  

F - 34

---

---

OPTIBASE LTD. AND ITS
SUBSIDIARIES

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

|NOTE 12:-  TAXES ON INCOME (Cont.)
|----------------------------------
|                                  
|                                  
|                                  
|                                  
|                                  
|                                  
|                                  
|                                  

| |                                                     |  | December 31, |        
| | --------------------------------------------------- |  | ------------ | -------
| |                                                     |  |              |        
| |                                                     |  | 2002         |        
| |                                                     |  |              |        
| |                                                     |  |              |        
| | Operating loss carryforward                         |  | $            | 11,536 
| | Reserves and allowances                             |  |              | 737    
| |                                                     |  |              |        
| |                                                     |  |              |        
| | Net deferred tax asset before valuation
  allowance |  |              | 12,273 
| | Valuation allowance                                 |  |              | (12,273
| |                                                     |  |              |        
| |                                                     |  |              |        
| | Net deferred tax asset                              |  | $            | -      
| |                                                     |  |              |        

| |    | The Company
  and its subsidiaries have provided valuation allowances in respect of
  deferred tax assets resulting from tax loss carryforward and other
  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. During 2003, the Company and its
  subsidiaries increased its valuation allowance by approximately $ 256.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | g. | Net
  operating losses carryforward:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    | Through
  December 31, 2003, Optibase Ltd. had a net operating losses carryforward for
  tax purposes in Israel of approximately $ 15,719, which may be carried forward
  and offset against taxable income in the future, for an indefinite period.                                                                                                                                                                                                                                                                                                         
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    | As of
  December 31, 2003, Optibase Inc. had U.S. federal net operating loss
  carryforward of approximately $ 15,416 that can be carried forward and offset
  against taxable income for 20 years, no later than 2006 to 2023. Utilization
  of U.S. net operating losses may be subject to the 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.          

F - 35

---

---

OPTIBASE LTD. AND ITS
SUBSIDIARIES

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

|NOTE 12:-  TAXES ON INCOME (Cont.)
|----------------------------------
|                                  
|                                  
|                                  
|                                  

| |                                                                                                                                                                                |  | Year ended
  December 31, |        
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ------------------------- | -------
| |                                                                                                                                                                                |  |                           |        
| |                                                                                                                                                                                |  | 2001                      |        
| |                                                                                                                                                                                |  |                           |        
| |                                                                                                                                                                                |  |                           |        
| | Income (loss) before taxes as reported                                                                                                                                         |  | $                         | (39,034
| |                                                                                                                                                                                |  |                           |        
| |                                                                                                                                                                                |  |                           |        
| | Theoretical tax expense (benefit) computed
  at the
      statutory rate (36%)                                                                                                 |  | $                         | (14,052
| | Tax adjustments in respect of inflation in
  Israel                                                                                                                            |  |                           | 368    
| | Issuance expenses and tax benefits in
  respect of
      options to employees that were allowed as an
      expense in respect of which deferred taxes were
      not provided |  |                           | (752   
| | Income (losses) and other items for which a
      valuation allowance was provided                                                                                             |  |                           | 4,550  
| | Interest income subject to a lower tax rate                                                                                                                                    |  |                           | (383   
| | Non-deductible write-off of in-process
  technology
      and amortization of other assets                                                                                     |  |                           | 8,343  
| | Interest income for tax purposes and other                                                                                                                                     |  |                           | 67     
| | Other non-deductible expenses                                                                                                                                                  |  |                           | 1,926  
| |                                                                                                                                                                                |  |                           |        
| |                                                                                                                                                                                |  |                           |        
| | Income tax expense                                                                                                                                                             |  | $                         | 67     
| |                                                                                                                                                                                |  |                           |        

| | i. | Income
  (loss) before taxes on income consists of the following:
| | -- | -----------------------------------------------------------------

| | Domestic |  | $ | (21,124 | ) | $ | (6,447  | ) | $ | 2,109 | 
| | -------- |  | - | ------- | - | - | ------- | - | - | ----- | 
| | Foreign  |  |   | (17,910 | ) |   | (5,161  | ) |   | 631   | 
| |          |  |   |         |   |   |         |   |   |       | 
| |          |  |   |         |   |   |         |   |   |       | 
| |          |  | $ | (39,034 | ) | $ | (11,608 | ) | $ | 2,740 | 
| |          |  |   |         |   |   |         |   |   |       | 

| | j. | The
  provision for income taxes is comprised as follows:
| | -- | ---------------------------------------------------------

| | Domestic |  | $ | 67 |  | $ | 124 |  | $ | - | 
| | -------- |  | - | -- |  | - | --- |  | - | - | 
| |          |  |   |    |  |   |     |  |   |   | 

F - 36

---

---

OPTIBASE LTD. AND ITS
SUBSIDIARIES

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

|NOTE 13:-  SHAREHOLDERS EQUITY
|-------------------------------
|                               
|                               
|                               
|                               
|                               
|                               
|                               
|                               
|                               
|                               
|                               
|                               
|                               
|                               
|                               
|                               

F - 37

---

---

OPTIBASE LTD. AND ITS
SUBSIDIARIES

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

|NOTE 13:-  SHAREHOLDERS EQUITY (Cont.)
|---------------------------------------
|                                       
|                                       
|                                       
|                                       
|                                       
|                                       
|                                       
|                                       
|                                       
|                                       
|                                       
|                                       
|                                       
|                                       
|                                       
|                                       
|                                       
|                                       

F - 38

---

---

OPTIBASE LTD. AND ITS
SUBSIDIARIES

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

|NOTE 13:-  SHAREHOLDERS EQUITY (Cont.)
|---------------------------------------
|                                       
|                                       

| |                                                   |  | Year ended
  December 31 |          
| | ------------------------------------------------- |  | ------------------------ | ---------
| |                                                   |  |                          |          
| |                                                   |  | 2001                     |          
| |                                                   |  |                          |          
| |                                                   |  | Amount                   |          
| |                                                   |  |                          |          
| |                                                   |  |                          |          
| | Outstanding at the 
      beginning of the year   |  |                          | 2,901,481
| | Granted                                           |  |                          | 1,004,891
| | Exercised                                         |  |                          | (211,781 
| | Forfeited                                         |  |                          | (386,210 
| |                                                   |  |                          |          
| | Outstanding at the end of 
      the year         |  |                          | 3,308,381
| |                                                   |  |                          |          
| |                                                   |  |                          |          
| | Exercisable options at the 
      end of the year |  |                          | 2,064,820
| |                                                   |  |                          |          

| | Deferred
  stock compensation, which represents the excess of the market value over the
  exercise price for options granted during 2000 amounted to $ 4,794. The
  deferred compensation is amortized to the statement of operations over a
  vesting period of up to four years. Amortization expenses during the years
  ended December 31, 2001, 2002 and 2003, amounted to $ 1,911, $ 1,156 and $ 246,
  respectively.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |                                                                                                                                                                                                                                                                                                                                                                                                                            
| | The options
  outstanding as of December 31, 2003, have been separated into ranges of
  exercise price as follows:                                                                                                                                                                                                                                                                                                         

| | Range of
  exercise
  price |  | Optionsoutstanding
  as of
  December 31,
  2003 |           | Weighted
  average number
  of years
  remaining
  contractual life |      | Weighted average
  exercise
  price |  | Options
  exercisable
  as of
  December 31,
  2003 |       | Weighted
  average
  exercise
  price | 
| | --------------------------- |  | ------------------------------------------------ | --------- | ------------------------------------------------------------------- | ---- | ----------------------------------- |  | --------------------------------------------------- | ----- | ------------------------------------- | 
| |                             |  |                                                  |           |                                                                     |      |                                     |  |                                                     |       |                                       | 
| |                             |  |                                                  |           |                                                                     |      |                                     |  |                                                     |       |                                       | 
| | $ 0.17                      |  |                                                  | 48,245    |                                                                     | 3.93 |                                     |  | $                                                   | 0.17  |                                       | 
| | $ 1.52 - $ 2.09             |  |                                                  | 18,000    |                                                                     | 7.44 |                                     |  | $                                                   | 1.70  |                                       | 
| | $ 2.38 - $ 4.34             |  |                                                  | 1,375,758 |                                                                     | 8.36 |                                     |  | $                                                   | 2.62  |                                       | 
| | $ 5.17 - $ 6.63             |  |                                                  | 708,550   |                                                                     | 3.95 |                                     |  | $                                                   | 5.79  |                                       | 
| | $ 7- $ 7.5                  |  |                                                  | 42,450    |                                                                     | 2.28 |                                     |  | $                                                   | 7.05  |                                       | 
| | $ 12.03 - $ 16.88           |  |                                                  | 247,533   |                                                                     | 3.52 |                                     |  | $                                                   | 15.45 |                                       | 
| | $ 17.5 - $ 19.63            |  |                                                  | 32,000    |                                                                     | 3.65 |                                     |  | $                                                   | 18.61 |                                       | 
| | $ 23.75                     |  |                                                  | 56,000    |                                                                     | 3.25 |                                     |  | $                                                   | 23.75 |                                       | 
| | $ 28.38                     |  |                                                  | 8,000     |                                                                     | 3.22 |                                     |  | $                                                   | 28.38 |                                       | 
| | $ 32                        |  |                                                  | 5,000     |                                                                     | 3.10 |                                     |  | $                                                   | 32.00 |                                       | 
| |                             |  |                                                  |           |                                                                     |      |                                     |  |                                                     |       |                                       | 
| |                             |  |                                                  |           |                                                                     |      |                                     |  |                                                     |       |                                       | 
| |                             |  |                                                  | 2,541,536 |                                                                     |      |                                     |  | $                                                   | 5.56  |                                       | 
| |                             |  |                                                  |           |                                                                     |      |                                     |  |                                                     |       |                                       | 

F - 39

---

---

OPTIBASE LTD. AND ITS
SUBSIDIARIES

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

|NOTE 13:-  SHAREHOLDERS EQUITY (Cont.)
|---------------------------------------
|                                       
|                                       

| |                                              |  | Weighted
  average fair valueson grant
  date |      | Weighted
  average exercise prices |  
| | -------------------------------------------- |  | --------------------------------------------- | ---- | ---------------------------------- | -
| |                                              |  |                                               |      |                                    |  
| |                                              |  | Year ended
  December 31,                     |     
| |                                              |  |                                               |     
| |                                              |  | 2001                                          |      | 2002                               |  
| |                                              |  |                                               |      |                                    |  
| |                                              |  |                                               |      |                                    |  
| | Equal to market value
      at date of grant |  | $                                             | 3.38 |                                    | $
| |                                              |  |                                               |      |                                    |  

| | e. | Warrants:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    | In December
  1992, the Company issued warrants to shareholders to purchase 125,725
  NIS 0.13 par value Ordinary shares of the Company at an exercise price
  of $ 0.33 per share. The warrants have no expiration date. On February 15,
  1999, 41,908 of these warrants were exercised. On August 22, 2003, 83,817
  warrants were exercised.                                                                                                                                                                                                                                                                                                                                                                                               
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | f. | Employee
  Share Purchase Plan:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    | In May 2000,
  the Company adopted an Employee Share Purchase Plan, allowing all eligible
  employees of the Company and its subsidiaries to purchase, with amounts
  deducted from the employees salaries, shares of the Company, at a discount
  from fair market value.                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    | The plan
  contains consecutive, overlapping 24-month offering periods. Each offering
  period includes four six-month purchase periods. Participants may purchase
  Ordinary shares through payroll deductions of up to 15% of their
  compensation. The price will be 85% of the lower of the fair market value of
  the Company Ordinary shares at the beginning of an offering period or at the
  end of a purchase period. If the fair market value at the end of a purchase
  period is less than the fair market value at the beginning of the offering
  period, participants will be withdrawn from the current offering period
  following their purchase of shares and will be automatically re-enrolled in a
  new offering period.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    | Under this
  plan, the Company granted 134,292 and 184,868 shares at an average share
  price of $ 3.36 and $ 1.85 in 2001 and 2002, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    | In November
  2002, the Board of Directors of the Company terminated this plan.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                

F - 40

---

---

OPTIBASE LTD. AND ITS
SUBSIDIARIES

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

|NOTE 14: -  GEOGRAPHIC INFORMATION AND MAJOR CUSTOMERS
|------------------------------------------------------
|                                                      
|                                                      
|                                                      
|                                                      
|                                                      
|                                                      

| |                            |  | 2001               |        | 2002                   |   | 2003               | 
| | -------------------------- |  | ------------------ | ------ | ---------------------- | - | ------------------ | 
| |                            |  |                    |        |                        |   |                    | 
| |                            |  | Total
  revenues*) |        | Long-
  lived
  assets |   | Total
  revenues*) | 
| |                            |  |                    |        |                        |   |                    | 
| |                            |  |                    |        |                        |   |                    | 
| | Israel                     |  | $                  | 1,971  |                        | $ | 5,750              | 
| | North America              |  |                    | 15,272 |                        |   | 6,403              | 
| | Europe                     |  |                    | 4,483  |                        |   | -                  | 
| | Far East (excluding Japan) |  |                    | 3,999  |                        |   | -                  | 
| | Japan                      |  |                    | 3,293  |                        |   | -                  | 
| | Other                      |  |                    | 414    |                        |   | -                  | 
| |                            |  |                    |        |                        |   |                    | 
| |                            |  |                    |        |                        |   |                    | 
| |                            |  | $                  | 29,432 |                        | $ | 12,153             | 
| |                            |  |                    |        |                        |   |                    | 

| |    | *)                                                       | Net revenues
  are attributed to countries based on end-customer location.
| | -- | -------------------------------------------------------- | --------------------------------------------------------------------------
| |    |                                                          |                                                                           
| | b. | Major
  customer data as a percentage of total revenues:

| |            |  | Year ended
  December 31, | 
| | ---------- |  | ------------------------- | 
| |            |  |                           | 
| |            |  | 2001                      | 
| |            |  |                           | 
| |            |  | %                         | 
| |            |  |                           | 
| | Customer A |  | 13.0                      | 

F - 41

---

---

OPTIBASE LTD. AND ITS
SUBSIDIARIES

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

NOTE 15:-  RELATED PARTY
TRANSACTIONS

| | The Company
  has signed lease, license and distribution agreements with V. Box through
  December 31, 2003.
| | ------------------------------------------------------------------------------------------------------------
| |                                                                                                             
| | The balances
  with and the revenues derived from related party were as follows:                            

| |                                       |  | December 31, |   
| | ------------------------------------- |  | ------------ | --
| |                                       |  |              |   
| |                                       |  | 2002         |   
| |                                       |  |              |   
| | a.     Balances
  with related party: |  |              |   
| | Trade
  receivables:                  |  |              |   
| | V.
  Box                              |  | $            | 38
| |                                       |  |              |   

| |    |                                                         | Year ended December 31, |  
| | -- | ------------------------------------------------------- | ----------------------- | -
| |    |                                                         |                         |  
| |    |                                                         | 2001                    |  
| |    |                                                         |                         |  
| |    |                                                         |                         |  
| | b. | Revenues from related party:
      V. Box               |                         | $
| |    |                                                         |                         |  
| |    |                                                         |                         |  
| | c. | Lease payment received from related party:
      V. Box |                         | $
| |    |                                                         |                         |  
| |    |                                                         |                         |  
| | d. | Purchases from related party:
      V. Box              |                         | $
| |    |                                                         |                         |  
| |    |                                                         |                         |  
| |    | See also
  Note 6.                                      |                         |  

NOTE 16:-  SELECTED STATEMENTS OF
OPERATIONS DATA

| | a. | Research and
  development, net:
| | -- | --------------------------------

| |                                                |  | Year ended
  December 31, |       
| | ---------------------------------------------- |  | ------------------------- | ------
| |                                                |  |                           |       
| |                                                |  | 2001                      |       
| |                                                |  |                           |       
| |                                                |  |                           |       
| | Total research and development costs           |  | $                         | 17,520
| | Less - grants and participation                |  |                           | (1,798
| | Capitalization of software development
  costs |  |                           | (160  
| |                                                |  |                           |       
| |                                                |  |                           |       
| |                                                |  | $                         | 15,562
| |                                                |  |                           |       

F - 42

---

---

OPTIBASE LTD. AND ITS
SUBSIDIARIES

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

NOTE 16:-  SELECTED STATEMENTS OF
OPERATIONS DATA (Cont.)

| | b. | Financial income:
| | -- | -----------------

| |                                                                                          |  | Year ended
  December 31, |      
| | ---------------------------------------------------------------------------------------- |  | ------------------------- | -----
| |                                                                                          |  |                           |      
| |                                                                                          |  | 2001                      |      
| |                                                                                          |  |                           |      
| |                                                                                          |  |                           |      
| | Financial income:                                                                        |  |                           |      
| | Interest                                                                                 |  | $                         | 3,187
| | Foreign currency remeasurement differences                                               |  |                           | 151  
| | Realized gains on sale of
  available-for-sale
      marketable securities               |  |                           | 5    
| |                                                                                          |  |                           |      
| |                                                                                          |  |                           |      
| |                                                                                          |  |                           | 3,343
| |                                                                                          |  |                           |      
| | Financial expenses:                                                                      |  |                           |      
| | Interest                                                                                 |  |                           | 212  
| | Unrealized losses on trading marketable
      securities                                 |  |                           | 465  
| | Realized losses on sale of trading
  marketable
      securities                         |  |                           | -    
| | Other than temporary decrease in value of
      available-for-sale marketable securities |  |                           | 1,791
| |                                                                                          |  |                           |      
| |                                                                                          |  |                           |      
| |                                                                                          |  |                           | 2,468
| |                                                                                          |  |                           |      
| |                                                                                          |  |                           |      
| |                                                                                          |  | $                         | 875  
| |                                                                                          |  |                           |      

|NOTE 17:-  SUBSEQUENT EVENTS (UNAUDITED)
|----------------------------------------
|                                        
|                                        
|                                        
|                                        
|                                        
|                                        

F - 43



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

|NOTE 17:-  SUBSEQUENT EVENTS (UNAUDITED) (Cont.)
|------------------------------------------------
|                                                
|                                                
|                                                
|                                                
|                                                
|                                                

- - - - - - - - - - -

F - 44

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Signatures

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

|Dated: May 17, 2004 |     | OPTIBASE LIMITED                                   
|------------------- | --- | ---------------------------------------------------
|                    |     |                                                    
|                    | By: | /s/ Tom Wyler                                      
|                    |     |                                                    
|                    |     | Chairman of the Board and
  Chief Executive Officer

81

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Exhibits

|Exhibit Number |  | Description
of Document
|-------------- |  | -----------------------

|1.1 |  | Amended
and  Restated  Memorandum  of  Association  of the Company  (incorporated  by  reference
to                       Exhibit 3.1 from the Company's Form 6K Dated February 15, 2002).
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|1.2 |  | Amended
 Articles of Association of the Company  (incorporated by reference to Exhibit 3.2 from
the                       Company's Form 6K dated February 15, 2002).
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

|2.1 |  | Escrow
 Agreement  dated December 4, 2000 by and among Optibase  Ltd.,  Viewgraphics
 Incorporated,                       American  Stock  Transfer  & Trust  Company  and
John  Krooss  as  Representative  of  Shareholders                       (incorporated by
reference to exhibits filed with the Form 6-K filed on December 7, 2000).
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.(a).1 |  | Agreement
and Plan of  Reorganization  dated  December 1, 2000 by and among  Optibase  Ltd.,  Vodka
                      Acquisition Corp., Viewgraphics Incorporated, John Krooss and the
Krooss 2000 Children's Trust
|------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Exhibit A Form Voting Agreement                            Exhibit B Form of Krooss Employment
Agreement (see Exhibit 10.1)                            Exhibit C Forms of Employment
Agreement                            Exhibit D Form of Individual Shareholder Agreement
                           Exhibit E Form Escrow Agreement (see Exhibit 2.3)
                           Exhibit F Form of Agreement of Merger
                           Exhibit G Form of Opinion from legal counsel to Viewgraphics
                           Exhibit H Forms of Opinion from legal counsels to Optibase
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | (incorporated by
reference to exhibits filed with the Form 6-K filed on December 7, 2000).
| |  | ------------------------------------------------------------------------------------------

|4.(a).2 |  | Asset
 Acquisition  Agreement  dated  December  1, 2000 by and among  Optibase  Ltd.,
 Viewgraphics                       Incorporated  and John Krooss  (incorporated by
reference to exhibits filed with the Form 6-K filed                       on December 7,
2000).
|------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.(a).3 |  | Settlement
 Agreement and Release dated  December 1, 2001 by and among Optibase Ltd. and the former
                      shareholders  of  Viewgraphics,  John  Krooss as  shareholder
 representative  and  American  Stock                       Transfer & Trust  Company as
the escrow agent  (incorporated  by reference to Exhibits 4.3 and 4.4
                      filed with the  Registrant's  Annual  Report on Form 20-F for the
fiscal year ended  December  31,                       2001).
|------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.(a).4 |  | Agreement
and General  Release dated January 15, 2002 by and between  Optibase Ltd. and John Krooss
                      (incorporated  by reference to Exhibits 4.3 and 4.4 filed with the
 Registrant's  Annual Report on                       Form 20-F for the fiscal year ended
December 31, 2001).
|------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.(a).5 |  | Termination
 Agreement  Between  Optibase Ltd.,  Optibase Inc. and Optibase Europe Ltd. and Mr. Ran
                      Eisenberg,  dated August 29, 2001  (incorporated  by reference to
exhibits filed with the Form 6-K                       filed on February 15, 2002).
|------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.(b).1 |  | Consulting
 Agreement  between  Optibase  Ltd.  and  Mr.  Ran  Eisenberg,  dated  August  29,  2001
                      (incorporated by reference to exhibits filed with the Form 6-K
filed on February 15, 2002).
|------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.(b).2 |  | Distribution
 Agreement between Optibase Ltd. and Beijing Digital Express Center dated December 20,
                      2002  (incorporated by reference to Exhibit 4.7 filed with the
Registrant's  Annual Report on Form                       20-F for the fiscal year ended
December 31, 2002).
|------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.(c).1 |  | Form
of Letter of Indemnity between Optibase Ltd. and its directors and officers
 (incorporated by                       reference  to Exhibit 4.8 filed with the
 Registrant's  Annual  Report on Form 20-F for the fiscal                       year
ended December 31, 2002).
|------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.(c).2 |  | Form
of Letter of Indemnity between Optibase, Inc. and its directors and officers
(incorporated by                       reference  to Exhibit 4.9 filed with the
 Registrant's  Annual  Report on Form 20-F for the fiscal                       year
ended December 31, 2002).
|------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.(c).3 |  | 1999
Israel Share Option Plan,  as amended  (incorporated  by reference to exhibits  filed
with the                       Registrant's Annual Report on Form 20-F for the fiscal
year ended December 31, 1999).
|------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.(c).4 |  | 1999
U.S.  Share  Option Plan,  as amended  (incorporated  by reference to exhibits  filed
with the                       Registrant's Annual Report on Form 20-F for the fiscal
year ended December 31, 1999)
|------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

82

---

---

|Exhibit Number |  | Description
of Document
|-------------- |  | -----------------------

|4.(c).5 |  | 102
Plan  (incorporated by reference to exhibits filed with the Registrant's  Annual Report
on Form                       20-F for the fiscal year ended December 31, 1999)
|------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.(c).6 |  | Employee
Stock  Purchase Plan  (incorporated  by reference to exhibits filed with the
 Registrant's                       Annual Report on Form 20-F for the fiscal year ended
December 31, 1999)
|------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.(c).7 |  | 2001
 Non-statutory  Share  Option  Plan as amended  and Form Option  Agreement  (incorporated
 by                       reference to Exhibit 10.5 filed with the  Registrant's  Annual
 Report on Form 20-F for the fiscal                       year ended December 31, 2000,
and with respect to the amendment,  Exhibit 99.7 filed with the Form
                      6-K filed on February 15, 2002).
|------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.(c).8 |  | Employment
 Agreement  with John Krooss  dated  November  30, 2000  (incorporated  by  reference to
                      exhibits filed with the Form 6-K filed on December 7, 2000).
|------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.(c).9 |  | 2003
Amendment to the 1999 Israel Share Option Plan.
|------- |  | ----------------------------------------------------

|8.1 |  | List
of the subsidiaries of the Company
|--- |  | ---------------------------------------

|10.1 |  | Consent
of Kost, Forer Gabbay & Kasierer, a member of Ernst & Young Global.
|---- |  | ---------------------------------------------------------------------------

|11 |  | Code
of Business Conduct and Ethics.
|-- |  | ------------------------------------

|12.(a).1 |  | Certification
 by Chief  Executive  Officer  pursuant to Rule  13a-14(a)  or Rule  15d-14(a) of the
                      Securities  Exchange Act of 1934, as adopted pursuant to Section
302 of the  Sarbanes-Oxley  Act of                       2002.
|-------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|12.(a).2 |  | Certification
 by Chief  Financial  Officer  pursuant to Rule  13a-14(a)  or Rule  15d-14(a) of the
                      Securities  Exchange Act of 1934, as adopted pursuant to Section
302 of the  Sarbanes-Oxley  Act of                       2002.
|-------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|32.1 |  | Certification
by Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|---- |  | ---------------------------------------------------------------------------------------------------

|32.2 |  | Certification
by Principal  Financial Officer pursuant to Section 906 of the  Sarbanes-Oxley Act of
                      2002.
|---- |  | -------------------------------------------------------------------------------------------------------------------------------

83

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