---

---

As filed with the Securities and
Exchange Commission on May 14, 2007.

UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWASHINGTON,
D.C. 20549

# FORM 20-F

(Mark
One)

|o | Registration
statement pursuant to section 12(b) or 12(g) of the Securities Exchange Act of 1934
|- | ------------------------------------------------------------------------------------------------

Or

|x | Annual
Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the
fiscal year ended          December 31, 2006
|- | -----------------------------------------------------------------------------------------------------------------------------------------

Or

|o | Transition
Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the
transition          period from ______ to ______.
|- | --------------------------------------------------------------------------------------------------------------------------------------------------

Or

|o | Shell
company report pursuant to section 13 or 15(d) of the Securities exchange act of 1934
         Date of event requiring this shell company report ________
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------

Commission File 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
|Ordinary Shares,                 | Nasdaq Global Market                     
|Nominal value NIS 0.13 per share

Securities
registered pursuant to Section 12(g) of the Act: None

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 the period covered by the annual report: 14,004,888 Ordinary
Shares, par value NIS 0.13 per share, including 368,523 Ordinary Shares held by the
registrant and 162,500 Ordinary Shares held by a trustee for the benefit of employees
under the Companys incentive plan, both have no voting or equity rights.

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

Yes o No x

If
this report is an annual or transition report, indicate by check mark if the registrant is
not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934.

Yes o No x

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

Yes x No o

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

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

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

Item 17 o Item 18 x

- ii -

---

---



# TABLE OF CONTENTS

|                                                              | PAGE
|------------------------------------------------------------- | ----
|
|
|
|
|                                                              |     
|Part I                                                        | 1   
|Item 1. Identity of Directors, Senior Management and Advisers | 1   
|Item 2. Offer Statistics and Expected Timetable               | 1   
|Item 3. Key Information                                       | 1   
|Selected consolidated financial data                          | 1   
|Capitalization and Indebtedness                               | 2   
|Reasons for the offer and use of proceeds                     | 2   
|Risk factors                                                  | 3   
|Item 4. Information on the Company                            | 16  
|History and development of the company                        | 16  
|Business overview                                             | 17  
|Organizational structure                                      | 28  
|Property, plants and equipment                                | 28  
|Item 4A. Unresolved Staff Comments                            | 28  
|Item 5. Operating and Financial Review and Prospects          | 28  
|Overview                                                      | 28  
|Operating results                                             | 32  
|Liquidity and capital resources                               | 41  
|Research and development, patents and licenses, etc           | 43  
|Trend information                                             | 43  
|Off balance sheet arrangements                                | 43  
|Tabular disclosure of contractual obligations                 | 44  
|Item 6. Directors, Senior Management and Employees            | 44  
|Directors and senior management                               | 44  
|Compensation                                                  | 46  
|Board practices                                               | 48  
|Employees                                                     | 52  
|Share ownership                                               | 53  
|Item 7. Major Shareholders and Related Party Transactions     | 55  
|Major shareholders                                            | 55  
|Related party transactions                                    | 57  
|Interests of experts and counsel                              | 57  

- iii -

---

---



|                                                                                      |   
|------------------------------------------------------------------------------------- | --
|
|
|
|
|                                                                                      |   
|Item 8. Financial Information                                                         | 57
|Consolidated statements and other financial information                               | 57
|Significant changes                                                                   | 58
|Item 9. The Offer and Listing                                                         | 59
|Item 10. Additional Information                                                       | 59
|Share capital                                                                         | 59
|Memorandum and Articles of Association                                                | 59
|Material contracts                                                                    | 63
|Exchange controls                                                                     | 63
|Taxation                                                                              | 63
|Dividend and paying agents                                                            | 73
|Statement by experts                                                                  | 73
|Documents on display                                                                  | 74
|Subsidiary information                                                                | 74
|Item 11. Quantitative and Qualitative Disclosure About Market Risk                    | 74
|Item 12. Description of Securities Other Than Equity Securities                       | 75
|Part II                                                                               | 75
|Item 13. Defaults, Dividend Arrearages and Delinquencies                              | 75
|Item 14. Material Modifications to the Rights of Security Holders and Use Of Proceeds | 75
|Item 15. Controls and Procedures                                                      | 75
|Item 16A.  Audit Committee Financial Expert                                           | 76
|Item 16B.  Code of Ethics                                                             | 76
|Item 16C.  Principal Accountant Fees and Services                                     | 76
|Item 16D.  Exemptions from Listing Standard For Audit Committees                      | 77
|Item 16E.  Purchases of Equity Securities by the Issuers and Affiliated Purchasers    | 77
|Item 17. Financial Statements                                                         | 77
|Part III                                                                              | 77
|Item 18. Financial Statements                                                         | 77
|Item 19. Exhibits                                                                     | 77
|Signatures                                                                            | 78

- iv -

---

---



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 subsidiary,
Optibase, Inc., a Californian corporation. 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 VideoPlex, as registered trademarks.
In addition, the names MPEG MovieMaker 200", MPEG MovieMaker
230", Media Gateway, MGW5100", MGW1100",
MGW2000", MGW2000e, MGW1000", VideoPlex
Xpress, VideoPlex Pro, MPEG MovieMaker,
Videoplex, MPEG ComMotion, MPEG Composer,
VideoPump, MGW200", MGW230", MovieMaker
HD and MediaPump, are our trademarks.

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.

- v -

---

---



# Part I

|Item 1: | Identity
of Directors, Senior Management and Advisers
|------- | -----------------------------------------------------

Not
applicable.

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

Not
applicable.

|Item 3: | Key
Information
|------- | ---------------

# 3A. Selected
Consolidated Financial Data

We
derived the consolidated statement of operations data for the years ended
December 31, 2004, 2005 and 2006, and consolidated balance sheet data as of
December 31, 2005 and 2006 from the audited consolidated financial statements
appearing elsewhere in this Annual Report. These financial statements have been prepared
in accordance with U.S generally accepted accounting principles (U.S. GAAP).
We derived the consolidated statement of operations data for the years ended
December 31, 2002 and 2003 and the consolidated balance sheet data as of
December 31, 2002, 2003 and 2004 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 below and
the financial statements, including the notes thereto, included elsewhere in this Annual
Report.

In
June 2004, we acquired certain assets and liabilities of Media 100 Inc. as part of a
pre-packaged bankruptcy filing of Media 100, in consideration for $2.5 million in cash and
costs incurred by us totaling $401,000. In September 2005, we entered into an agreement
for the sale of our Digital Non-Linear Editing operation to Artel Software Corp. During
the fourth quarter of 2006, based on recent assessments in accordance with the guidance of
SFAS 144 and EITF 03-13, we have decided to present the non-linear editing product line
operation as discontinued operations. Comparable results for 2005 and 2004 were adjusted
accordingly.

- 1 -

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|                                                                  | Year Ended December 31,
|----------------------------------------------------------------- | -----------------------
|
|
|
|
|
|Revenues                                                          |                        
|                                                                  |                        
|Cost of revenues                                                  |                        
|Gross profit                                                      |                        
|                                                                  |                        
|Operating expenses:                                               |                        
|Research and development, net                                     |                        
|Selling and marketing, net                                        |                        
|General and administrative                                        |                        
|Write off of in process research and development.                 |                        
|Impairment of long lived assets                                   |                        
|                                                                  |                        
|Restructuring cost                                                |                        
|Total operating expenses                                          |                        
|Operating (loss)                                                  |                        
|                                                                  |                        
|Other income (expenses), net                                      |                        
|Financial income, net                                             |                        
|Net income (loss) before tax                                      |                        
|Provision for income tax                                          |                        
|                                                                  |                        
|Net income (loss) before cumulative effect of changes             |                        
|in accounting principle                                           |                        
|Cumulative effect of changes in accounting principle              |                        
|                                                                  |                        
|Net (loss) income from continuing operations                      |                        
|Income (Loss) related to discontinued operations (1)              |                        
|Net income (loss)                                                 |                        
|                                                                  |                        
|Net income (loss) per share from continuing operations:           |                        
|Basic                                                             |                        
|Diluted                                                           |                        
|Basic and diluted earnings per share from discontinued operations |                        
|Net income (loss) per share                                       |                        
|Basic                                                             |                        
|Diluted                                                           |                        
|                                                                  |                        
|Weighted average shares used in computing net earning             |                        
|(loss) per share (in thousands):                                  |                        
|Basic                                                             |                        
|                                                                  |                        
|Diluted                                                           |                        

|                                                    | December 31,
|--------------------------------------------------- | ------------
|
|
|
|
|
|Cash, cash equivalents and short term investment in |             
|marketable securities net                           |             
|Working capital                                     |             
|Long term investment in marketable securities       |             
|Total assets                                        |             
|Long term loans and capital lease obligations,      |             
|including current maturities                        |             
|Capital Stock                                       |             
|Total shareholders' equity                          |             

(1)    
          The financial statements have been reclassified in order to reflect the
          discontinued operations of the digital non linear product line. See also Note
          1.e to our consolidated financial statements included elsewhere in this annual
          report.

# 3B. Capitalization and
indebtedness

Not
applicable.

3C.
          Reasons for the offer and use of proceeds

Not
applicable.

- 2 -

---

---



# 3D. 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.

# Risks Relating to the
Economy, Our Financial Condition and Shareholdings

We have a history of
losses and we might not be able to reach profitability.

Since
2000 and until the quarter ended March 31, 2003, we operated at a loss. We returned to
profitability in the quarter ended June 30, 2003 and remained profitable until the quarter
ended March 31, 2004. Since the second quarter of 2004 we returned to operating at a loss.
As of December 31, 2006, we have accumulated losses of $73 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 may
continue to operate at a loss and may not be able to reach 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 achieve profitability.

The economic outlook may
adversely affect the demand for our products and 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 and streaming 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 be able to 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, which may result in an adverse impact on our
results of operations. Any such adverse impact on the result of our operations from a
changing economy may cause the price of our ordinary shares to decline.

We manage our available
cash through various investments the market value of which is subject to fluctuations. Impairment
of our investments could harm our earnings.

We
manage our available cash through investments of various holdings, types and maturities
which are subject to fluctuations that may adversely affect the value of our available
cash. As of December 31, 2006, approximately 64% of our available cash invested in
structured notes, or the Notes, acquired from several banks. Under the terms of the Notes,
for each day in which the relevant 6-month LIBOR rate is below an agreed fixed rate, which
ranges from 3% to 10% (calculated on an annual basis), the Notes bear interest at a rate
of 10% to 10.5% per annum. On all other days, the Notes do not bear any interest. Under
the terms of the Notes, the issuer of the Notes has a call option that allows such issuer
to prepay the Notes at PAR at any coupon date. Changes in the rate of the LIBOR may
significantly affect the market value of our investments.

- 3 -

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Investments
of our available cash 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, interest rates and other factors may adversely
affect the value of our available cash. As a result, we may recognize in earnings the
decline in fair value of investments of our available cash when the decline is judged to
be other- than- temporary. For further information regarding the investment of our
available cash, see Item 5B. Liquidity and Capital Resources below.
Furthermore, our 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.

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 the entities affiliated with them, in the aggregate,
beneficially own approximately 22.6% of our outstanding ordinary shares, of which Tom
Wyler, our President, Chief Executive Officer and Executive Chairman of our Board of
Directors holds 19.25% (calculated taking into consideration shares subject to options
that are currently exercisable or exercisable within 60 days of April 15, 2007which are deemed to be outstanding); see Item 7A. Major Shareholders
below. 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.

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:

|v | The
timing of purchases of our products by system integrators and other large customers;
|- | ----------------------------------------------------------------------------------------

|v | The
rate of acceptance of new products we introduce;
|- | ----------------------------------------------------

|v | The
loss of major customers;
|- | ----------------------------

|v | Product
introductions and other actions taken by our competitors;
|- | -----------------------------------------------------------------

|v | Market
acceptance of IPTV (previously called "Broadband TV") video services;
|- | ----------------------------------------------------------------------------

|v | Changing
networking standards in the digital video and streaming industry and our ability to
anticipate and react to such changes in a timely manner;
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------

|v | Changes
in sales and distribution environments and costs;
|- | ---------------------------------------------------------

|v | Fluctuations
in manufacturing yields and delays in product shipments;
|- | ---------------------------------------------------------------------

|v | Personnel
changes;
|- | ------------------

|v | Changes
in foreign exchange rates; and
|- | --------------------------------------

|v | 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. As a result, we have reduced prices for our products and we may have to reduce
prices in the future. In addition, we may have to increase our research, development and
marketing expenditures in response to competitive conditions in order to develop new
technologies and products. 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, our operating results may be below expectations of public market analysts or
investors. If this occurs, the market price of our ordinary shares 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:

|v | The
announcement of new products, services or service enhancements by us or our competitors;
|- | --------------------------------------------------------------------------------------------

- 4 -

---

---



|v | Quarterly
variations in our results of operations or in our competitors' results of operations;
|- | -----------------------------------------------------------------------------------------------

|v | Changes
in earnings estimates or recommendations by securities analysts;
|- | ------------------------------------------------------------------------

|v | Perceptions
of the digital video and streaming and networking industry's relative strength or
weakness;
|- | -------------------------------------------------------------------------------------------------------

|v | Developments
in our industry and change in demand for our products;
|- | -------------------------------------------------------------------

|v | General
market conditions and other factors, including factors unrelated to our operating
performance or the      operating performance of our competitors; and
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------

|v | Seizure
of a substantial business opportunity by our competitors or us.
|- | -----------------------------------------------------------------------

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 market
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 video and streaming 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 2006 through April 15, 2007, the price of our ordinary shares rose
to a high of $5.01 from a low of $2.62 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.

If we are deemed to be an
investment company, we may have to comply with burdensome requirements that limit our
ability to carry on effectively our operating business.

We
hold more than 40 percent of our assets in investment securities, which presents the risk
that we may be deemed to be an investment company under the Investment Company Act of 1940
(the ICA). If we are deemed to be an investment company, we may be required to
register under the ICA, and thereby become subject to the ICAs requirements. These
requirements may make it more difficult for us to carry on our operating business
effectively. For example, registration under the ICA would subject us to:

| | v | restrictions
on the nature of our investments;
| | - | ----------------------------------------------

| | v | restrictions
on our issuance of securities;
| | - | -------------------------------------------

| | v | restrictions
regarding our form of corporate structure;
| | - | -------------------------------------------------------

| | v | reporting,
record-keeping, voting, proxy and disclosure requirements; and
| | - | -------------------------------------------------------------------------

| | v | other
rules and regulations.
| | - | ----------------------------

In addition to the foregoing,
registration as an investment company could render certain of our contracts voidable under
the ICA. If we fail to comply with these or other provisions of the ICA, we could be
subject to civil and criminal penalties.

Additionally,
because we hold more than 40 percent of our assets in investment securities, we must
manage our investments carefully to avoid classification as an investment company. As a
result, we may be required to invest in assets that yield lower returns than assets in
which we would invest absent ICA considerations.

- 5 -

---

---



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, 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 at the market value. If we were 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. Taxation under the heading
United States Federal Income Tax Consequences below for a more complete
discussion of the U.S. federal income tax risks related to owning and disposing 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 to 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 and could adversely affect the
price of our ordinary shares.

We
received net proceeds in the amount of approximately $67 million from our secondary public
offering in March 2000, and we spent approximately $37 million in cash as a component of
the consideration paid to acquire Viewgraphics, Incorporation and certain other assets,
see also Item 4A. History and Development of the Company below. 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.

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.

# Risks Relating to Our
Business

The digital video and
streaming market is highly competitive, and we may lose sales to our competitors and be
forced to continue to lower the prices for our products, which may result in reduced
revenues.

We
currently develop and market two product lines: the IPTV product line and the Video
Technologies product line. The IPTV product line enables telephone operators and service
providers to offer TV services to their subscribers by leveraging their existing digital
subscriber lines, or DSL, and fiber communications infrastructure. The Video Technologies
product line enables a variety of content creation and streaming applications. Both the
IPTV and the Video Technologies operate and market their products in the Enterprise,
Government and Broadcast.

Competition
in each of these markets is intense and we expect competition to increase. The Video
Technologies markets have grown in recent years and have attracted many competitors.
Advances in video encoding technologies and in desk-top processing capabilities have also
enabled sophisticated new applications within these markets which require an in-depth
understanding of customer needs and significant development efforts. Moreover, the
availability of video encoding technologies has also driven prices for products down
within these markets. In contrast, the IPTV market is in its infancy, but is currently
dominated by large companies that can afford to aggressively promote their products by
reducing prices in order to gain market share. To be competitive in each product line, we
must continue to respond promptly and effectively to changing customer preferences,
feature and pricing requirements, technological change and competitors innovations.

- 6 -

---

---



We
expect price competition to escalate in the digital video and 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 further lower product prices and we may 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.

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, some companies in the digital video and streaming products
industry, 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.

If the digital video and
streaming market does not grow as we expect, the demand for some of our products and
technology may decline and our revenues will be materially adversely affected.

Digital
video and streaming products generally are part of an 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 and streaming equipment into the market generally.
Because of the early stage of development of some digital video and streaming markets, 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 and
streaming 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 for our products. If the economic conditions persist and
demand does not increase, our revenues will decline, and our business will be materially
adversely affected.

The digital video and streaming
market are 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 largely 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, which is a 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 in most of our target markets, we cannot
assure you that the current de facto standards will not be replaced in the future. For
instance, in April 2006 the Society of Motion Picture and Television Engineers (SMPTE)
announced completion of the standardization process for VC-1, Microsofts audio and
video codec. Until now the IPTV market has not accepted VC-1 outside the Microsoft
eco-system, however, if this changes, or if Microsoft becomes more dominant in the IPTV
market and we fail to enhance our existing products to meet this standard in a timely
fashion, we may not be able to compete efficiently with our competitors.

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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.

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 an adverse impact on our financial performance,
revenues, and income.

Our
MovieMaker encoder product family accounted for 36% of our revenues in 2004, 33% of our
revenues in 2005 and 28% of our revenues in 2006. While our revenues from the MovieMaker
encoder product family continue to decrease, we expect that this product family will
continue to account for a significant portion of our revenues in the next year. 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, it would
have a material adverse affect on our results of operations.

There is a slow decrease
in the sales of our Video Technologies product line which we expect to continue over the
years. If such decrease grows significantly beyond our expectations, it could
adversely affect our financial results.

Our
sales from the Video Technologies product line were $15.4 million in 2004, $15.3 million
in 2005 and $12 million in 2006. The decrease in the sales of our Video Technologies
products are mainly attributed to significant advances in PC technology supporting
software products for standard definition encoding. We expect that our sales from the
Video Technologies products will slowly decrease over the years. Nevertheless, if the
decrease in the sales of our Video Technologies grows significantly beyond our
expectations it could adversely affect our financial results.

We have a limited backlog
of orders and have to plan production and inventory levels on unpredictable or deringpatterns.
Maintaining sufficient inventory levels to meet anticipated demand increases the risk
of inventoryobsolescence and associated write-offs, which could adversely affect our
financial performance.

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 vary substantially from early estimates provided by customers
to us for planning purposes.

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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, in particular in the Video
Technologies product line, is conducted through a network of independent distributors. 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 adversely affect our
business.

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.

Some
of our sales to the telecommunication, or Telco, market segment are conducted directly.
However, sales to major Telcos largely depend on our ability to develop relationship and
form business combinations with well-recognized Telco vendors, such as: Alcatel, Siemens
and Nortel. Failure to develop such relationships will have a material adverse affect on
our revenues and results of operations.

As we market our products
internationally our business is affected by the WEEE and RoHS directives.

As
manufacturers and sellers of electronic equipment, certain aspects of the Restriction of
Hazardous Substances in Electrical and Electronic Equipment (RoHS) Directive (2002/95/EC)
which bans the use of certain hazardous materials including lead, mercury, cadmium,
chromium, and halogenated flame-retardants and the Waste Electrical and Electronic
Equipment (WEEE) Directive (2002/96/EC) which regulates the collection, recovery and
recycling of waste from electrical and electronic products apply to our operation.
Although we make efforts to comply with the directives, if we fail to do so, we may not be
able to market our products effectively in some countries (mainly in Europe) and as a
result, our operations will be adversely affected. In order to comply with these
directives we have invested and may need to further invest development resources to
replace non-compliant components with compliant components with the same function. Our
costs of goods sold may also increase due to the use of certain new components and
manufacturing processes. We cannot assure you that lack of compliance with the WEEE and
RoHS directives will not have a material adverse effect on our financial condition or
results of operations. In some cases compliance with these directives may require changing
a hardware product in a way that requires some of our customers to make changes to their
own systems. The need by a customer to change an existing system requires an investment of
resources and presents the opportunity for a customer to reconsider the advantages of our
products in comparison with those of competitors, and may result in the loss of some of
our customers.

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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 address 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 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:

|v | H.264
SD and HD video encoding tools provided by a technological partner;
|- | -------------------------------------------------------------------------

|v | Various
modules, which are integrated in our systems, both for the MGW5100, MGW 1100 and the
MGW1000 including: Switches supplied by PTI (Performance Technologies Inc.) and
Interface, a switch supplied by Intel, Hosts supplied by Freescale and Kontron, backplane
board by Kaparel Corporation Pentium, CPU modules supplied by Kontron and Compact Pci
platforms supplied by EPS (Israel) TECH 1992 Ltd.;
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|v | Digital
Signal Processing, or DSP, compression techniques, manufactured by Equator Inc. and TI,
which are used in our MGW 5100, MGW 1100, MGW 2400, MGE 400 and Movie Maker 400 products;
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|v | Video
compression chips manufactured by LSI Logic;
|- | --------------------------------------------------

|v | Audio
Analog to Digital Converters (A/D), Digital to Analog Converters (D/A) and decompression
chips manufactured by Crystal Semiconductor Corporation, or Crystal, a subsidiary of
Cirrus Logic, which are included in our encoders and decoders;
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|v | Freescale,
Inc.'s DSPs, which are included in our decoders and encoders;
|- | ------------------------------------------------------------------------

|v | A
video decoding chip manufactured by IBM;
|- | ------------------------------------------

|v | HD
compression chips manufactured by NEL;
|- | -----------------------------------------

|v | SDI
interface chips manufactured by Gennum;
|- | -------------------------------------------

|v | Microprocessor
and PCI bridge devices from Intel that are used in our MediaPump and MovieMaker boards;
|- | ------------------------------------------------------------------------------------------------------

|v | A
video processing chipset from Gennum, which is used in our MM200s; and
|- | ------------------------------------------------------------------------

|v | Programmable
devices by Xilinx, which are used in our Mediapump.
|- | ----------------------------------------------------------------

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.

Some of our products were
designed a number of years ago and we may face problems acquiring components for the seproducts
which will result in an adverse effect on our reputations and sales.

Though
we monitor the availability of components and make reasonable effort to procure sufficient
quantities to meet demand, the availability of components is largely beyond our control,
in particular for older components. If a manufacturer declares one or more of these
components obsolete, we may not be able to meet the demand for our products which may
adversely affect our reputation and our sales.

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We depend on a limited
number of key personnel who would be difficult to replace, and if we lose the services of
the seindividuals or cannot hire additional qualified personnel, our business will be
adversely affected.

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 and streaming 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.

The length of our sales
cycle of streaming products depends on factors beyond our control and may cause revenues
to vary significantly.

Sales
of our streaming products, and in particular, the IPTV products, which are generally
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 be adversely affected.

Cost-reduction efforts
may adversely impact our productivity and service levels.

Since
2001 and until the first quarter of 2006, we have continuously implemented various
cost-control measures affecting various aspects of our business operations, including
several reductions in our workforce in particular in our U.S. based and Israeli based
research and development divisions. 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 affect on our financial
conditions. 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,
our strength and stability as perceived by our customers 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 conditions.

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:

|v | Additional
operating expenses without additional revenues;
|- | ----------------------------------------------------------

|v | Potential
dilutive issuances of equity securities;
|- | --------------------------------------------------

|v | The
incurrence of debt and contingent liabilities;
|- | --------------------------------------------------

|v | Amortization
of goodwill and other intangibles;
|- | -----------------------------------------------

|v | Research
and development write-offs;
|- | ------------------------------------

|v | Impairment
charges; and
|- | -----------------------

|v | Other
acquisition-related expenses.
|- | -----------------------------------

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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 cannot
assure you that our efforts to protect our proprietary rights will be adequate. Our
inability to protect our proprietary rights effectively could have a material adverse
effect on our business, financial condition and results of operations. 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 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 the patents we own or otherwise obtaining and using our
products, designs or other information. 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. 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.

All
of our products rely on technology that could be the subject of existing patents or patent
applications of third parties. Many participants in the digital video and streaming 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. 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. Such 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.

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
commercially acceptable terms could result in a material adverse affect on our business,
financial condition and results of operations.

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.

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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 affect on our business.

# Risks Relating to
Operations in Israel

Deterioration in the
economic, political and military instability in Israel may adversely affect our results of operations.

We
are incorporated under the laws of and our main offices are located in the State of
Israel. The economic, political and military conditions in Israel directly influence us.
Israeli economy has suffered in the past and may suffer in the future from instability,
which may adversely affect our financial condition and results of operations.

Following
the recession and the instability that characterized the Israeli economy from the year
2001 through 2003, the Israeli economy showed signs of improvement during 2004 and 2005. The
Israeli economy has also been subject to significant changes, as a result of
implementation of new economic policies and privatization. If the results of these changes
are unsuccessful or the economic deterioration in Israel continues, it may adversely
affect our financial conditions, the results of operations and our ability to obtain
financing from Israeli banks.

Potential political and
military instability in Israel may adversely affect our results of operations.

The
political and military conditions in Israel directly influence us. 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. Although
Israel has entered into various agreements with Egypt, Jordan and the Palestinian
Authority, there has been an increase in unrest and terrorist activity in Israel, which
began in September 2000 and which has continued with varying levels of severity through
2006. In July 2006, an armed conflict began between Israel and Hezbollah forces in
Lebanon, which involved rocket attacks on populated areas in the northern parts of Israel.
On August 14, 2006, a cease-fire between Hezbollah and Israel took effect. This situation
has had an adverse effect on Israels economy, primarily in the geographical areas
directly harmed by this conflict. Any future armed conflict, political instability or
violence in the region may have a negative effect on our business condition, harm our
results of operations and adversely affect our share price. No predictions can be made as
to whether or when a final resolution of the areas problems will be achieved or the
nature thereof and to what extent the situation will impact Israels economic
development or our operations.

Most
of our directors, officers and employees are currently obligated to perform annual reserve
duty. Additionally, all reservists are subject to being called to active duty at any time
under emergency circumstances. We cannot assess the full impact of these requirements on
our workforce and business if conditions should change, and we cannot predict the effect
on us of any expansion or reduction of these obligations.

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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 1.2% in
2004, approximately 2.4% in 2005, and approximately 0.1% in 2006. At the same time the
appreciation of the NIS against the dollar was approximately 1.6% in 2004, the devaluation
of the NIS against the dollar approximately 6.8% in 2005, the appreciation of the NIS
against the dollar was approximately 8.2% in 2006. As a result of this differentiation, we
experienced an increase in the dollar costs of operations in Israel in 2004, a decrease in
2005, and an increase in 2006, 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.

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, Trade and Labor for research and development programs that meet specified
criteria. . 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, the terms of the OCS grants limit us from manufacturing products or transferring
technologies developed using these grants outside of Israel without special approvals,
which may or may not be granted. Even if we receive approval to manufacture the OCS
supported products outside of Israel, we would be required to pay an increased total
amount of royalties, which may be up to 300% of the grant amount plus interest, depending
on the manufacturing volume that is performed outside of Israel at an increased annual
return rate. On March 30, 2005, the Israeli parliament approved an amendment to the
Israeli Law for Encouragement of Industrial Research and Development, 1984, or the R&D
Law and regulations promulgated under that R&D Law which permits under certain
conditions the transfer of such technology outside of Israel, including the payment of a
redemption price to be determined by the OCS under the R&D Law. If we fail to comply
with these conditions in the future, the benefits received could be cancelled and we could
also be required to refund any grants previously received under these programs as well as
the maximum interest rate permitted by Law, and we may be subject to criminal charges.
Through 2006, we received an aggregate of $6.6 million in grants from the OCS and our
accrued and paid royalties to the OCS totaled $3.6 million. In addition, the Law for
Encouragement of Capital Investment, 1959, or the Encouragement of Capital Investment Law,
prescribes an expiry date for the grant of new benefits. The expiry date has been extended
several times in the past and the expiry date currently in effect is on December 31, 2007,
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 Encouragement
of Capital Investment Law. There can be no assurance that new benefits will be available
after December 31, 2007, however benefits already granted will stay in effect throughout
the plan period. As we have already been granted approved enterprise status under this
Encouragement of Capital Investment 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 OCS MAGNET program operated by
the Israeli Ministry of Industry, Trade and Labor and under a series of research and
development programs sponsored by the Commission of the European Union. Through
December 31, 2006, we have received an aggregate of $5.4 million in grants from the
MAGNET program. In 2004, 2005 and 2006 we recorded grants from the OCS, the MAGNET and the
European Union programs in the aggregate amount of $2 million, $2.1 million and $1.9
million respectively.

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 Item 10E.
Taxation below) or for new programs. These requests might not be approved. The
termination or reduction of these grants (or grants of these type) and tax benefits could
harm our business, financial condition and results of operations.

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Anti-takeover provisions
could negatively impact our shareholders.

The
Israeli Companies Law  1999, or the Companies Law, provides that certain purchases
of securities of a public company are subject to tender offer rules. As a general rule,
the Companies Law prohibits any acquisition of shares in a public company that would
result in the purchaser holding 25% or 45% or more of the voting rights in the company, if
there is no other person holding 25% or 45% or more of the voting rights in the company,
respectively, without conducting a special tender offer.

The
Companies Law further provides that a purchase of shares of a public company or a class of
shares of a public company, which will result in the purchasers holding 90% or more
of the companys shares or class of shares, is prohibited unless the purchaser
conducts a full tender offer for all of the companys shares or class of shares. The
purchaser will be allowed to purchase all of the companys shares or class of shares
(including those shares held by shareholders who did not respond to the offer), if the
shareholders who did not respond to the offer constitute 5% of the companys issued
share capital, or of the issued class of shares. At the request of an offeree of a full
tender offer which was accepted, the court may determine that the consideration for the
shares purchased under the tender offer, was lower than their fair value and compel the
offeror to pay to the offerees the fair value of the shares. Such application to the court
may be filed as a class action.

In
addition, the Companies Law provides for certain limitations on a shareholder that holds
more than 90% of the companys shares, or class of shares.

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 and officers 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 and officers and
enforcement of judgments obtained in the United States against us, and our directors and
executive officers 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:

|v | The
judgment was rendered by a court which was, according to the laws of the state of the
court, competent to      render the judgment;
|- | ---------------------------------------------------------------------------------------------------------------------------------------

|v | The
judgment can no longer be appealed;
|- | ---------------------------------------

|v | 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
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|v | The
judgment is executory in the state in which it was given.
|- | -------------------------------------------------------------

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 will
also not declare a foreign judgment enforceable in the occurrence of any of the following:

|v | The
judgment was obtained by fraud;
|- | -----------------------------------

|v | There
was no due process;
|- | -------------------------

|v | The
judgment was rendered by a court not competent to render it according to the laws of
private international      law in Israel;
|- | ----------------------------------------------------------------------------------------------------------------------------------

|v | 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
|- | -----------------------------------------------------------------------------------------------------------------------------------------

|v | 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.
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------

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|Item 4. | Information
on the Company
|------- | --------------------------

# 4A. History and
Development of the Company

# History

Optibase
was founded and incorporated in the State of Israel in 1990 under the name of Optibase
Advanced Systems (1990) Ltd. In November 1993 we changed our name to Optibase Ltd. 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., was incorporated in 1991 in Delaware,
and is located at 880-2 Maude Avenue, Mountain View, California 94043.

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. On September 10, 2004, Festin Management Corp. transferred all of its holdings in
us to its shareholders. Based on Schedule 13D filed with the Securities and Exchange
Commission, which we refer to herein as the Commission or the SEC,
on June 9, 2005 by Tom Wyler and Arthur Mayer-Sommer, Mr. Wyler holdings at the time were
1,800,000 ordinary shares representing 13.31% of our issued share capital and Mr.
Mayer-Sommers were 1,200,000 ordinary shares representing 8.87% of our issued share
capital. On May 27, 2006, Mr. Wyler purchased from Moshe Namdar 601,838 ordinary shares.
Based on Schedule 13D filed with the SEC on May 27, 2006 by Tom Wyler, Mr. Wyler holds
2,401,838 ordinary shares representing 17.8% of our issued share capital. Mr. Wyler also
serves as our Chief Executive Officer, President and Executive Chairman of the Board of
Directors.

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
video and streaming infrastructure application which was merged with and into our
subsidiary Optibase, Inc. in June 2001. In connection with the acquisition, we paid an
aggregate consideration of approximately $43.6 million, of which $11.8 million (net of
issuance expenses) was paid in 1.37 million newly issued ordinary shares.

In
June 2004, we acquired certain assets and liabilities of Media 100 Inc. as part of a
pre-packaged bankruptcy filing of Media 100, in consideration for $2.5 million in cash and
costs incurred by us totaling $401,000. During the quarter ended December 31, 2004, we
wrote down long-lived assets and goodwill related to the acquisition totaling
approximately $2 million. In September 2005, we entered into an agreement for the sale of
our Digital Non-Linear Editing operation to Artel Software Corp. (for details regarding
the sale agreement, see Item 10C. Material Contracts below) and we recorded
additional restructuring charges, of $125,000 related to our facilities future rent
obligation. In the fourth quarter of 2006, based on recent assessments in accordance with
the guidance of SFAS 144 and EITF 03-13, we have decided to present the non-linear editing
product line operation as discontinued operations. Comparable results for 2005 and 2004
were adjusted accordingly.

In
January 2007, we purchased from Koor Corporate Venture Capital and Koor Industries Ltd.
3,035,223 ordinary shares of Scopus Video Networks Ltd., or Scopus, representing
approximately 23% of Scopus issued share capital, at an aggregate purchase price of
approximately US$ 16 million. Scopus develops, markets and supports digital video
networking products that enable network operators to offer advanced video services to
their subscribers.

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In
addition, we hold interest in two companies, as follows:

V.Box
Communication Ltd.  In July 2001, we signed an agreement with a privately held
Israeli company called V.Box Communication Ltd., or V.Box, pursuant to which we have
invested an initial amount of $250,000 in consideration for convertible bonds which if
converted will constitute approximately 34% of V.Box. Through December 31, 2006, we have
invested an aggregate amount of $2.6 million in Vbox in order to retain our holdings. The
investment was made by way of a loan against a note that can be converted into ordinary
shares of V. Box, at any time, by a five-day prior written notice. The principal amount of
the loan should be payable upon the earlier of: (i) July 1, 2010; (ii) actual liquidation
of V.Box; or (iii) mutual consent of us and the other investors of V.Box. In February 2007
we have invested an additional $154,000 by the way of a promissory note bearing no
interest and no linkage differentials. Such additional amount will be repaid only out of
proceeds received by V.Box on account of sale of all or substantially all of the assets of
V.Box or a specific line of products and/or upon the occurrence of an event of default,
including among others, insolvency or bankruptcy of V.Box, appointment of a receiver or a
liquidator to V.Box and exercise of any liens on all or substantially all of V.Box
assets. If an event of default occurs, we have a right of first refusal towards V.Box with
regard to the purchase of V.Box line of product. We sublease a part of our premises
to Vbox and also provide Vbox with distribution services in the North America market.

Mobixell
Networks Inc.- In November 2000, we entered into 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 valued at $300,000, and committed to
invest through one of our subsidiaries at least $1 million. In December 2000, we invested
$1,064 million in Mobixells series A preferred stock. Mobixell Networks designs,
develops and markets solutions for mobile rich media adaptation, optimization and
delivery. During the quarter ended March 31, 2003, based on updated information, we
decided to adjust downward the value of the investment in Mobixell by its full amount,
totaling $1.36 million. However, during the quarter ended September 30, 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 stock. In
May 2004 we decided to participate in another financing round in the amount of $400,000 in
Mobixells series C preferred stock. As a result, our holdings in Mobixell represent
7.08% of its equity. We may participate in future financing rounds in Mobixell and our
holdings may be further diluted.

# 4B. Business Overview

We
provide high quality equipment for a wide range of professional video applications in the
broadband IPTV, broadcast, government, enterprise and post-production markets. During
2006, we operated two product lines: Video Technologies and IPTV. Our products are
generally manufactured by the same subcontractors by the use of similar raw materials
purchased from the same suppliers. We market our products through a combined sales and
marketing team and sell them by way of direct sales and through independent distributors,
system integrators and resellers. During the quarter ended December 31, 2005, we decided
to significantly reduce the operation of our Digital Non-Linear Editing product line and
in September 2005, we entered into an agreement for the sale of our Digital Non-Linear
Editing operation to Artel Software Corp. (commonly known as Boris FX), or Boris FX. We
will supply Boris FX, at its request, with manufacturing services for the Media 100 HD
boards for a period of 24 months beginning on September 28, 2005. During the fourth
quarter of 2006, based on recent assessments in accordance with SFAS 144 and EITF 03-13,
we have decided to present the non-linear editing product line operation as discontinued
operations. Comparable results for 2005 have been adjusted accordingly. See also Item 10C.
Material Contracts below.

# Products

Video Technologies

The
Video Technologies product line which consist products such as PCI platforms for encoding,
decoding and interfacing with DVB networks, and Media Gateways enables a variety of
content creation and streaming applications.

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The
Video Technologies products target the broadcast, government, enterprise and
post-production markets.

In
the enterprise markets, our encoding and streaming products enable applications such as
corporate training, videoconferencing, TV to the desktop and corporate video messages
distributed over the corporate network. In the governmental markets, our products enable
the logging and streaming of legal and legislative proceedings, surveillance, military and
police monitoring, and simulated training sessions for later retrieval and debrief. In the
Broadcast markets our products enable the preparation of video content for Video on Demand
(VOD) or Broadcast servers, the playout of video from servers, ad-insertion into channel
feeds, and the monitoring and archiving of channels for compliance checks as required by
the regulator in some countries. Our streaming products provide broadcasters with the
ability to reliably and cost effectively transport video between facilities using Internet
Protocol or IP networks. Independent post-production houses use our encoder products to
create DVDs for corporate marketing departments, music videos, digital signage, and for
private use. Broadcaster post-production facilities use our products to create show
dailies and for internal review.

We
sell the Video Technologies products directly to OEMs and to video system integrators and
also through a worldwide network of distributors, resellers and value added resellers.

We
develop and market platforms that can be inserted into a host computer (PC or Macintosh),
for encoding video into compressed digital formats and decoding compressed digital formats
into playable video. These platforms connect to the host computer using the Peripheral
Component Interconnect bus (PCI). In addition, our products enable the transmission of
such compressed digital formats over Digital Video Broadcast (DVB) networks. Our PCI
platforms are the basis for other products (described below). They are also sold to system
integrators who use them to build their own professional video applications. They are
provided with documented SDKs (Software Developer Kits) to facilitate the development by
our customers.

Based
on these encoder and decoder platforms we also develop and market content creation
software applications which run on the PC and Macintosh computer respectively.

In
addition to the PCI platforms, their SDKs and the software applications that run above
them, we also develop and market integrated devices for encoding and streaming which we
call Media Gateways. These devices do not require installation of hardware and are
remotely managed by either a web interface or an SNMP management application. They do not
use the PCI platforms for encoding or decoding though they are based on similar
technology.

We
are working on new releases for the MovieMaker HD and a new product that uses the Video
Technologies product technology to facilitate the task of encoding content
(Ingest).

IPTV

IPTV
(Internet Protocol Television) is a system where a digital television service is delivered
using the Internet Protocol over a network infrastructure, which may include delivery by a
broadband connection. For residential users, IPTV is often provided in conjunction with
Video on Demand and may be bundled with Internet services such as Web access and VoIP. The
commercial bundling of IPTV, VoIP and Internet access is referred to as a Triple Play.
IPTV is typically supplied by a broadband operator using a closed network infrastructure.
IPTV may be used to deliver television content over corporate LANs and business networks.

The
IPTV product line enables telephone operators and service providers to offer TV services
to their subscribers by leveraging their existing digital subscriber lines, or DSL, and
fiber communications infrastructure

The
primary market of the IPTV product line is the IPTV market which mainly consists of
telephone operators and internet service providers worldwide who are offering broadband
and telephone services. These companies are exploring ways to leverage their existing
networks to add new services, and in particular, personalized multi-channel television.
These networks (sometimes called access networks) are typically Internet
Protocol, or IP, enabled over digital subscriber line, or DSL, a family of digital
telecommunication protocols designated to allow high speed data communication over
existing telephone lines or fiber networks or combinations of these. The new services are
offered to home subscribers, to organizations, gated communities or within hotels for
entertainment.

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We
expect that the IPTV market will grow over the next few years and several market research
firms support this expectation. For instance, according to Multimedia Research Group (MRG)
market research from March 2006, the number of worldwide DSL subscribers will grow from 97
million in 2004 to 256 million in 2009 and the total number of IPTV subscribers will grow
dramatically from 4.3 million in 2005 to 36.8 million in 2009. However, we cannot assure
you that the market will grow according to our expectation and indeed, the growth of this
market has been lower than expected.

In
these applications, our IPTV products are integrated in a video head-end. They receive
content from various analog or digital video sources, like Betacam tape machines or
satellite-receivers and distribute the content over an access network. Three key features
of the IPTV products are their ability to encode, transcode and transrate uncompressed
and/or compressed video feeds. Encoding means to compress an uncompressed
video source (analog or digital); Transcoding means the conversion of a video
bitstream from one compression format to another and Transrating is the
reduction of the bitrate of the video content without changing the compression format. The
IPTV products may also be used to implement networked personal video recording, or nPVR,
by streaming live channels to a video server in the headend rather than delivering to
subscribers directly. Instead, the server delivers the content to subscribers allowing
pause, continue, rewind and fast forward through its recently recorded content.

The
IPTV products are also suitable for other applications, complementing the Video
Technologies products, where there is a requirement to handle many channels at one
location, where high availability is crucial or when transcoding or transrating are
needed, such as in certain enterprise and governmental applications, and monitoring for
military and police organizations.

The
IPTV products may also be used to stream live broadcasts to a logging video server to meet
compliance check requirements enforced by government regulation bodies or by advertisers.

The
MGW5100 is a video streaming platform that lets carriers transport video over broadband IP
or ATM networks such as Digital Subscriber Line, or DSL, and optical fiber, or FTTx. The
MGW5100 encodes, transcodes, transmits and recasts up to 26 streams in MPEG-1, MPEG-2,
H.264 (i.e. MPEG-4 Part 10 or AVC) or Windows Media Technology (WMT) compatible
formats. Our suite of management solutions allows the operator to configure each MGW5100
device and receive its status including the receipt of alarms upon malfunction. The
management applications also support channel redundancy whereby a malfunctioning channel
is substituted by a redundant channel. The management applications are implemented using
the Simple Network Management Protocol (or SNMP), which is commonly used by network
equipment vendors, thus enabling smooth integration of our products into common higher
level network management applications.

The
MGW1100 has a smaller form factor than the MGW5100 and supports up to 12 channels. It
targets regional headends and other smaller installations where fewer channels are
required.

For
the MGW5100 and MGW1100, we continue the development of the H.264 (i.e. MPEG-4 Part
10 or AVC) encoders and transcoders by releasing quality improvements and we plan to
support H.264 High-Definition encoding. During 2007 we also plan to add the capability to
deliver closed captions, teletext and subtitles to these products. We believe that these
new features will enable our customers to add new services and will better position our
platform.

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# Sales and Marketing

We
sell our products through the combined efforts of our direct internal 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. Our marketing strategy for IPTV products includes partnering
with other vendors and system integrators to create an IPTV eco-system thus making our
offering more complete and reducing integration complexities for the customer or system
integrator.

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 telecommunication operators, system integrators and OEM
accounts that offer strategic opportunities or large volume potential. North American
sales efforts are supplemented by our value added resellers, or VAR, channel, through
which our products are sold directly to end-users. North America accounted for
approximately 54% of our total sales in 2004, approximately 50% of our total sales in 2005
and approximately 45% of our total sales in 2006.

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. Our distributors do not usually have 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. 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 many of our distributors.
Many of our largest distributors have carried our products for over three years.

Distributor
and direct account relationships outside of North America are managed directly or
indirectly from our headquarters in Israel. In Europe these distributors and customers are
supported by our sales managers in Israel. This local presence approach brings with it
many advantages related to culture and language. Our office in Beijing, China directs our
sales efforts in China and Hong Kong and those in Japan are aided by our Japanese
representative in Tokyo. In India, we sell our products through our new local sales
office. Sales to Asia Pacific or APAC are managed from our office in Singapore and
directly from our headquarters in Israel. European sales constituted approximately 18% of
our total revenues in 2004, approximately 24% of our total revenues in 2005, and
approximately 18% of our total revenues in 2006, while sales in Eastern Asia constituted
approximately 18% of our total revenues in 2004, approximately 17% of our total revenues
in 2005, and approximately 24% of our total revenues in 2006. Sales in Israel and other
areas outside of North America was approximately 10% of our total revenues in 2004,
approximately 9% of our total revenues in 2005 and approximately 13% of our total revenues
in 2006. Please also see Item 5A. Operating Results below.

# Technology

Since
our inception, we have focused the efforts of our team of experienced personnel on
developing digital video solutions based on standards.

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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 enabled us to develop real-time MPEG data
transfer products and content creation tools.

In
December 2000, we acquired Viewgraphics Inc. Viewgraphics provided Optibase with expertise
in DVB (Digital Video Broadcast) technology, primarily through its development of the
MediaPump product. Since the acquisition we successfully incorporated the DVB
de-multiplexing technology of the MediaPump into our IPTV Product line to enable the
transcoding of video content from satellite and its distribution over IP and ATM-based
access networks. We continue to invest efforts in the development of these and other
technologies:

Encoder and decoder
related technology

Our
video encoding technology is based on the MPEG-1, MPEG-2, MPEG-4 part 2, and MPEG-4 part
10 international standards and Microsofts proprietary WMT streaming format. MPEG-4
Part 10, also known as H.264 and as AVC (Advanced Video Coding) is a relatively new video
compression format jointly developed by the ITU and MPEG. H.264 has been adopted by the
emerging IPTV industry for video compression and is also expected to be an enabler for the
distribution of high definition video signals (HDTV) over Satellite and Cable
infrastructures in the future. Our IPTV products use our standard definition H.264
encoding technology today. We are in the process of developing high definition H.264
encoding technology to be incorporated in our IPTV product line .

The
audio encoding technologies in our products include MPEG-1 Layer II encoding, Dolby AC-3
encoding licensed from Dolby and AAC (Advanced Audio Encoding).

We
have implemented some of these technologies on multimedia DSPs and others by integrating
dedicated silicon components and in some cases by integrating technology from a third
party.

Our
MPEG-2 encoder products use video encoding technology from LSI Logic. We have developed an
MPEG-4 part 2 encoder on a powerful multimedia DSP from Equator Technologies for some of
our products. Our H.264 technology was developed in cooperation with a certain technology
partner, primarily for our IPTV products. We have also developed an MPEG-2 PCI encoder of
high definition video using a dedicated component from NEL for various applications
including ingest in broadcast facilities and digital signage.

We
have developed an MPEG-1 Layer II encoder on a dedicated digital signal processor, or DSP,
and have integrated an implementation of a Dolby AC3 audio encoder, licensed from Dolby,
on the same DSP. Our AAC encoders were also developed in cooperation with technology
partners including Fraunhofer.

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, a patented technology we call EverSync assures the synchronization
of both audio and video, even when our products receive unstable video sources or are
subject to random noise and disconnections, eliminating the need for an external timing
correction device (or TBC).

Another
layer of encoding related technology is the multiplexing layer, which combines the
elementary audio and video streams into a single multiplexed stream. This layer also
supports the 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 the MPEG and MPEG 2
standards do not support certain lower frame rates, our patented technology (that we call
SmartMux) embodied in this layer enables the generation of streams with low frame rates,
trading smoothness of motion for higher image quality at a given bit rate.

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FPGA and Embedded
technology

For
some of our product we have developed proprietary technology running on field-programmable
gate arrays (FPGA) for processing video before encoding. Some aspects of the technology
are designed to stabilize the video input before it is sent for encoding, others are
designed to filter the video and derive a signal that is easier for the encoder to encode
efficiently. Recent developments in this field enable the scale down of a high definition
feed down to standard resolution for standard definition encoding.

DVB (Digital Video
Broadcast) technology

We
provide proprietary technology to record, play and process multiple program transport
streams (MPTS). The MediaPump can capture all the programs in a multiple program transport
stream. Also, on output, the MediaPump takes several single program transport streams, or
SPTS, 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 splice together the
digital data bits for two single program transport streams. This patented 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 also 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 hardware component that scrambles the content
emitted by the MediaPump before transmission. Having the scrambling feature implemented in
our hardware reduces the total cost of providing a service.

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, and the real time control
protocol, or RTCP, that are becoming widely adopted and standard in the industry. In
particular, we have implemented the specifications of the ISMA (Internet Streaming Media
Alliance) for the transmission of audiovisual content over the Internet. We have also
developed smoothing algorithms in our streaming products that are used to reduce
congestion of the network and prevent the dropping of packets in routers and by other
networking interfaces. Another mechanism enables graceful recovery when encountering
packet loss during the playing of a stream.

SDK (Software Development
Kit) technology

Our
PCI encoders, decoders and DVB related technologies as well as the networking related
technology described above are exposed by our software development kits, or SDKs. The
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, decoders and
DVB interface 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 SDKs have been designed so that once 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 Composer. The Composer handles the frame
accurate operation of encoding and controls a VCR (video cassette recorder) to enable
frame accurate capture from the device for the content creation process. A real-time
preview component allows for previewing encoded material via an external MPEG decoder.

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We
have developed support for the Material Exchange Format, or MXF in the Composer. MXF is a
file format that was designed for the interchange of audiovisual material and its
associated descriptive data (metadata) for the content creation workflow. The
Composer with MXF support will assist video 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.

We
are also developing the ability to transcode files from one compression format to another
using our PCI encoding technology. As the handling of high definition video is typically
processing intensive, the use of hardware is advantageous because it offloads the task
from the PC and speeds up the transcoding tasks.

We
have also developed the ability to encode two copies of the content simultaneously. One of
the copies is called the Master and is typically encoded at a high bit-rate and high pixel
resolution in order to retain the best video quality. The other copy is called the Proxy
and is encoded at a lower bit-rate and quality. The Master is the primary output of the
content creation process. The Proxy is frame-aligned with the Master, but being smaller,
can be used for browsing content easily over a network for review, annotation or for
preparing translated audio tracks or subtitles.

Management Software
Technology

As
part of the development of our media gateways products we have developed management
software. For some of our products we have implemented hyper text markup language, or
HTML, software for management using web-based browsers. For our IPTV products we have
developed a comprehensive management application using SNMP (simple network management
protocol). The application enables the provisioning of each device and provides
monitoring, alarm generation and automatic fail-over.

Transcoding technology

An
important feature developed for the IPTV products 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 (compliant with part 2 or part 10, the latter also referred to as AVC or
H.264), from MPEG-2 to Windows Media compliant format 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. Some of the technology is
licensed from a technology vendor and integrated into our products. 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 IPTV products, the MGW 5100 and the MGW 1100, 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.

# 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 developing technologies for a High Definition video encoder compliant with the
H.264 video compression specification to be incorporated into the IPTV product line. We
are also working to improve the quality of our standard definition H.264 encoder for
instance by implementing advanced preprocessing before encoding.

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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 April 15, 2007, our
research and development department was comprised of 45 employees all of whom are located
in our headquarters in Israel. Our research and development net expenses were $3.8 million
in 2004, $4 million in 2005, and $4.2 million in 2006.

Due
to the significant reduction of our Digital Non-Linear Editing operations we have
eliminated all of our R&D activities related to the Digital Non-linear product line.

Our
research and development efforts have been financed through internal resources as well as
through programs sponsored by the Israel Office of the Chief Scientist, or OCS, in the
Israeli Ministry of Industry and Trade, and the European Union Research and Development
Program. The total funding from these sources was $2 million in 2004, $2.1 million in
2005, and $1.9 million in 2006.

The
OCS funding programs support projects that result in commercial products until their
pre-release stage with an emphasis on technological innovation as well as business
justification. In addition, the OCS has reached agreements with offices of similar
function in other European countries to support collaborative international projects
between organizations in their respective countries. Within these programs an
international administrative body such as EUREKA and CELTIC and the national offices
approve projects and the national offices provide funding under their own terms. The terms
of funding by the OCS are described below.

Generally,
grants from the OCS constitute up to 50% of qualifying research and development
expenditures for a particular approved project. 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 limited to 100%
ofthe 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
payment of royalties is contingent upon actual sales of the products. The terms of the OCS
grants limit us from manufacturing products or transferring technologies developed using
these grants outside of Israel without special approvals, which may or may not be granted.
Even if we receive approval to manufacture the OCS supported products outside of Israel,
we would be required to pay an increased total amount of royalties, which may be up to
300% of the grant amount plus interest, depending on the manufacturing volume that is
performed outside of Israel at an increased annual return rate. In March 2005, the Israeli
parliament approved an amendment to the R&D Law, which permits under certain
conditions the transfer of such technology outside of Israel, including the payment of a
redemption price to be determined under regulations that have not yet been promulgated.
Through December 31, 2006, we received grants from the OCS aggregating $6.6 million
for certain of our research and development projects. As of December 31, 2006,
accrued and paid royalties to the OCS totaled $3.6 million. As of December 31, 2006 the
Company had an outstanding contingent obligation to pay royalties in the amount of
approximately $3 million plus interest.

In
addition to the programs mentioned above the OCS provides royalty-free grants through the
MAGNET program which dedicates its funds to the development of generic technology by
consortia of Israeli companies in Israel. We have already participated in two MAGNET
consortia, MOST and STRIMM and are currently participating in NEGEV. One of the goals of
the MOST project was the creation and distribution of digital video over networks for
on-line services. The MOST project was completed and the consortium terminated on
March 31, 2000. The goals of the STRIMM project were 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 are
transcoded without user intervention, according to the connection and device capabilities
of the terminal. The STRIMM project was completed on July 31, 2005. Through
December 31, 2006, we recorded grants from the MAGNET, MOST and STRIMM consortiums,
aggregating $5.4 million. The goal of the NEGEV consortium is to develop the
infrastructure and techniques for the processing, management and delivery of content to
facilitate personalized, on-demand services over broadband and mobile networks. This
consortium began operation in August 2006.

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We
are also involved in joint development projects with large European companies under the
auspices of, and with financial assistance from, the European Union Research and
Development Framework Programs. We have been active contributors in many such projects and
have been the coordinator of three: VideoGateway, MUFFINS and TIRAMISU.

The
VideoGateway project developed a gateway between the narrow band internet and the next
generation broadband internet for the purpose of offering live and on-demand video
content. MUFFINS was established to investigate the problem of description, delivery and
protection of rich-media content, and to propose different scenarios for using that
content. The scenarios include the definition and search for the content, as well as the
delivery and the related handling of rights management. TIRAMISU proposes a protected
framework for the creation, delivery and consumption of audio-visual media across a wide
range of hybrid networks and platforms.

We
believe that participation in such projects increases our exposure to new technologies,
products and potential customers. Within the EU framework we have cooperated closely with
large European organizations such as France Telecom, Alcatel, T-Systems, Siemens AG,
Fraunhofer, Telefónica I+D and THALES. 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, 2006 we have obtained approvals for grants for fifteen research and
development projects for a total amount of approximately $6.9 million (of which
approximately $6.3 million has already been offset against research and development
expenses).

# Service and Support

We
believe that providing a high level of customer service and support is essential to our
success. Since 2005, we have been offering our IPTV customers two types of service level
agreements (SLA) Silver service and Gold service. The main differences between the two
types of services is that SLA is offered during standard working hours and Gold SLA is
available for 24 hours a day, on all days of the year. The gold service level also offers
an advance replacement service. Our technical support personnel provide worldwide services
through each of our main offices in Israel, United States, China, Singapore, India and
Japan. In the United States, we provide the first-line of support through our wholly owned
subsidiary, Optibase Inc., from the Mountain View office. 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 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 also provide a one-year
warranty on our hardware products. In addition, we 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 facilities belonging to the subcontractors and at 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 products are presently available from, or supplied by, only one
source and other components are available from limited sources.

|v | H.264
SD and HD video encoding tools provided by a technological partner;
|- | -------------------------------------------------------------------------

|v | Various
modules, which are integrated in our systems, both for the MGW5100, MGW 1100 and the
MGW1000 including: Switches supplied by PTI (Performance Technologies Inc.) and
Interface, a switch supplied by Intel, Hosts supplied by Freescale and Kontron, backplane
board by Kaparel Corporation Pentium, CPU modules supplied by Kontron and Compact Pci
platforms supplied by EPS (Israel) TECH 1992 Ltd.;
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|v | Digital
Signal Processing, or DSP, compression techniques, manufactured by Equator Inc. and TI,
which are used in our MGW 5100, MGW 1100, MGW 2400, MGE 400 and Movie Maker 400 products;
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|v | Video
compression chips manufactured by LSI Logic;
|- | --------------------------------------------------

|v | Audio
Analog to Digital Converters (A/D), Digital to Analog Converters (D/A) and decompression
chips manufactured by Crystal Semiconductor Corporation, or Crystal, a subsidiary of
Cirrus Logic, which are included in our encoders and decoders;
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|v | Freescale,
Inc.'s DSPs, which are included in our decoders and encoders;
|- | ------------------------------------------------------------------------

|v | A
video decoding chip manufactured by IBM;
|- | ------------------------------------------

|v | HD
compression chips manufactured by NEL;
|- | -----------------------------------------

|v | SDI
interface chips manufactured by Gennum;
|- | -------------------------------------------

|v | Microprocessor
and PCI bridge devices from Intel that are used in our MediaPump and MovieMaker boards;
|- | ------------------------------------------------------------------------------------------------------

|v | A
video processing chipset from Gennum, which is used in our MM200s;
|- | --------------------------------------------------------------------

|v | Programmable
devices by Xilinx, which are used in our Mediapump;
|- | ----------------------------------------------------------------

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 in the future we will not face
interruptions or delays in the 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

Competition
in the markets of both Video Technologies and IPTV product lines is intense and we expect
competition to increase.

The
Video Technologies markets have grown in recent years and have attracted many competitors.
Advances in video encoding technologies and in desk-top processing capabilities have also
enabled sophisticated new applications within these markets which require an in-depth
understanding of customer needs and significant development efforts. Moreover, the
availability of video encoding technologies has also driven prices for products down
within these markets. In contrast, the IPTV market is in its infancy, but is currently
dominated by large companies that can afford to aggressively promote their products by
reducing prices. To be competitive in each product line, we must continue to respond
promptly and effectively to changing customer preferences, feature and pricing
requirements, technological change and competitors innovations.

The
principal competitors of our Video Technologies products in the Enterprise and Government
markets are VBrick Systems Inc., Amnis Systems (formerly Optivision, Inc.) and Verint
Systems, Inc. In the Broadcast markets our competitors for these products include Vela
Research Inc., Dektec, VideoPropulsion, CMI and Stradis, Inc. In the post-production
market we compete with Canopus and Matrox, The post-production market is also
characterized by increasing indirect competition from vendors of software encoders and
decoders like Digital Rapids, Ligos and Intervideo combined with capture cards from
Winnov, Inc. and Viewcast, Inc.

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The
principal competitors in the IPTV market include Envivio, Thomson, Tandberg Television
ASA, Harmonic Inc., Minerva Inc. and to a limited extent, Scopus. In January 2007, we
purchased from Koor Corporate Venture Capital and Koor Industries Ltd. approximately 23%
of Scopus issued share capital. Item 10C. Material Contracts below. Many
of these competitors have substantially greater financial, technical, and marketing
resources than Optibase. 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, some companies in the digital
video and streaming market, 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 digital video and streaming
market. 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 further lower product prices and we may 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.

# Intellectual Property

Our
future success and ability to compete are dependent, in part, upon our proprietary
technology. We rely on patent, trade secret, trademark, copyright law, and confidential
agreements to protect our intellectual property. Relating to technologies developed in
Optibase Ltd., we hold ten issued patents, four granted in Israel, four granted in the
United States, one in Australia and one in Europe (verified in France and the United
Kingdom). We also have two pending application in the United States and one in Israel
relating to the MGW 5100 (one of which was already granted in Europe).

We
also acquired a patent portfolio relating to the DVB technology in connection with the
Viewgraphics transaction, see Item 4A. History and Development of the Company
above. This includes five allowed patents in the United States and one in Israel.

Certain
patents acquired by us in the Media 100 transaction were sold to Acoustics Technology LLC,
see Item 10C. Material Contracts below.

# Effect of Government
Regulation on 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 OCS, in the Israeli Ministry of Industry, Trade and Labor for the support
of research and development activities. We also obtained funding from the MOST, STRIMM and
NEGEV consortia, which are part of the OCS MAGNET program. The terms of the OCS grants
limit us from manufacturing products or transferring technologies developed using these
grants outside of Israel without special approvals, which may or may not be granted. For
further information see Research and Development above.

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We
are subject to the Companies Law and regulations promulgated under that law, which
regulate the activities of companies incorporated in Israel. Please see the Item 3D.
Risk Factors under the heading Risks Related to Operating in
Israel above, as well as Item 10. Additional Information below for
more information on the effects of governmental regulation of our business.

# 4C. Organizational
Structure

Optibase
has one wholly owned subsidiary: Optibase, Inc. which was incorporated in 1991 in Delaware
and is currently located in Mountain View, California. Optibase, Inc. manages our North
American sales, marketing and customer support activities.

Our
sales activities in Europe (including Israel) are conducted through sales managers. In
1999 and 2000 we established offices in Japan and in China, respectively, to cultivate
closer relationships with local sales forces and potential system integrators and expand
our business development activities in those local markets. In 2005 we established an
office in Singapore that focuses on marketing, and supports our products in Asia Pacific.
During 2007 we established a new office in India, which will focus on marketing and
supporting our products in India.

In
addition, we hold convertible bonds which if converted will constitute approximately 34%
of V.Box, a provider of Digital TV and Data Broadcast receiver equipment for Video and
Data applications. We also hold approximately 7.08% of Mobixells issued and
outstanding share capital, which designs, develop and markets solutions for mobile rich
media adaptation, optimization and delivery. We further hold approximately 23% of Scopus
Video Networks Ltd. which is engaged in the development, marketing and support of digital
video networking products that enable network operators to offer advanced video services
to their subscribers.

# 4D. 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 7,404 square feet in Mountain View,
California. The current lease expires on August 31, 2009.

We
rent an office of approximately 1,496 square feet in Beijing, China pursuant to a one-year
lease that will expire in December 2007. We rent an office of approximately 590 square
feet in Singapore. Since March 2007 we are renting 430 square feet in India.

|Item 4A. | Unresolved
Staff Comments
|-------- | -------------------------

Not
Applicable.

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

The
following discussion and analysis 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 3D. Risk Factors above and Item
5D.  Trend Information below, 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 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 through two product lines: Video Technologies and IPTV. Our products
are sold both directly and through various indirect channels, such as independent
distributors, system integrators, OEMs and resellers.

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In
June 2004, we purchased certain assets and liabilities of Media 100, Inc. which formed the
basis of our former Digital Non-Linear Editing product line. While the Digital Non-Linear
Editing product line represented approximately 13.6% of our revenues in 2005, it also
required diversion of research and development resources and significantly increased our
expenses. As a result, during the quarter ended December 31, 2004 our board of directors
decided to significantly reduce the operation of our Digital Non-Linear Editing product
line and focus our resources on initiatives in the IPTV market. On January 7, 2005, we
announced a restructuring of our Digital Non-Linear Editing product line. A considerable
number of employees were laid off and our research and development efforts were
significantly reduced. As a result, we recorded impairment of long-lived assets of
approximately $2 million in the quarter ended December 31, 2004 and restructuring charges
of approximately $84,000 in the quarter ended March 31, 2005.

On
June 22, 2005, we signed an agreement with Artel Software Corp. (commonly known as Boris
FX), pursuant to which we sold one of our products known as the Final Effects complete
product suite, in consideration for $100,000. In respect of such sale we recorded other
income in the amount of $75,000 (net of transaction expenses in the amount of $25,000.
During the third quarter of 2005 we entered into an additional agreement with Boris FX
pursuant to which we sold our Digital Non-Linear Editing product line activity including
all service, warranty and maintenance obligations. We have further undertaken to supply
Boris FX, at Boris FX request, with manufacturing services for the Media 100 HD
boards for a period of 24 months beginning on September 28, 2005, see also Item 10C.
Material Contracts below. As a result, we recorded capital losses in the
amount of $60,000 due to the sale of certain fixed assets to Boris FX and restructuring
charges of approximately $125,000 related to our facilities future rent obligation.

On
November 1, 2005, as part of the agreements signed with Boris FX, we entered into a
sublease agreement with Boris FX pursuant to which we subleased our facilities in
Marlborough, Massachusetts (totaling approximately 19,182 square feet) to Boris FX until
December 31, 2007. The aggregate consideration to be paid to us in connection with the
sublease is approximately $453,000. Our future lease payment under the lease agreement
until December 31, 2007 amount to approximately $550,000. We have recorded the sublease
payment as a reduction of the restructuring accrual. In the fourth quarter of, 2006 based
on recent assessments and in accordance with the guidance of SFAS 144 and EITF 03-13, we
have decided to present the Digital Non Linear product line operation as discontinued
operations and our comparable results for 2005 and 2004 were adjusted accordingly.

As
we believe the IPTV market is still in its infancy, we have invested significantly in the
promotion and sales of our products in order to increase sales and position ourselves as a
major player in the market. During 2005 and 2006, we strengthened our sales team and sales
support team and expanded our worldwide reach

During
the fourth quarter of 2005, we introduced a new version of the MGW5100 that supports H.264
video encoding. H.264 also known as MPEG-4 Part 10 and as AVC (Advanced Video Coding), is
a new video compression standard jointly developed by the ITU and MPEG. H.264 has been
adopted by the emerging IPTV industry for video compression and is also expected to be an
enabler for the distribution of high definition video signals (HDTV) over Satellite and
Cable infrastructures in the future. During 2006 we have seen this trend strengthening.
The H.264 compression standard is a requirement in the majority of IPTV deployments.
Moreover, the requirement to provide HDTV channels encoded with H.264 for IPTV is also
quite common.  On March 10, 2006, the Society of
Motion Picture and Television Engineers (SMPTE) formally published the Final Specification
for SMPTE 421M, also known as VC-1. VC-1 is an advanced compression format based on
Microsofts Windows Media 9. Though now standardized, the industry is not widely
deploying IPTV services using this format.

We
generate most of our revenues from three territories: North America, Europe, including
Israel, and Asia Pacific. During 2006, these three regions accounted for 45%, 31% and 24%
of our revenues, respectively.

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As
of December 31, 2006, we had available cash, cash equivalents, long term investments and
other financial investments net of approximately $42.9 million. For information regarding
the investment of our available cash, see Item 5B. Liquidity and Capital
Resources below.

We
use the U.S. dollar as our functional currency. Our consolidated financial statements are
presented in U.S. dollars and prepared in accordance with generally accepted accounting
principles in the U.S., or U.S. GAAP. In 2006, most of our revenues were denominated in
U.S. dollars and we expect that a significant portion of our revenues will continue to be
denominated in U.S. dollars, with a smaller portion denominated in Euros and other
currencies. Our expenses to date have been incurred, in almost equal parts, in U.S.
dollars or currencies linked to the U.S. dollar, and in New Israeli Shekels. Our
transactions denominated in currencies other than the U.S. dollar are converted into U.S.
dollars and recorded based on the exchange rate at the time we issue the invoice for the
transaction. Our headquarters are located in Herzliya Pituach, Israel; our subsidiary
facilities in the United States are located in Mountain View, California. We maintain
offices in Japan, China, Singapore and India in order to establish and expand our
local presence at the markets and use the advantages, related to culture and
language, of that approach.

Revenues and Sales

The
following table sets forth, for the periods indicated, the total consolidated sales (in
thousands) derived from each of our product lines.

|                 | Year Ended December 31,
|---------------- | -----------------------
|
|
|
|
|Video Technology |                        
|IPTV             |                        
|                 |                        
|Total            |                        

Our
level of revenues fluctuated in recent years from $17.8 million in 2004, to $19.3 million
in 2005 and to $18 million in 2006. The decrease in 2006 compared to 2005 can mainly be
attributed to the decrease in our Video Technology product line sales in 2006 which was
partially offset by the addition in sales of our IPTV product line sales. The IPTV product
line generated revenues of approximately $6 million in the 2006 compared to approximately
$4 million in the 2005 and approximately $2.4 million in 2004. The increase is mainly due
to our increased focus on the IPTV market and allocation of sales efforts and resources
towards it. The increase in 2005 compared to 2004 can be mainly attributed to the increase
in our IPTV product line sales. However, our level of losses in recent years has stayed
relatively the same with a slight improvement over the years. We managed to reduce the
yearly loss from net loss of $3.7 million in 2004 to $3.4 million in 2005 and to $3.1
million in 2006. The decrease in our net loss in 2006 can be mainly attributed to the
decrease in our other expenses, which reflect the recorded impairment losses of Vbox
Communications. The decrease in our net loss in 2005 can be mainly attributed to the
significant decrease in our operating expenses as a result of selling our Digital
Non-Linear Editing product line activity during 2005, offset by the decrease in our
financial income. As of December 31, 2006, we had accumulated losses of $73 million.

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.

|                                  | Year Ended December 31,
|--------------------------------- | -----------------------
|
|
|
|
|North America                     |                        
|Europe                            |                        
|Eastern Asia                      |                        
|Other countries, including Israel |                        

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The
portion of our revenues, as a percentage of total sales and in dollar amounts, derived
from sales into North America and Europe decreased in 2006 compared to 2005 while the
portion of sales into Eastern Asia and other countries including Israel increased. The
decrease in sales into North America can be mainly attributed to infancy of the IPTV
market in this region, on the other hand the increase in sales into eastern Asia is a
result of our successful efforts to promote our product, close few significant IPTV deals
and increase sales in this region. We sell directly to system integrators, OEMs and
value-added resellers, or VARs. Outside of North America, we also sell to 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.

The
majority of our revenues are derived from sales of our standard products. 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. Dollar
amount and the percentage of revenues represented by standard products and customized
products, respectively, fluctuate from period to period depending on a variety of factors,
including the number, size and timing of customized product activities.

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 Israeli OCS, amortization of capitalized software development costs,
other acquisition related costs and allocated overhead attributable to our production
operations.

Research and development
expenses

Research
and development expenses, net, consist primarily of labor expenses, development-related
raw materials and sub contractors services, acquisition related costs and stock option
compensation charges and related overheard, offset by grants from the OCS, including the
OCS MAGNET program, and from the European Union.

Sales and marketing
expenses

Selling
and marketing expenses, net, consist primarily of compensation expenses, promotional
expenses, travel costs and related overhead and expenses.

General and
administrative expenses.

General
and administrative expenses consist primarily of fees to outside consultants, legal and
accounting fees, stock option compensation charges and certain office maintenance costs.

Financial income
(expenses), Net.

Financial
expenses consist primarily of interest we paid in connection with 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 and financial
instruments. Our exchange differences occur primarily as a result of the change of the NIS
value relative to the U.S. dollar.

Taxes

As
of 2006, Israeli companies are generally subject to a corporate income tax rate of 31%.
The income tax rate for Israeli companies is scheduled to be gradually reduced to 25% by
2010. We were granted Approved Enterprise status under the Law for the Encouragement of
Capital Investment, 1959 which allow us to enjoy two alternative tax benefits. Under one
of the alternatives, a companys undistributed income derived from an Approved
Enterprise will be exempt from corporate 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
of 10%-25% for the remainder of the benefits period depending on the level of foreign
investment. See also Item 10E. Taxation under the heading Israeli
Taxation-Law for the Encouragement of Capital Investment, 1959 below. The period
during which we are entitled to receive these benefits is limited to seven or ten years
from the first year that taxable income is generated, 12 years from commencement of
production or within 14 years from the date of approval of the Approved Enterprise
status.A recent amendment to the Law, which has been officially published
effective as of April 1, 2005 has changed certain provisions of the Law. An eligible
investment program under the amendment will qualify for benefits as a Privileged
Enterprise (rather than the previous terminology of Approved Enterprise). See also Item
10E. Taxation under the heading Israeli Taxation-Law for the
Encouragement of Capital Investment, 1959 below.

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As
of December 31, 2006, we had approximately $32.9 million of net operating loss
carry-forwards for Israeli tax purposes which we will have to utilize before we can make
use of the tax benefits arising from our Approved Enterprise status. These net
operating loss carry-forwards have no expiration date

# 5A. Operating Results

The
following table sets forth, for the years ended December 31, 2004, 2005 and 2006
statements of operations data as percentages of our revenues:

|                                             | Year Ended December 31
|-------------------------------------------- | ----------------------
|
|
|
|
|Revenues                                     |                       
|Cost of revenues                             |                       
|Gross margin                                 |                       
|Operating expenses:                          |                       
|Research and development, net                |                       
|Selling and marketing, net                   |                       
|General and administrative                   |                       
|Total operating expenses                     |                       
|Operating (loss)                             |                       
|Other income (expenses), net                 |                       
|Financial income, net                        |                       
|Net income (loss) from continuing operations |                       
|                                             |                       
|(Loss) Income from Discontinued Operations   |                       
|Net loss                                     |                       

# Results of Operations
for the Years Ended 2006 and 2005

In
June 2004, we acquired certain assets and liabilities of Media 100 Inc. as part of a
pre-packaged bankruptcy filing of Media 100. In September 2005, we entered into an
agreement for the sale of our Digital Non-Linear Editing operation to Artel Software Corp.
for details regarding the sale agreement, see Item 10C. Material Contracts
below. In December 2006, based on recent assessments in accordance with the guidance SFAS
144 and EITF 03-13, we have decided to present the non-linear editing product line
operation as discontinued operations and as such all amounts related to the operational
results of the digital non linear product line presented accordingly. For further
information on the digital non linear transactions see Item 5. Operating and
Financial Review and Prospects  Overview above.

Revenues.
          Our revenues decreased by 7.1% to $18 million in 2006 from $19.3 million in
          2005. The decrease can mainly be attributed to the decline in our Video
          Technology product line sales by approximately 21% partially compensated by the
          increase in sales of the IPTV product line, mainly in Europe and Asia Pacific.

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Cost
of Revenues. Cost of revenues as a percentage of revenues increased to approximately
42.9% in 2006 compared to approximately 40.4% in 2005, an increase of approximately 3%,
and amounted both in 2005 and 2006 to $7.8 million. The slight increase can be mainly
attributed to the increased sales of our IPTV products in which the cost of materials is
relatively higher than the Video Technology product line. Our cost of revenues may
fluctuate as a percentage of revenues depending on our product mix, changes in raw
materials cost and other factors.

Research
and Development Expenses, Net. Our net research and development expenses increased by
approximately 5.2% to $4.2 million in 2006 from $4 million in 2005. As a percentage of
revenues, net research and development expenses increased to approximately 23.4% in 2006
from approximately 20.7% in 2005. The increase in research and development expenses can
primarily be attributed to the decrease in our research and development grants received
from the OCS and the European Union by approximately $215,000 and compensation expenses,
due to the implementation of SFAS 123R, totaling approximately $268,000, partially offset
by the reduction of other expenses mainly subcontractors costs. Research and development
grants received from the OCS, including the OCS MAGNET program, and from the European
Union decreased to approximately $1.9 million in 2006 from approximately $2.1 million in
2005.

Selling
and Marketing Expenses, Net. Our net selling and marketing expenses decreased
approximately by 5.8% to $8.3 million in 2006 from $8.8 million in 2005. As a percentage
of revenues, net selling and marketing expenses increased to approximately 46.1% in 2006
from approximately 45.4% in 2005. The decrease in selling and marketing expenses can be
primarily attributed to the decrease in salaries and related costs which was a result of
departure of employees mainly in our U.S base company. Selling and marketing
expenses may fluctuate as a percentage of revenues, depending, in part, on fluctuations in
the level of revenues.

General
and Administrative Expenses. General and administrative expenses increased
approximately by 12.8% to $2.1 million in 2006 from $1.9 million in 2005. As a percentage
of revenues, general and administrative expenses increased to approximately 11.9% in 2006
from approximately 9.8% in 2005. The increase in dollar amount can be mainly attributed to
an increase in our expenses for professional services, increase in our bad debt expenses
and compensation expenses, due to the implementation of SFAS 123R.

Operating
Income. As a result of the foregoing, we recorded operating loss of $4.4 million in
2006 compared with an operating loss of $3.2 million in 2005. The decrease in the
operational loss can be primarily attributed to the increase in research and development
costs, the increase in our general and administrative expenses and the decrease in our
revenues.

Other
Income (Expenses), Net. We recorded other expenses, net, of $171,000 in 2006, compared
to other expenses, net of $622,000 million in 2005. In 2006 and 2005 we recorded expenses
totaling approximately $173,000 and $622,000, respectively in respect of our investment in
V.Box by following the guidelines of the hypothetical liquidation method.

Financial
Income (Expenses), Net. We recorded financial income, net of $1.4 million in 2006,
compared with $1.6 million in 2005. The decrease can be mainly attributed to the
continuing increase in the 6-month Libor rate during 2006, which resulted in our
continuing loss of interest on the structured notes we acquired. For additional details
regarding our structured notes, see Item 3D. Risk Factors under the heading
Risks Relating to the Economy, Our Financial Condition and Shareholdings above
and Item 11 Quantitative and Qualitative Disclosure About Market Risk under
the heading Investment Risk below.

Net
Income (Loss) from Continuing Operations. We recorded net loss of $3.1 million in
2006, compared with a net loss of $2.2 million in 2005. The increase in our net loss from
continuing operations can be mainly attributed to the decrease in our Gross profit as a
result of the decrease in our sales partially offset buy the decrease in other expenses,
representing Impairment losses of our subsidiary V.Box, by approximately $450,000.

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Discontinued
Operation.In the fourth quarter of 2006 based on recent assessments and in accordance
with the guidance of SFAS 144 and EITF 03-13, we have decided to present the Digital Non
Linear product line operation, which was sold in the third quarter ending September 30,
2005, as discontinued operations. Net income related to discontinued operation in 2006
totaled to $15,000, compared to net loss of $1.3 millions in 2005.

Net
Income (Loss). We recorded net loss of $3.1 million in 2006, compared with a net loss
of $3.4 million in 2005. The slight decrease in our net loss can be mainly attributed to
the termination of the Digital Non Linear Editing product line activity during 2005, this
activity, which was classified as discontinued operation, (see Item 5.
Operating and Financial Review and Prospects  Overview above) generated a net
loss of $1.3 millions in 2005 compared to net revenues of $15,000 in 2006. The decrease
can also be attributed to the decrease in our other expenses, representing Impairment
losses of our subsidiary V.Box, by approximately $450,000. The decrease in our expenses
was offset by the decrease in our sales and as a result the decrease in our gross profit
by approximately $1.3M.

# Results of Operations
for the Years Ended 2005 and 2004

Revenues.
          Our revenues increased by 8.4% to $19.3 million in 2005 from $17.8 million in
          2004. The increase can mainly be attributed to the increase in sales of the IPTV
          product line, mainly in Europe, while the Video Technology product lines remain
          stable.

Cost
of Revenues. Cost of revenues increased by approximately 3.9% to $7.8 million in 2005
from $7.5 million in 2004. The increase can be mainly attributed to the increased sales of
our IPTV products in which the cost of materials is relatively higher than the Video
Technology product line. Cost of revenues as a percentage of revenues decreased to
approximately 40.4% in 2005 compared to approximately 42.1% in 2004. Our cost of revenues
may fluctuate as a percentage of revenues depending on our product mix, changes in raw
materials cost and other factors.

Research
and Development Expenses, Net. Our net research and development expenses increased by
approximately 6.4% to $4 million in 2005 from $3.8 million in 2004. As a percentage of
revenues, net research and development expenses decreased to approximately 20.7% in 2005
from approximately 21.1% in 2004. The increase in research and development expenses can
primarily be attributed to an increase in developmentrelated raw materials and
subcontractors services. Research and development grants received from the OCS, including
the OCS MAGNET program, and from the European Union increased to approximately $2.1
million in 2005 from approximately $2 million in 2004.

Selling
and Marketing Expenses, Net. Our net selling and marketing expenses increased
approximately by 10.9% to $8.8 million in 2005 from $7.9 million in 2004. As a percentage
of revenues, net selling and marketing expenses increased to approximately 45.5% in 2005
from approximately 44.4% in 2004. The increase in selling and marketing expenses can be
primarily attributed to our efforts to thicken our sales and technical support force and
our efforts to expand our local presence mainly in the Far East. Selling and marketing
expenses may fluctuate as a percentage of revenues, depending, in part, on fluctuations in
the level of revenues.

General
and Administrative Expenses. General and administrative expenses decreased
approximately by 20.2% to $1.9 million in 2005 from $2.4 million in 2004. As a percentage
of revenues, general and administrative expenses decreased to approximately 9.8% in 2005
from approximately 13.3% in 2004. The decrease in dollar amount can be mainly attributed
to the decrease in labor costs and other expenses.

Operating
Income. As a result of the foregoing, we recorded operating loss of $3.1 million in
2005 compared with an operating loss of $3.7 million in 2004. The decrease in the
operational loss can be primarily attributed to the increase in gross profit as a result
of the sales incrementtotaled to approximately $1.2 million and the decrease in
our general and administrative expenses offset by the increase in our R&D and
marketing and selling costs.

Other
Income, Net. We recorded other expenses, net, of $622,000 in 2005, compared to other
income of $808,000 in 2004. The expenses in 2005 consist of approximately $622,000 in
respect of our investment in Vbox by following the guidelines of the hypothetical
liquidation method. In 2004 we have recorded net income of $808,000. Of the total income
in 2004, $1.4 million is related to the claim settlement with Merrill Lynch & CO. paid
to us during February 2004 following an award in favor of us by the arbitration panel on
December 24, 2003. We also recorded expenses totaling approximately $574,000 in respect of
our investment in V.Box by following the guidelines of the hypothetical liquidation
method.

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Financial
Income (Expenses), Net. We recorded financial income, net of financial expenses, of
$1.6 million in 2005, compared with $5.7 million in 2004. The decrease can be mainly
attributed to the increase in the 6-month Libor rate during 2005 which resulted in our
loss of interest on the structured notes we acquired. For additional details regarding our
structured notes, see Item 3D. Risk Factors under the heading Risks
Relating to the Economy, Our Financial Condition and Shareholdings above and Item 11
Quantitative and Qualitative Disclosure About Market Risk under the heading
Investment Risk below.If the 6-month Libor rate remains in its current
rate or continues to increase, we expect not to receive the interest for the upcoming
payment period with respect to all of our structured notes.

Net
Income (Loss). We recorded net loss of $3.4 million in 2005, compared with a net loss
of $3.7 million in 2004. The decrease in our net loss can mainly be attributed to our
decision to significantly reduce our Digital Non-Linear Editing research and development
effort which eventually resulted in our decision to terminate the Digital Non-Linear
Editing activity which is presented as discontinued operation and the decrease in other
income net, which was offset by the decrease in our financial income and the decrease in
other operating expenses.

# 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 our 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:

|v | Revenue
recognition;
|- | --------------------

|v | allowance
for doubtful debts;
|- | -----------------------------

|v | Inventories   valuation;
|- | ------------------------

|v | Impairment
of goodwill and long- lived assets;
|- | ----------------------------------------------

|v | Impairment
of other long- term investment;
|- | ------------------------------------------

|v | Impairment
and classifications of marketable securities investments;
|- | --------------------------------------------------------------------

|v | Accounting
for stock-based compensation; and
|- | --------------------------------------------

|v | 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 directly and through
distributors, systems integrators, VARs and OEMs who are considered end-customers.

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Revenues
from product sales in which the software is incidental to the hardware 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.

Revenues
from sale of products that include post customer support are recognized in accordance with
Emerging Issues Task Force (EITF) Issue No. 00-21, Revenue Arrangements
with Multiple Deliverables (EITF 00-21) a multiple-element arrangement
(an arrangement that involves the delivery or performance of multiple products, services
and/or rights to use assets) is separated into more than one unit of accounting, if the
functionality of the delivered element(s) is not dependent on the undelivered element(s),
there is vendor-specific objective evidence (VSOE) of fair value of the undelivered
element(s) and delivery of the delivered element(s) represents the culmination of the
earnings process for those element(s). If these criteria are not met, the revenue is
deferred until such criteria are met or until the period in which the last undelivered
element is delivered.

Revenues
from sale of products that require significant customization, integration and installation
are recognized based on SOP 81-1, Accounting for Performance of Construction-Type
and Certain Production-Type Contracts, according to which revenues are recognized on
a percentage of completion basis. Percentage of completion is determined based on the
Output Method, upon completion of milestones, when collectibility is probable.
After delivery of milestone, if uncertainty exists about customer acceptance, revenues are
not recognized until acceptance. Provisions for estimated losses on uncompleted contracts
are recognized in the period in which the likelihood of the losses is identified.

Revenues
from product sales in which the software is fundamental to the hardware are recognized in
accordance with Statement of Position 97-2, Software Revenue Recognition, as
amended (SOP No. 97-2). SOP No. 97-2 generally requires revenue earned on
software arrangements involving multiple elements to be allocated to each element based on
the relative fair value of the elements. In addition, we adopted Statement of Position
98-9, Modification of SOP 97-2, Software Revenue Recognition with Respect to Certain
Transactions, (SOP No. 98-9). SOP No. 98-9 requires that revenue be
recognized under the residual method when Vendor Specific Objective Evidence
(VSOE) of Fair Value exists for all undelivered elements and VSOE does not
exist for all of the delivered elements. Under the residual method any discount in the
arrangement is allocated to the delivered elements.

Maintenance
and support revenue included in multiple element arrangements is deferred and recognized
on a straight-line basis over the term of the maintenance and support agreement. The VSOE
of fair value of the undelivered elements (maintenance and support) used by us, is
determined based on the renewal rate charged when these elements are sold separately. We
recognize revenues from 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.

Amounts
received from customers for whom revenue has not yet been recognized, are presented as
deferred revenues.

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.

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.

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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, 2006, our provision for doubtful
debt was approximately $313,000.

Inventories valuation

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

Impairment of Goodwill
and Long- Lived Assets.

Our
business acquisitions resulted in goodwill and other long-lived assets. We periodically
evaluate our goodwill and long-lived assets for potential impairment indicators. Our
judgments regarding the existence of impairment indicators are based on legal factors,
market conditions and operational performance of our acquired businesses and investments.

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 No. 142, which became effective in 2002.

Impairment of other long-
term investment

We
have made investments in companies, which management believes is in our best interest and
may promote our strategic objectives. Before investments are executed, our executive
management and our board of directors approve them. 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 its 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. Our investment in companies: (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); (ii) 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 SAB 59. 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.

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Impairment and
classifications of marketable securities investments

As
of December 31, 2006 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. As of December 31, 2006, we reclassified
our structured notes having fair value lower than the amortized cost as long-term or short
terms investment according to the expected maturity date of the notes or the expected
redemption date of the note if See Item 11 Quantitative and Qualitative
Disclosure. Since we believe that the decline in fair market value is not
other-than- temporary and we have the intent and ability to hold the structured notes till
recovery in accordance with SAB 59.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.

Accounting for
equity-based compensation

Effective
January 1, 2006, we adopted FASB Statement No. 123(R), Share-Based Payment,
(SFAS 123(R)). SFAS 123(R) supersedes Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees (APB No. 25) and related
interpretations, and amends FASB Statement No. 95, Statement of Cash Flows.
Generally, the approach in SFAS 123(R) is similar to the approach described in SFAS 123.
However, SFAS 123(R) requires all equity-based payments to employees, including grants of
employee stock options, to be recognized in the statement of income based on their fair
values. Pro-forma disclosure is no longer an alternative. In 2006, we recognized
equity-based compensation expense under SFAS 123(R) in the amount of $714,000.

As
of December 31, 2006, we had $1.3 million of unrecognized compensation expense related to
non-vested shares options and non-vested restricted shares awards. For options granted
before January 1, 2006, and which had graded vesting, we recognized compensation expenses,
based on the accelerated attribution method over the requisite service period of each of
the awards. Forfeitures were accounted for as they occurred, but have been estimated with
the adoption of SFAS 123(R) for those awards not yet vested. SFAS 123(R) requires
forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent
periods if actual forfeitures differ from those estimates. Estimated forfeitures are based
on actual historical pre-vesting forfeitures.

We
adopted SFAS 123(R) using the modified-prospective-transition method. Under this
transition method, compensation costs recognized in 2006 include (a) compensation costs
for all stock-based payments granted prior to, but that had not yet vested as of, January
1, 2006, based on the grant date fair value estimated in accordance with the pro-forma
provisions of SFAS 123, adjusted for the effect of estimating forfeitures, and (b)
compensation costs for the equity-based payments granted subsequent to January 1, 2006,
based on the grant date fair value estimated in accordance with SFAS 123(R). Our
consolidated financial statements for prior periods have not been restated to reflect, and
do not include, the impact of SFAS 123(R). We selected the Black-Scholes option pricing
model as the most appropriate fair value method for our stock-options awards and value
restricted stock based on the market value of the underlying shares at the date of grant.

As
a result of adopting SFAS 123(R) on January 1, 2006, our income before income taxes for
2006 is $519,000 lower than if we had continued to account for equity-based compensation
under APB No. 25. Basic and diluted earning per share for 2006 is $0.04 lower than if we
had continued to account for equity-based compensation under APB No. 25

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.

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In
accordance with SFAS 5, accruals for exposures or contingencies are being provided when
the expected outcome is probable. 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, the actual outcome of such proceedings or as a result of the
effectiveness of our strategies related to these proceedings.

# Recent Accounting
Pronouncements

In
July 2006, the FASB issued FASB Interpretation No. 48 Accounting for Uncertainty in
Income Taxes an Interpretation of FASB Statement No. 109 (FIN 48). FIN
48 clarifies the accounting for income taxes by prescribing the minimum recognition
threshold a tax position is required to meet before being recognized in the financial
statements. FIN 48 utilizes a two-step approach for evaluating tax positions. Recognition
(step one) occurs when an enterprise concludes that a tax position, based solely on its
technical merits, is more-likely-than-not to be sustained upon examination. Measurement
(step two) is only addressed if step one has been satisfied (i.e., the position is
more-likely-than-not to be sustained). Under step two, the tax benefit is measured as the
largest amount of benefit, determined on a cumulative probability basis that is
more-likely-than-not to be realized upon ultimate settlement. FIN 48 applies to all tax
positions related to income taxes subject to the Financial Accounting Standard Board
Statement No. 109, Accounting for income taxes (FAS 109). This
includes tax positions considered to be routine as well as those with a high
degree of uncertainty. FIN 48 has expanded disclosure requirements, which include a
tabular roll forward of the beginning and ending aggregate unrecognized tax benefits as
well as specific detail related to tax uncertainties for which it is reasonably possible
the amount of unrecognized tax benefit will significantly increase or decrease within
twelve months. These disclosures are required at each annual reporting period unless a
significant change occurs in an interim period. FIN 48 is effective for fiscal years
beginning after December 15, 2006. The cumulative effect of applying FIN 48 will be
reported as an adjustment to the opening balance of retained earnings. We do not expect
the adoption of FIN 48 will have any material effect on our consolidated financial
statements.

In
September 2006, the FASB issued SFAS No. 157, Fair Value Measurements
(SFAS No. 157). This statement provides a single definition of fair value, a
framework for measuring fair value, and expanded disclosures concerning fair value.
Previously, different definitions of fair value were contained in various accounting
pronouncements creating inconsistencies in measurement and disclosures. SFAS No. 157
applies under those previously issued pronouncements that prescribe fair value as the
relevant measure of value, except SFAS No. 123(R) and related interpretations. The
statements does not apply to accounting standard that require or permit measurement
similar to fair value but are not intended to measure fair value. This pronouncement is
effective for fiscal years beginning after November 15, 2007. We are currently evaluating
the impact of adopting SFAS 157.

In
February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities (SFAS No. 159). This statement provides
companies with an option to report selected financial assets and liabilities at fair
value. Generally accepted accounting principles have required different measurement
attributes for different assets and liabilities that can create artificial volatility in
earnings. The Standards objective is to reduce both complexity in accounting for
financial instruments and the volatility in earnings caused by measuring related assets
and liabilities differently. This Statement is effective as of the beginning of an
entitys first fiscal year beginning after November 15, 2007. We are currently
evaluating the impact of adopting SFAS 159.

# 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.

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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.
Although Israel has entered into various agreements with Egypt, Jordan and the Palestinian
Authority, there has been an increase in unrest and terrorist activity in Israel, which
began in September 2000 and which has continued with varying levels of severity through
2006. In July 2006, an armed conflict began between Israel and Hezbollah forces in
Lebanon, which involved rocket attacks on populated areas in the northern parts of Israel.
In August 2006, a cease-fire between Hezbollah and Israel took effect. This situation has
had an adverse effect on Israels economy, primarily in the geographical areas
directly harmed by this conflict. Any future armed conflict, political instability or
violence in the region may have a negative effect on our business condition, harm our
results of operations and adversely affect our share price. No predictions can be made as
to whether or when a final resolution of the areas problems will be achieved or the
nature thereof and to what extent the situation will impact Israels economic
development or our operations. 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 45 are
obligated to perform military reserve duty of up to 36 days annually or longer under
certain circumstances. 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.

Economic Conditions

Israels
economy has been subject to numerous destabilizing factors, including a period of rampant
inflation in the early to mid-1980s, 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.

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 April 15, 2007, the deflation rate in Israel has decreased at a rate of 0.2% and the
NIS had devaluated against the dollar by approximately 3.7%. The inflation rate in Israel
was approximately 1.2% in 2004, the inflation rate in Israel was approximately 2.4% in
2005, and the deflation rate in Israel was approximately 0.1% in 2006. At the same time
the appreciation of the NIS against the dollar was approximately 1.6% in 2004, the
devaluation of the NIS against the dollar was approximately 6.8% in 2005 and the
appreciation of the NIS against the dollar was approximately 8.2% in 2006. As a result of
this differential, we experienced an increase in the dollar costs of operations in Israel
in 2004, a decrease in 2005, and an increase in 2006, 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.

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Trade Agreements

Israel
is a member of the United Nations, the International Monetary Fund, the International Bank
for Reconstruction and Development and the International Finance Corporation. Israel is
also a signatory to the General Agreement on Tariffs and Trade, which provides for
reciprocal lowering of trade barriers among its members. Israel has also been granted
preferences under the Generalized System of Preferences from Japan. These preferences
allow Israel to export the products covered by these programs either duty-free or at
reduced tariffs.

Israel
and the U.S. entered into a Free Trade Agreement (FTA) in 1985. Under the FTA, most
products receive immediate duty-free status. The FTA eliminated all tariff and some
non-tariff barriers on most trade between the two countries in 1995. Israel became
associated with the European Economic Community, now known as the European Union, under a
1975 Free Trade Agreement, which confers some advantages with respect to Israeli exports
to most European countries and obligates Israel to lower its tariffs with respect to
imports from those countries over a number of years. Israel is a member of the European
Unions Sixth Research and Development Program, giving Israelis access to research
and development tenders in the European Union countries. Since 1993, a free trade
agreement has been in effect between Israel and the European Free Trade Association, or
EFTA, whose members include Switzerland, Norway, Iceland and Liechtenstein. The agreement
grants the exporting countries of EFTA trading with Israel conditions similar to those
Israel enjoys with the U.S.

In
recent years, Israel has established commercial and trade relations with a number of other
nations, including Russia, China, India and other nations in Asia and Eastern Europe, with
which Israel previously had not had these relations.

# 5B. Liquidity and
Capital Resources.

We
have funded our operations primarily through private andpublic sales of our equity
securities, banks credit, research and development grants from, among others, the
Commission of the European Union and the OCS. As of December 31, 2006, we had cash,
cash equivalents, long term investments and other financial investments net of $42.9
million. Our operating activities used cash of $3.7 million and $2.6 million in 2006 and
2005 respectively, and in 2004 yield cash of 2.5 million. Cash provided by operating
activities in 2004 was primarily the result of our net loss for the period, as adjusted
for impairment of other assets and impairment of goodwill, depreciation and amortization,
in process research and development write off, a significant increase in trade payables,
accrued expenses and other liabilities, partially offset by gain from sale of
available-for-sale marketable securities and a significant increase in inventories. Cash
used by operating activities in 2005 was primarily the result of our net loss for the
period, as adjusted for accrued interest on available-for-sale marketable securities,
depreciation and amortization, partially offset by gain from sale of patent rights and a
significant increase in inventories a significant decrease in deferred revenues, accrued
expenses and other liabilities. Cash used by operating activities in 2006 was primarily
the result of our net loss for the period, as adjusted for compensation related to the
grant of option and restricted shares, depreciation and amortization and net changes of
our working capital mainly decrease in trade payables partially offset by the decrease in
accrued expenses and other accounts payables.

Net
cash provided from investing activities in 2006 reflects primarily the result of the
redemption of available for sale marketable securities partially offset by purchase of
fixed assets and investing in companies. Net cash used in investing activities in 2006 and
2005 reflects primarily the purchase of financial assets, fixed assets and investments in
companies. In 2006 our investing activity provided $1.2 million mainly as a result of
proceeds from sale of available-for-sale marketable securities totaled to $2.1 million,
partially offset by $716,000 which was used for a purchase of property and equipment and
$175,000 which were used for an investment in a company. In 2005, $17 million were used
primarily for the purchase of financial assets, $833,000 were used for a purchase of
property and equipment, $600,000 were used for an investment in a company, partially
offset by $15 millions of proceeds from redemption of matured available-for-sale
marketable securities and proceeds from sale of patent rights. In 2004, $38.8 million were
used primarily for the purchase of financial assets, $2.9 million were used for the
acquisition of certain assets and liabilities of Media 100 Inc, $650,000 were used for
investments in companies, partially offset by $40.8 millions of proceeds from sale of
available-for-sale marketable securities.

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Net
cash provided by financing activities in 2006 reflects primarily the net proceeds from the
exercise of stock options approximately in the amount of $498,000 and the increase in bank
credit by approximately $2.4 millions. Net cash provided by financing activities in 2005
reflects primarily the net proceeds from the exercise of stock options approximately in
the amount of $437,000 and the increase in bank credit. Net cash used in financial
activities in 2004 reflects primarily the decrease of approximately 1.6 million in bank
credit, partially offset by proceeds from exercise of stock options in the amount of
approximately $411,000. As of December 31, 2006, we have an authorized credit line in the
amount of $13.2 million (out of which $3.7 million utilized). An amount of approximately
$32 million is secured against marketable securities. We have an agreement with Clal
Credit Insurance Ltd. for the provision of insurance against default on outstanding
receivable balances.

As
of December 31, 2006, our available cash including cash, cash equivalent, short-term
investments in marketable securities net was $40.7 million. Our long-term investment in
marketable securities was $2.2 million. We manage our available cash 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 U.S. 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) on the date of their purchase, provided that investments in any one
corporation or entity will not exceed $3 million; (iv) investments in bonds and notes with
lower rating then BBB- and higher rating of B, provided that investments in any one
corporation or entity will not exceed $1 Million; (v) various financial instruments
including structure range note products issued by a rated institution (A and above) in
which the interest income may be subjected to changes in interests rate; (vi) hedge funds
up to $5 million of total portfolio 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 billion; (vii) entering into hedging transactions
in order to protect us against currency fluctuations between the US dollar and the NIS as
relates to up to $3 million operating expenses of the Company. The investment guidelines
are to be reviewed periodically by our board of directors with the President and the Chief
Financial Officer.

On
December 24, 2003 we won an arbitration award against Merrill Lynch & Company and its
subsidiary brokerage firm Merrill Lynch, Pearce, Fenner & Smith, or collectively
Merrill Lynch, pursuant to which we received in February 2004 approximately $1.8 million
in damages inclusive of interest, and assessed $33,850 in costs associated with the
arbitration against Merrill Lynch. As a result, we recorded other income at the amount of
approximately $1.4 million net of expenses during the quarter ended March 31, 2004.

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

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
marketable securities 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.

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# 5C. Research and
Development

Research
and development expenses, net, consist primarily of labor expenses, development-related
raw materials and subcontractors services and related overhead, offset by grants.
Our net research and development expenses have decreased from $3.8 million in 2004 to $4
millions in 2005 and increased to 4.2 million in 2006. As a percentage of revenues, our
net research and development expenses changed to approximately 23% in 2006 from
approximately 21% in 2005 and approximately 21% in 2004. Our level of research and
development expenses stayed relatively the same over the years. Research and development
grants totaled $1.9 million in 2006, $2.1 million in 2005 and $2 million in 2004

For
grants received from certain entities, see Item 4B. Business Overview - Research and Development above.

# 5D. Trend Information

The
digital video and streaming industry continues to be intensely competitive. 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
video and streaming industry. In order to strengthen our position and improve and expand
our offering variety to the market we continue to explore new investment alternatives both
of companies and of technologies.

Our
financial income is greatly affected by changes in the 6-month Libor rate, see Item 3D.
Risk Factors under the heading Risks Relating to the Economy, Our
Financial Condition and Shareholdings above and Item 11 Quantitative and
Qualitative Disclosure about Market Risk  Investment Risk below. Due to the
increase in the 6-month Libor rate during 2005 and despite the fact that the Federal
Reserve suspended the increase in interest rates during 2006, our financial income was
significantly reduced. Although it is difficult to predict changes in interest rate,
including the Libor, we expect that during 2007 we will not receive the interest of our
upcoming coupons related to the structured note that we acquired. However according to the
projected six months LIBOR rates, received from our bank on December 31, 2006, most of our
Structure notes are expected to be called back during 2007. See Item 11 Quantitative
and Qualitative Disclosure about Market Risk below.

We
have been operating at a loss since the quarter ended December 31, 2000. We were able to
return to profitability in the quarter ended June 30, 2003 and remain profitable until the
quarter ended March 31, 2004. Since the second quarter of 2004 we returned to operate in
loss. If global economic conditions worsen resulting in weakening the demand for our
products, we may not be able to return to profitability in 2007.

# 5E. 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.

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# 5F. Tabular Disclosure
of Contractual Obligations

Set
forth below are our contractual obligations and other commercial commitments as of
December 31, 2006:

|                                   | Payments Due by Period
(USD in thousands)
|---------------------------------- | -----------------------------------------
|
|
|
|
|Long-Term Debt                     |                                          
|Capital Lease Obligations          |                                          
|Operating Leases                   |                                          
|Purchase Obligations               |                                          
|Severance pay                      |                                          
|Other Long-Term Obligations        |                                          
|                                   |                                          
|Total Contractual Cash Obligations |                                          

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

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

# 6A. 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)            | 55  | President, Chief Executive Officer and Executive Chairman of the Board of Directors.
|Danny Lustiger          | 40  | Chief Financial Officer                                                             
|David Sackstein         | 41  | Vice President of Research and development and Chief Technical Officer              
|Adam Schadle            | 44  | President of Optibase Inc. and Vice President of Sales North and South America      
|Yaron Comarov           | 42  | Vice President of Operations                                                        
|Orna Gil-Bar Shir       | 42  | Vice President of Human Resources                                                   
|Meir Sudri              | 47  | Vice President of Professional Services and Projects                                
|Yossi Aloni             | 38  | Vice President of Marketing                                                         
|Udi Shani               | 39  | Executive Vice President of International Sales                                     
|Dana Tamir(2)           | 58  | Director                                                                            
|Chaim Labenski(1)(2)(3) | 59  | Director                                                                            
|Alex Hilman             | 55  | Director                                                                            
|Gil Weiser(1) (2)       | 65  | Director                                                                            

---

(1)    
          Member of the compensation committee 
(2)    
          Member of the audit committee 
(3)    
          Member of the investment committee

Tom
Wyler serves as President, Chief Executive Officer and Executive Chairman of our Board
of Directors. Since his investment in us in September 2001 (through Festin Management
Corp.), Mr. Wyler served in various senior executive positions. 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.

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Danny
Lustiger has been serving as our Chief Financial Officer since May 2004. Prior to his
present position, Mr. Lustiger served as Vice President Finance and President of
Optibase Inc. from July 2001 and November 2003. 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 & Co.
(currently Brightman Almagor & 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 Tel-Aviv University.

David
Sackstein joined us in November 1994 and serves as Vice President of research &
development and Chief Technological Officer. Prior to his present position, Mr. Sackstein
served as General Manager of the Video Technologies product line  a position he held
from November 2003 until September 2005. Since joining us, Mr. Sackstein has held various
technical and managerial positions in the research & development departments. Prior to
joining us, Mr. Sackstein led a research project 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 holds an Executive MBA degree
from Tel-Aviv University.

Adam
Schadle joined us in December 2000 in the acquisition of Viewgraphics, Inc. and has
been serving as president of Optibase Inc. since October 2004. During his tenure as Vice
President, Sales and Marketing of 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 San Jose University.

Yaron
Comarov joined us in 1994 and has been serving as our Vice President of Operations
since the year 2000. Prior to his present position, Mr. Comarov served as our Director of
Operations. Before joining us, 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 and an MBA degree
from Boston University.

Orna
Gil-Bar Shir has been serving as our Vice President of Human Resources since her
joining us in August 2000. Prior to joining us, Ms. Gil-Bar served as Human Resource
Manager for Computer Associates Ltd. in Israel. During her tenure at Computer Associates,
Ms. Gil-Bar was involved with the human resource implications resulting from Computer
Associates acquisition of Platinum Inc. and other acquisitions. 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 behavior) from the Tel-Aviv University.

Meir Sudryhas been serving as our Vice President of Professional Services and
Projects since June 2006, rejoined Optibase in 2005 after serving as Director of
Infrastructure between 2001 and 2002. From 2002 to 2005, Mr. Sudry served at Israeli
Military Industries as Senior System Engineer at the Tank Modernization Program. Until
2002, he served in the Israeli Defense Force in the rank of Lieutenant Colonel and managed
various programs in the Missile branch and the Electro-Optic branch. Mr. Sudry holds a
B.Sc. and a Master degree in Electronic Engineering from Tel Aviv University.

Yossi Aloni serves as our Vice President of Marketing. Mr. Aloni joined Optibase in
May 2005 as Director of Broadcast Solutions in January 2006 he was appointed as director
of Projects and in May 2006 was appointed as Vice President of Marketing. Previously, from
1998 to 2005, Mr. Aloni served as Director of Engineering/Chief Engineer at Telad, an
Israeli channel originator. Prior to his appointment, he was Head of Post-Production at
Telad. During his career in the video arena over almost two decades, Mr. Aloni also served
as Technical Manager at Feltronics, and Golden Channels, as well as Head of the Video
Section in the Israel Defense Forces.  Mr. Aloni earned his B.Sc. in Computer Science
from the Weizmann Institute of Science.

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Udi
Shani serves as the Executive Vice President International Sales and Technical
Support. Mr. Shani joined Optibase in 1999 as regional sales manager. In 2001, he was
appointed as AVP of European Sales, in 2002 relocated to North America where he founded
and managed the Americas IPTV sales force and in 2005 Mr. Shani returned to Israel and was
appointed Executive Vice President International Sales. Prior to Optibase, Mr. Shani
served as Sales and marketing manager at Eden Telecom (pointer) and as Sales Manager at
Muller Co. Mr. Shani holds a B.A. in Business Administration from the Israeli College of
Management and an MBA from Manchester University.

Dana
Tamir joined our board of directors in September 2000. Presently Ms. Tamir is serving
as the co-manager of the Indian offshore operation for Comverse. 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 Interactive. Prior to that Ms. Tamir 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 the Securities Division of Bank Hapoalim BM,
including 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 has been acting as a private investor. Mr. Labenski holds a B.Sc
degree in Civil Engineering from Aston University, U.K, an M.Sc degree in Engineering
Management from Leeds University and a D.B.A degree in Business Administration from
Manchester Business School.

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 on 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 Accounting and Economics from Tel Aviv University.

Gil
Weiserjoined our board of directors in December 2004. Mr. Weiser has been involved in
the Israeli Hi-Tech business environment for the past 30 years. Mr. Weiser is currently
the Chief Executive Officer of Orsus and is a member of the Board of Directors at Fundtech
and Clicksoftware.  Between 1994 and 2006 Mr. Weiser was the Chairman of the
Executive Board of Haifa University.  Between 2002 and 2004 Mr. Weiser was
a board member of the Tel Aviv Stock Exchange. Mr. Weiser also served as a board
member at the Formula Group. From 1995 to 2000, Mr. Weiser served as Managing Director of
Hewlett Packard, Israel, and between 1993 and 1995, Mr. Weiser served as President and
Chief Executive Officer of worldwide network solutions provider Fibronics. Prior to
that, Mr. Weiser was Chief Executive Officer/Managing Director of Digital Israel.
Mr. Mr. Weiser holds a M.Sc from University of Minnesota and a B.Sc from
The Technion  Israel Institution of Technology.

On
April 11, 2007 we announced that Danny Lustiger, our Chief Financial Officer is leaving us
and that he will be replaced effective May 15, 2007 by Amir Philips who currently serves
as Vice President Finance of our subsidiary, Optibase, Inc. Mr. Philips has been with us
for 7 years in various capacities, including as our controller.

# 6B. Compensation.

The
aggregate remuneration we paid to all persons as a group (13 persons) who served in the
capacity of director or executive officer in the year ended December 31, 2006 was $1.38
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. Our directors and executive
officers (13 persons) beneficially owned as of December 31, 2006, 3,236,348 shares (out of
which 834,510 options that are currently vested or will vest within 60 days as of April
15, 2007), excluding 61,500 shares held by a trustee for the benefit of directors and
executive officers under the Companys incentive plan which as of April 15, 2007 and
60 days thereafter have no voting or equity rights. In addition our directors and
executive officers (13 persons) beneficially owned as of December 31, 2006 share options
to purchase an aggregate of 265,833 ordinary shares which have not vested on April 15,
2007 or within 60 days thereafter. The exercise price of the options varies between $1.52
and $23.75, the vesting period is spread out over a 4-year period and the expiration date
of such options is generally 7 years as of their date of grant.

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Indemnification,
exemption and insurance of Directors and Officers

The
Israeli Companies Law permits a company to insure its directors and officers provide 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 subject to the terms and
conditions set forth by the Companies Law, as described below.

Subject
to statutory limitations, our articles of association provide that we may insure the
liability of our directors and offices to the fullest extent permitted by the Companies
Law. Without derogating from the aforesaid we may enter into a contract to insure the
liability of our directors and officer for an obligation imposed on such director or
officer in consequence of an act done in his capacity as a director or officer of
Optibase, in any of the following cases:

|v | a
breach of the duty of care vis-a-vis us or vis-a-vis another person;
|- | ----------------------------------------------------------------------

|v | a
breach of the fiduciary duty vis-a-vis us, provided that the director or officer acted in
good faith and had a reasonable basis to believe that the act would not harm us;
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|v | a
monetary obligation imposed on him in favor of another person.
|- | ----------------------------------------------------------------

|v | any
other matter in respect of which it is permitted or will be permitted under applicable
law to insure the liability of our director or officer.
|- | --------------------------------------------------------------------------------------------------------------------------------------------------

Our
articles of association further provide that we may indemnify our directors and officer,
to the fullest extent permitted by the Companies Law. Without derogating from the
aforesaid, we may indemnify our directors and officers for liability or expense imposed on
him in consequence of an action made by him in the capacity of his position as a director
or officer of Optibase, as follows:

|v | Any
financial liability he incurs or imposed on him or her in favor of another person in
accordance with a judgment, including a judgment given in a settlement or a judgment of
an arbitrator, approved by a court.
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|v | Reasonable
litigation expenses, including legal fees, incurred by the director or officer or which
he was ordered to pay by a court, within the framework of proceedings filed against him
by or on behalf of Optibase, or by a third party, or in a criminal proceeding in which he
was acquitted, or in a criminal proceeding in which he was convicted of a felony which
does not require a finding of criminal intent.
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|v | Reasonable
litigation expenses, including legal fees he incurs due to an investigation or proceeding
conducted against him by an authority authorized to conduct such an investigation or
proceeding, and which was ended without filing an indictment against him and without
being subject to a financial obligation as a substitute for a criminal proceeding, or
that was ended without filing an indictment against him, but with the imposition of a
financial obligation, as a substitute for a criminal proceeding relating to an offence
which does not require criminal intent, within the meaning of the relevant terms in the
Companies Law.
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|v | Any
other obligation or expense in respect of which it is permitted or will be permitted
under law to indemnify a director or officer of Optibase.
|- | --------------------------------------------------------------------------------------------------------------------------------------------------

In
addition, our articles of association provide that we may give an advance undertaking to
indemnify a director and/or an officer in respect of all of the matters above, provided
that with respect to the first matter above, the undertaking is restricted to events,
which in the opinion of our board of directors, are anticipated in light of our actual
activity at the time of granting the obligation to indemnify and is limited to a sum or
measurement determined by our board of directors as reasonable under the circumstances. We
may further indemnify an officer therein, save for the events subject to any applicable
law.

- 47 -

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---



Our
articles of association further provide that we may exempt a director or officer in
advance and retroactively for all or any of his liability for damage in consequence of a
breach of the duty of care vis-a-vis Optibase, to the fullest extent permitted by the
Companies Law. Notwithstanding the foregoing, the Companies Law prohibits a company to
exempt any of its directors and officers in advance from their liability towards such
company for the breach of its duty of care in distribution, as defined in the Companies
Law, for such companys shareholders (including distribution of dividend and purchase
of such companys shares by the company or an entity held by it).

The
above provisions with regard to insurance, exemption and indemnity are not and shall not
limit the Company in any way with regard to its entering into an insurance contract and/or
with regard to the grant of indemnity and/or exemption in connection with a person who is
not an officer of the Company, including employees, contractors or consultants of the
Company, all subject to any applicable law.

All
of the above shall apply mutatis mutandis in respect of the grant of insurance,
exemption and/or indemnification for persons serving on behalf of the Company as officers
in companies controlled by the Company, or in which the Company has an interest.

The
Companies Law provides that companies may not give insurance, indemnification (including
advance indemnification), or exempt their directors and/or officers from their liability
in the following events:

|v | a
breach of the fiduciary duty, except for a breach of the fiduciary duty vis-à-vis
the company with respect to indemnification and insurance if the director or officer
acted in good faith and had a reasonable basis to believe that the act would not harm the
company;
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|v | an
intentional or reckless breach of the duty of care, except for if such breach was made in
negligence;
|- | --------------------------------------------------------------------------------------------------------

|v | an
act done with the intention of unduly deriving a personal profit; or
|- | -----------------------------------------------------------------------

|v | a
fine imposed on the directors or officers.
|- | --------------------------------------------

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) $10 million.

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.

# 6C. Board Practices

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.

- 48 -

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Under
the Companies Law, each Israeli public company is required to determine the minimum number
of directors with accounting and financial expertise that such company
believes is appropriate in light of the particulars of such company and its activities. A
director with accounting and financial expertise is a person that, due to
education, experience and qualifications, is highly skilled and has an understanding of
business-accounting issues and financial statements in a manner that enables him/her to
understand in depth the companys financial statements and stimulate discussion
regarding the manner of presentation of the financial data. Our board of directors
resolved on March 30, 2006 that the minimum number of directors with accounting and
financial expertise appropriate for us in light of the size of the board of directors and
nature and volume of the Companys operations is 1 director (such director may serve
as an external director, see below).

# External directors

Under
the Companies Law, Israeli public companies are required to appoint at least two external
directors to serve on their board of directors. Our shareholders approved in December 2004
the reappointment of Mr. Chaim Labenski as our external director, for an additional 3-year
term and the appointment of Mr. Gil Weiser as our external director for a 3-year term. In
addition, each committee of the board of directors entitled to exercise any powers of the
board is required to include at least one external director. The audit committee must
include all the external directors, See Committees of the Board of Directors
below.

Pursuant
to the Israeli Companies Law at least one external director is required to have
accounting and financial expertise and the other is required to have
professional expertise or accounting and financial expertise. A
director has professional expertise if he or she satisfies one of the
following:

| | (i) | the
director holds an academic degree in one of these areas: economics,           business
administration, accounting, law or public administration;
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------

| | (ii) | the
director holds an academic degree or has other higher education, all in the
          main business sector of the company or in a relevant area for the board
          position; or
| | ---- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (iii) | the
director has at least five years experience in one or more of the
          following (or a combined five years experience in at least two or more of
          these: (a) senior management position in a corporation of significant business
          scope; (b) senior public office or senior position in the public sector; or (c)
          senior position in the main business sector of the company.
| | ----- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

A
director with accounting and financial expertise is a person that due to his
or her education, experience and skills has high skills and understanding of
business-accounting issues and financial reports which allow him to deeply understand the
financial reports of the company and hold a discussion relating to the presentation of
financial information. The companys board of directors will take into consideration
in determining whether a director has accounting and financial expertise,
among other things, his or her education, experience and knowledge in any of the
following:

| | (i) | accounting
issues and accounting control issues characteristic to the segment in
               which the company operates and to companies of the size and complexity of
the                company;
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (ii) | the
functions of the external auditor and the obligations imposed on such
               auditor;
| | ---- | -------------------------------------------------------------------------------------------------

| | (iii) | preparation
of financial reports and their approval in accordance with the                companies
law and the securities law.
| | ----- | -------------------------------------------------------------------------------------------------------------------------------

The
above qualifications do not apply to external directors appointed prior to January 19,
2006, such as our external directors. However, an external director may not be appointed
to an additional term unless: (i) such director has accounting and financial
expertise; or (ii) he or she has professional expertise, and on the date
of appointment for another term there is another external director who has
accounting and financial expertise and the number of accounting and
financial experts on the board of directors is at least equal to the minimum number
determined appropriate by the board of directors.

- 49 -

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A
company whose shares are traded in certain exchanges outside of Israel, including Nasdaq
Global Market, such as our company, is not required to nominate at least one external
director who has accounting and financial expertise as long as another independent
director for audit committee purposes who has such expertise serve on board of directors
pursuant to the applicable foreign securities laws. In such case all external directors
will have professional expertise.

Under
Israeli law, a person may not serve as an external director if at the date of the
persons appointment or within the prior two years the person, or his or her
relatives, partners, employers or entities under the persons control, have or had
any affiliation with us or any entity controlling, controlled by or under common control
with us. Under the Companies Law, affiliation includes an employment
relationship, a business or professional relationship maintained on a regular basis or
control or service as an office holder, excluding service as a director in anticipation of
serving as an external director in a company that is about to offer its shares to the
public for the first time.

A
person may not serve as an external director if that persons position or other
business activities create, or may create, a conflict of interest with the persons
service as an external director or may otherwise interfere with the persons ability
to serve as an external director. If at the time any external director is appointed, all
members of the board are the same gender, then the external director to be appointed must
be of the other gender.

External
directors are elected by a majority vote at a shareholders meeting, as long as
either:

| | (i) | the
majority of shares voted for the election includes at least one-third of           the
shares of non-controlling shareholders voted at the meeting; or
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------

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

The
Companies Law provides for an initial three-year term for an external director which may
be extended, for additional three-year terms, in the case of a company whose shares are
traded in certain exchanges outside of Israel, including Nasdaq Global Market, such as our
company, if both the audit committee and the board of directors confirm that in light of
the expertise and contribution of the external director, the extension of such external
directors term would be in the interest of the company. Election of external
directors requires a special majority, as described above. External directors may be
removed only by the same special majority required for their election or by a court, and
then only if the external directors cease to meet the statutory qualifications for their
appointment or if they violate their duty of loyalty to the company. In the event the
number of external directors is less than two external directors, our board of directors
is required under the Companies Law to call a shareholders meeting to appoint a new
external director.

External
directors may be compensated only in accordance with regulations adopted under the
Companies Law.

We
currently comply voluntarily with the NASDAQ Global Market rules requiring that the board
of directors of a listed company contain a majority of independent directors.

# Committees of the Board
of Directors

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

- 50 -

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Audit Committee

The
Companies Law requires public companies to appoint an audit committee. The
responsibilities of the audit committee include identifying irregularities in the
management of the companys business and approval of 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 recommends approval of
transactions that are deemed interested party transactions, including directors
compensation and transactions between a company and its controlling shareholder or
transactions between a company and another person in which its controlling shareholder has
a personal interest. 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.

The
rules of NASDAQ currently applicable to foreign private issuers such as us require us to
establish an audit committee of at least three members, comprised solely of independent
directors. All of the members of the audit committee must be able to read and understand
basic financial statements, and at least one member must have experience in finance or
accounting, requisite professional certification in accounting or comparable experience or
background. The board has determined that Gil Weiser and Chaim Labenski are audit
committee financial experts as defined by applicable SEC regulation. The responsibilities
of the audit committee under the NASDAQ rules include the selection and evaluation of the
outside auditors and evaluation of their independence.

The
members of the audit committee are Messrs. Weiser and Labenski 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, and
satisfies the requirements of Companies Law, the SECs rules and NASDAQ rules.

Compensation Committee

The
compensation committee, which is comprised of Gil Weiser 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 rules.

Investment Committee

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

The
Israeli Companies Law requires the board of directors 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. Our internal auditor is Doron
Cohen, CPA (Isr.), CIA (USA).

- 51 -

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We
currently do not have in place nomination or compensation committees, and the actions
ordinarily taken by such committees are resolved by the majority of our independent
directors, in accordance with the NASDAQ Global Market listing requirements.

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 and bonuses.
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 for some of the management members
in acceleration of the vesting of options by an additional 12 to 24 months. 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.

# 6D. Employees

As
of April 15, 2007, we had, including our subsidiary and regional offices, 130 employees,
out of which approximately 8 are part-time employees. The following is a list of our
employees as of December 31, 2006 compared to December 31, 2005 and to December 31, 2004
divided by our divisions and location.

|                                                        | December 31,
|------------------------------------------------------- | ------------
|
|
|
|
|Research & Development                                  |             
|Sales and Technical Marketing                           |             
|Marketing                                               |             
|Operations                                              |             
|General and Administrative, Finance and Human
Resources |             
|Total                                                   |             
|                                                        |             

---

(1)    
          3 employees in Asia, 1 employee in Europe 
(2)    
          10 employees in Asia 
(3)    
          9 employees in Asia

The
decrease in the number of employees between December 31, 2005 and December 31, 2006 is
mainly the result of departure of our sales and technical marketing employees mainly at
our U.S based company. The decrease in the number of employees between December 31, 2004
and December 31, 2005 is mainly the result of our decision to close the Digital Non-Linear
Editing product line during September 2005.

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 Industry,
Trade and Labor. These provisions principally concern the maximum length of the workday
and the workweek, 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 consumer price index, which was extended by
an extension order. The amounts and frequency of such adjustments are modified from time
to time.

- 52 -

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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. 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. In May 2006, an extension order has broadened our pension liabilities towards our employees.
To the extent the order applies to us, we believe that the order will not materially adversely affect our results of
operations.

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

# 6E. Share Ownership

As
of April 15, 2007, our current directors and executive officers (13 persons) beneficially
owned an aggregate of 3,244,744 ordinary shares of our Company of which 842,906 shares are
issuable upon exercise of options that may be exercisable within 60 days after April 15,
2007. Such number excludes 61,500 ordinary shares held by a trustee for the benefit of
directors and executive officers under the Companys incentive plan which have not
vested on April 15, 2007 or the 60 days thereafter and have no voting or equity rights.
Our current directors and executive officers (13 persons) beneficially owned as of April
15, 2007 options to purchase an aggregate of 1,077,343 ordinary shares, of which options
to purchase 842,906 shares are vested or exercisable within 60 days as of April 15, 2007.
Other than Tom Wyler, all of our directors or executive officers hold less than 1% of our
shares. See 7A. Major Shareholders for more information below regarding Tom Wyler
holdings.

# Incentive Plans

Since
1990, we have granted options to employees and directors to purchase ordinary shares at
exercise prices ranging from $0.17 to $19.625. As of April 15, 2007, options and warrants
to purchase 2,021,860 of our ordinary shares were outstanding, with exercise prices
ranging from $0.17 to $19.625 per share. As of April 15, 2007, 1,618,323 of the options
described above have vested or exercisable within 60 days as of such date. The expiration
date of the aforementioned options is generally 7 years as of their date of grant. As of
December 31, 2006 the number of options outstanding and reserved for issuance under our
plans was 2,209,923 and 1,303,137, respectively. The following table shows as of April 15,
2007 the number of options outstanding and reserved for issuance under each of our
incentive plans.

|Plan                                 | Number of options outstanding | Number of options reserved for
issuance
|------------------------------------ | ----------------------------- | ---------------------------------------
|
|
|
|
|1994 Plan                            |                               |                                        
|Viewgraphics Plan                    |                               |                                        
|1999 Plans                           |                               |                                        
|2001 Non-statutory share option plan |                               |                                        
|Total options                        |                               |                                        

|Plan                                     | Number of shares outstanding | Number of shares reserved for
issuance
|---------------------------------------- | ---------------------------- | --------------------------------------
|
|
|
|
|2006 Israeli Incentive Compensation Plan |                              |                                       
|Total shares                             |                              |                                       

- 53 -

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The
following is a description of our incentive plans currently in effect.

1999 Plans

In
January 1999, our shareholders approved the adoption of an Israeli option plan, or the
1999 Israeli Plan, and a U.S. option plan, or the 1999 U.S. Plan, collectively the
1999 Plans both plans have a joint pool of underlying shares to be granted
thereunder. The 1999 Plans were amended from time to time to include different tax tracks.
The purposes of the 1999 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 1999 Plans in a manner that as of April 1, 2000, the number of shares made
available for grant under the 1999 Plans will be automatically increased annually, to
equal 5% of our outstanding share capital at the relevant time. As of April 15, 2007 an
aggregate of 1,297,762 ordinary shares has been reserved for issuance under this plan, and
1,695,273 were granted and are outstanding. Unless specifically changed for a certain
grantee, options vest monthly over a period of four years, starting one year after the
date of grant, 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 1999 Plans will have a term of no more than seven 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 three
months from termination. We may make, from time to time, certain exceptions in the vesting
and expiration terms of options granted to certain grantees.

Options Issued in
Connection with the Acquisition of Viewgraphics

In
connection with the acquisition of Viewgraphics in December 2000 (see Item 4A.
History and Development of the Company above), 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 April 15, 2007, 5,113 options are still outstanding.

2001 Non-statutory Share
Option Plan

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 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. As of April 15, 2007 an aggregate of 145,471 ordinary shares has
been reserved for issuance under this plan, and 317,671were granted and are outstanding.
The plan otherwise has terms similar to those contained under the 1999 U.S. Plan.

2006 Israeli Incentive
Compensation Plan

In
May 2006, our board of directors approved the adoption of the 2006 Israeli Incentive
Compensation Plan, or the 2006 Plan, the purposes of which is to secure the benefits
arising from ownership of share capital by our employees, officers and directors who are
expected to contribute to the Companys future growth and success. The 2006 Plan
provides for the grant of options, restricted shares and restricted share units in
accordance with various Israeli tax tracks. We currently use the 2006 Plan for the grant
of restricted shares only. The restricted shares are granted for no consideration and with
a vesting schedule of two years (50% each year). The restricted shares are granted in
accordance with the Israeli capital gains tax track. Termination of employment of a
grantee for any reason will result in the forfeiture of such grantees unvested
restricted shares. All restricted shares are subject to earlier termination upon
termination of the grantees employment or other relationship with us, generally no
less than 90 days from termination. We may make, from time to time, certain exceptions in
the vesting and expiration terms of the securities granted to certain grantees. As of
April 15, 2007 an aggregate of 141,450 ordinary shares has been reserved for issuance
under the 2006 Plan, and 158,550 were granted and are outstanding.

- 54 -

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NASDAQ
Marketplace Rules permit foreign private issuers to follow home country practices in
regard to certain requirements, including the requirement to obtain shareholder approval
in connection with the establishment of certain incentive plans. In June and September
2006, we notified Nasdaq that we elected to follow home practices with regard to the
adoption of, and the amendment to, the 2006 Plan. Accordingly, the adoption of, and the
amendment to, the 2006 Plan were not approved by our shareholders.

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

# 7A. Major Shareholders

The
following table sets forth certain information known to the Company regarding the
beneficial ownership of the ordinary shares at April 15, 2007 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                                  | No. Of Ordinary Shares
Beneficially Owned(1) | Percentage of Ordinary Shares Beneficially Owned
|--------------------------------------------------------- | -------------------------------------------- | ------------------------------------------------
|
|
|
|
|Tom Wyler(2)                                              |                                              |                                                 
|Arthur Mayer - Sommer(3)                                  |                                              |                                                 
|Kern Capital Management LLC(4)                            |                                              |                                                 
|Shareholding of all directors and officers as a group (13 |                                              |                                                 
|persons)(5)                                               |                                              |                                                 

---

|(1) | Number
of shares and percentage ownership is based on 13,526,367 ordinary shares
                    outstanding as of April 15, 2007. Such number excludes: (i) 372,473
ordinary                     shares held by us or for our benefit, and (ii) 158,550
ordinary shares granted                     under our 2006 Israeli Incentive Compensation
Plan held by a trustee for the                     benefit of the grantees thereunder,
both have no voting or equity rights as of                     the date hereof or within
60 days thereafter. 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 April 15, 2007 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) | Mr.
Tom Wyler currently serves as President, Chief Executive Officer and
                    Executive Chairman of our Board of Directors. The information is
based on                     Schedule 13D filed by Mr. Tom Wyler on July 12, 2006.
Includes 2,401,838                     ordinary shares, 200,000 ordinary shares issuable
upon exercise of options                     currently exercisable with an exercise price
of $2.38 per option and expiration                     date of December 2009 and 50,000
ordinary shares issuable upon exercise of                     option exercisable within
60 days of April 15, 2007 with an exercise price of $6                     per option and
expiration date of December 2011.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | To
the best of our knowledge, the information is accurate as of April 30, 2007
                    and is based on the website of NASDAQ online whose address is
www.nasdaq.net.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | The
information is as of December 31, 2006 and based on Schedule 13G filed with
                    the SEC by Kern Capital Management LLC (KCM) on February
14, 2007.                     Robert Kern and David Kern as controlling members of KCM
may be deemed the                     beneficial owner of the securities owned by KCM in
that they might be deemed to                     share the power to direct the voting or
disposition of the securities. Based on                     the Schedule 13G, Robert Kern
and David Kern disclaim beneficial ownership.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) | Includes
2,401,838 ordinary shares and 842,906 ordinary shares issuable upon
                    exercise of options exercisable within 60 days of April 15, 2007.
Excludes                     61,500 ordinary shares held by a trustee for the benefit of
our directors and                     executive officers under our Israeli Incentive
Compensation Plan, which have not                     vested on April 15, 2007 or within
60 days thereafter and do not acquire any                     voting or equity rights.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

- 55 -

---

---



# 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 Schedules 13D filed by Festin Management
Corp beginning on January 1, 2003 (whose holdings were transferred to Tom Wyler and Arthur
Mayer-Sommer on September 10, 2004), regarding ownership of our shares:

|                       |  | 
|---------------------- |  | 
|
|
|
|
|Festin Management Corp |  | 
|Tom Wyler              |  | 
|Tom Wyler              |  | 
|Arthur Mayer-Sommer    |  | 

The
following table specifies significant changes in the ownership of our shares held by
Avraham and Moshe Namdar. This information is based on Schedules 13D filed by Avraham and
Moshe Namdar beginning on January 1, 2003, regarding ownership of our shares:

|Beneficial Owner -
Avraham and Moshe Namdar | Date | No. Of Shares Beneficially Held
|------------------------------------------- | ---- | -------------------------------
|
|
|
|
|                                            |      |                                
|                                            |      |                                
|                                            |      |                                
|                                            |      |                                
|                                            |      |                                
|                                            |      |                                
|                                            |      |                                

The
following table specifies significant changes in the ownership of our shares by Bricoleur
Capital Management LLC. This information is based on Schedule 13G filed by Bricoleur
Capital Management LLC beginning on February 11, 2005, regarding ownership of our shares:

|Beneficial Owner -
Bricoleur Capital Management LLC | Date | No. Of Shares Beneficially Held
|--------------------------------------------------- | ---- | -------------------------------
|
|
|
|
|                                                    |      |                                
|                                                    |      |                                
|                                                    |      |                                

| | *
To the best of our knowledge, the information is accurate as of April 30, 2007 and is
based on the website of NASDAQ online whose address is www.nasdaq.net.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------

- 56 -

---

---



The
following table specifies significant changes in the ownership of our shares by Kern
Capital Management LLC. This information is based on Schedules 13G filed by Kern Capital
Management LLC beginning on October 11, 2005, regarding ownership of our shares:

|Beneficial Owner -
Kern Capital Management LLC | Date | No. Of Shares Beneficially Held
|---------------------------------------------- | ---- | -------------------------------
|
|
|
|
|                                               |      |                                
|                                               |      |                                
|                                               |      |                                

All
of our shares have the same voting rights.

On
April 15, 2007, there were approximately 68 shareholders of record of our ordinary shares.
As of such date, 48 record holders in the United States hold approximately 70.579% 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.

# 7B. Related Party
Transactions

For
a description of the insurance, indemnification and exemption granted to our directors and
officers, see Item 6B  Compensation above.

For
a description of the grant of options to our directors and officers, see Item 6E.
Share Ownership above. In addition, each member of our board of directors is
paid an annual fee of $18,000 for his/her service as a director. On November 8, 2006 our
shareholders approved reimbursement of expenses to Tom Wyler, our President, Chief
Executive Officer and Executive Chairman who is also considered our controlling
shareholder in an approximated aggregate amount of $37,000 for 2005 and an amount not to
exceed $50,000 for each year beginning in 2006, all on account of performing his duties
towards us.

See
also the discussion regarding our relationships with Mobixell and V.Box under Item 4A.
History and Development of the Company above.

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

# 7C. Interests of Experts
and Counsel

Not
applicable.

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

# 8A. Consolidated
Statements and Other Financial Information

The
following financial statements of the Company and the auditors report appearing on
pages F-1 through F-40 of this Annual Report for fiscal 2006 are incorporated herein by
reference:

|v | Independent
auditors report.
|- | -----------------------------

|v | Balance
Sheets as of December 31, 2006 and 2005.
|- | ------------------------------------------------

|v | Statements
of Income for the years ended December 31, 2006, 2005 and 2004.
|- | --------------------------------------------------------------------------

|v | Statements
of Shareholders Equity for the years ended December 31, 2006, 2005 and 2004.
|- | ----------------------------------------------------------------------------------------

|v | Statements
of Cash Flows for the years ended December 31, 2006, 2005 and 2004.
|- | ------------------------------------------------------------------------------

|v | Notes
to financial statements.
|- | ------------------------------

- 57 -

---

---



# Legal proceedings

In
September 2005, we were served with a lawsuit filed by Vsoft Ltd., or Vsoft, a company
that is undergoing liquidation proceedings and arguing that during 2002 we held
negotiations with it not in good faith regarding a potential purchase of its share
capital, which led to Vsofts entering into bankruptcy proceedings. Vsoft demanded
damages in the amount of $2,129,000 as well as the payment of reimbursement of expenses,
legal fees and applicable VAT. On January 1, 2006, we filed a motion to dismiss the
lawsuit under the argument that Vsofts receiver did not approve the lawsuit as
determined by the liquidation court. To date, no decision has been granted. We believe,
based on the facts known to us as of the date hereof, 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.

# Dividend Policy

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.

A
dividend policy, if adopted, 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. 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 cash dividends 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. 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 U.S. 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.

|Item 8B. | Significant
Changes
|-------- | -------------------

There
are no significant financial changes since December 31, 2006.

In
January 2007, the Company purchased 3,035,223 ordinary shares of Scopus Video Networks Ltd
(Scopus), representing approximately 23% of Scopus issued share capital, from
Koor Corporate Venture Capital and Koor Industries Ltd. at an aggregate purchase price of
approximately $ 16 million. The company is currently evaluating the accounting treatment of
its investment in Scopus under the guidance of APB 18.

In
February 2007 we have invested approximately $154,000 in additional to our existing
investment in V.Box. See item 4. Information on the Company  4A. History and
development of the company  History above.

- 58 -

---

---



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

# 9A. Offer and Listing Details

Our
ordinary shares are traded on the NASDAQ Global 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 Global Market.

|                             | High | Low
|---------------------------- | ---- | ---
|
|
|
|
|2001                         |      |    
|2002                         |      |    
|2003                         |      |    
|2004                         |      |    
|2005                         |      |    
|                             |      |    
|2005                         |      |    
|First Quarter                |      |    
|Second Quarter               |      |    
|Third Quarter                |      |    
|Fourth Quarter               |      |    
|2006                         |      |    
|First Quarter                |      |    
|Second Quarter               |      |    
|Third Quarter                |      |    
|Fourth Quarter               |      |    
|                             |      |    
|Most Recent Six Months       |      |    
|October 2006                 |      |    
|November 2006                |      |    
|December 2006                |      |    
|January 2007                 |      |    
|February 2007                |      |    
|March 2007                   |      |    
|April (until April 15, 2007) |      |    

On
April 15, 2007, the reported closing sale price of our ordinary shares on the NASDAQ
Global Market was $3.94 per share.

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

# 10A. Share Capital

Not
applicable.

# 10B. Memorandum and Articles
of Association

# Purposes and Objects of
the Company

We
are a public company registered under the Companies Law as Optibase Ltd., registration
number 52-0037078.

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.

- 59 -

---

---



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, see
Approval of Certain Transaction below.

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 3,900,000 divided into a single class of 30,000,000
ordinary shares, par value NIS 0.13 per share, of which 14,057,390ordinary shares
were outstanding as of April 15, 2007. 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 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. Taxation below.

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.

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.

- 60 -

---

---



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 the Israeli
Companies Law. 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.

Under
the NASDAQ corporate governance rules, foreign private issuers are exempt from many of the
requirements if they instead elect to be exempted from such requirements, provided they
are not prohibited by home country practices and disclose where they have elected to do
so. In March 1999, we have received exemptions form NASDAQ Rules 4320(e)(21)(E),
4320(e)(21)(F) and 4320(e)(21)(H) regarding (i) quorum at general meetings of
shareholders; (ii) solicitation and provision of proxy statements; and (iii) obtaining of
shareholders approvals prior to certain issuances of securities, respectively.
Nevertheless, we did not rely on any of these exemptions at least since 2003 and we
elected instead to follow NASDAQ Marketplace Rules. Currently, we satisfy the respective
NASDAQ requirements, and have not elected to be exempt from any such requirement

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 the rights of such shares may be altered 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. As of the
date hereof, we only have one class 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 non-residents of Israel, and neither the memorandum and articles of association
nor Israeli law restricts the voting rights of non-residents of Israel, except that under
Israeli law, any transfer or issue of shares of a company to a resident of an enemy state
of Israel is prohibited and shall have no effect, unless authorized by the Israeli
Minister of Finance.

- 61 -

---

---



# 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under the heading Risks Relating to Operations in Israel 
Anti-takeover Provisions above.

# 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.

# Fiduciary Duty and Duty
of Care of Directors and Officers

The
Companies Law codifies the duties directors and officers owe to a company. An
Officer includes a companys general manager, general business manager,
executive vice president, vice president, any other person assuming the responsibilities
of any of the foregoing positions without regard to such persons title and other
managers directly subordinate to the general manager. The directors and
officers principal duties to the company are a duty of care and a fiduciary duty to
act in good faith for the companys benefit which include:

| | v | the
avoidance of any conflict of interest  between the director's or officer's  position with
the company and any                   other position he fulfills or with his personal
affairs;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | v | the
avoidance of any act in competition with the company's business;
| | - | --------------------------------------------------------------------

| | v | the
avoidance of exploiting any of the company's  business  opportunities  in order to gain a
personal  advantage                   for himself or for others; and
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | v | the
disclosure to the company of any information and documentation relating to the companys
affairs obtained by the director or officer due to his position with the company.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The
Companies Law requires that directors, officers or a controlling shareholder of a public
company disclose to the company any personal interest that he or she may have, including
all related material facts or documents in connection with any existing or proposed
transaction by the company. The disclosure must be made without delay and no later than
the first board of directors meeting at which the transaction is first discussed.

# Approval of Certain
Transactions

Generally,
under the Companies Law, engagement terms of directors, including the grant of an
exemption from liability, purchase of directors and officers insurance, or
grant of indemnification (whether prospective retroactive) and engagement terms of such
director in other positions require the approval of the audit committee, the board of
directors and the shareholders of the company. In addition, transactions between a public
company and its director or officer, or a transaction between such company and other
person in which such director or officer has a personal interest must be approved by such
companys board of directors, and if such transaction is considered an extraordinary
transaction (as defined below) it must receive the approval of such companys audit
committee as well.

The
Companies Law also requires that any extraordinary transaction between a public company
and its controlling shareholder or an extraordinary transaction between such company and
other person in which such companys controlling shareholder has a personal interest
must be approved by the audit committee, the board of directors and the shareholders of
the company by a an ordinary majority, provided that (i) such majority vote at the
shareholders meeting shall include at least one third (1/3) of the total votes of
shareholders having no personal interest in the transaction, participating at the voting
(excluding abstaining votes); or (ii) the total number of votes of shareholders mentioned
in clause (i) above who voted against such transaction does not exceed one percent (1%) of
the total voting rights in the company. An extraordinary transaction is
defined in the Companies Law as any of the following: (i) a transaction not in the
ordinary course of business; (ii) a transaction that is not on market terms; or (iii) a
transaction that is likely to have a material impact on the companys profitability,
assets or liability.

- 62 -

---

---



The
Companies Law further provides that the engagement terms of a controlling shareholder with
the company, either as an officer or an employee, must also be approved by such
companys audit committee, board of directors and general meeting by the special
majority described above.

The
Companies Law prohibits any director who has a personal interest in a matter to
participate in the discussion and voting pertaining to such matter in the companys
board of directors or audit committee except for in circumstances when the majority of the
board of directors have a personal interest in the matter and then such matter must
also be approved by the companys shareholders.

# 10C. Material Contracts

# Agreement with Acoustic
Technology LLC

In
September 2005, we executed an agreement with Acoustic Technology LLC for the sale of
certain intellectual property rights for $1 million in cash. Pursuant to the agreement we
will still maintain a worldwide right and license to develop and sell products covered by
such intellectual property rights.

# Agreement with Artel
Software Corp.

In
June 2004 we acquired certain assets and assumed liabilities of Media 100 Inc. as part of
a pre-packaged bankruptcy filing of Media 100, see Item 4A. History and Development
of the Company  Capital Expenditures for the Last Three Years above. During
the third quarter of 2005 we entered into an agreement with Artel Software Corp. (commonly
known as Boris FX), or Boris FX, for the sale of our Digital Non-Linear Editing product
line activity including all service, warranty and maintenance obligations for $20,000.
Under the terms of the agreement Boris FX and us will share revenues derived from any
future sales of these products and services up to $2 million and we will supply Boris FX,
at Boris FX request, with manufacturing services for the Media 100 HD boards for a
period of 24 months beginning on September 28, 2005.

# Agreement with Koor
Corporate Venture Capital and Koor Industries Ltd.

In
January 2007, we purchased from Koor Corporate Venture Capital and Koor Industries Ltd.
3,035,223 ordinary shares of Scopus, representing approximately 23% of Scopus issued
share capital at an aggregate purchase price of approximately $16 million.

# 10D. 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 as otherwise as set forth under Item 10E.
Taxation below.

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.

# 10E. Taxation

The
following is a discussion of Israeli and United States tax consequences material to us and
our Israeli and U.S. shareholders. 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.

- 63 -

---

---



# Israeli taxation

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, or CFC, was introduced
according to which an Israeli company may become subject to Israeli taxes on certain
income of a non-Israeli subsidiary if, among other things, the subsidiarys primary
source of income is passive income (such as interest, dividends, royalties, rental income
or capital gains).

General Corporate Tax
Structure in Israel

Generally,
Israeli companies are subject to Corporate Tax on their taxable income. On
July 25, 2005, the Knesset (Israeli Parliament) approved an amendment to the Income Tax
Ordinance, which prescribes, among others, a gradual decreased in the corporate tax rate
in Israel to the following tax rates: in 2006  31%, in 2007  29%, in 2008
 27%, in 2009  26% and in 2010 and thereafter  25%. However, the
effective tax rate payable by a company which derives income from an approved enterprise
(as further discussed below) may be considerably less.

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

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

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

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

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

| | v | accelerated
depreciation rates on equipment and buildings.
| | - | ----------------------------------------------------------

| | v | Expenses
related to a public offering on TA stock exchange and as of 1.1.2003 on recognized stock
markets outside of Israel, are deductible in equal amounts over three years.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

Eligibility
for benefits under the Industry Encouragement Law is not subject to receipt of prior
approval from any governmental authority.. No assurance can be given that the Israeli tax
authorities will agree that we qualify, or, if we qualify, that we will continue to
qualify as an industrial company or that the benefits described above will be available to
us in the future.

- 64 -

---

---



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

Tax
benefits prior the 2005 amendment

The
Law for the Encouragement of Capital Investments, 1959, as amended (effective as of April
1, 2005) (the Investments Law), provides that a proposed capital investment in
eligible facilities may, upon application to the Investment Center of the Ministry of
Industry and Commerce of the State of Israel, be designated as an approved enterprise. The
Investment Center bases its decision as to whether or not to approve an application, among
other things, on the criteria set forth in the Investments Law and regulations, the then
prevailing policy of the Investment Center, and the specific objectives and financial
criteria of the applicant. Each certificate of approval for an approved enterprise relates
to a specific investment program delineated both by its financial scope, including its
capital sources, and by its physical characteristics, e.g., the equipment to be purchased
and utilized pursuant to the program.

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

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

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

A
company may elect to receive an alternative package of benefits. Under the alternative
package of benefits, a companys undistributed income derived from the approved
enterprise will be exempt from corporate tax for a period of between two and ten years
from the first year the company derives taxable income under the program, depending on the
geographic location of the approved enterprise within Israel, and such company will be
eligible for a reduced tax rate for the remainder of the benefits period. A company that
has elected the alternative package of benefits, such as us, that subsequently pays a
dividend out of income derived from the approved enterprise during the tax exemption
period will be subject to corporate tax in respect of the amount distributed, including
any taxes thereon, at the rate which would have been applicable had it not elected the
alternative package of benefits, generally 10%-25%, depending on the percentage of the
companys ordinary shares held by foreign shareholders. The dividend recipient is
subject to withholding tax at the rate of 15% applicable to dividends from approved
enterprises, if the dividend is distributed during the tax exemption period or within
twelve years thereafter. The company must withhold this tax at source.

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Foreign
investors Company (FIC)

A
company that has an approved enterprise program is eligible for further tax benefits if it
qualifies as a foreign investors company. A foreign investors company is a
company which more than 25% of its share capital and combined share and loan capital is
owned by non-Israeli residents. A company that qualifies as a foreign investors
company and has an approved enterprise program is eligible for tax benefits for a ten-year
benefit period. As specified above, depending on the geographic location of the approved
enterprise within Israel, income derived from the approved enterprise program may be
entitled to the following:

|v | Extension
of the benefit period up to ten years.
|- | ------------------------------------------------

|v | An
additional period of reduced corporate tax liability at rates ranging between 10% and
25%, depending on the level of foreign (i.e., non-Israeli) ownership of our
shares. Those tax rates and the related levels of foreign investment are as set forth in
the following table:
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Region
B
| | --------

| | Rate of
Reduced Tax | Reduced Tax
Period | Tax Exemption
Period | Percent of
Foreign Ownership
| | ------------------- | ------------------ | -------------------- | ----------------------------
|
| | 25                  | 1 years            | 6 years              | 0-25%                       
| | 25                  | 4 years            | 6 years              | 25-48.99%                   
| | 20                  | 4 years            | 6 years              | 49-73.99%                   
| | 15                  | 4 years            | 6 years              | 74-89.99%                   
| | 10                  | 4 years            | 6 years              | 90-100%                     

---

| | Region
A
| | --------

| | Rate of
Reduced Tax | Reduced Tax
Period | Tax Exemption
Period | Percent of
Foreign Ownership
| | ------------------- | ------------------ | -------------------- | ----------------------------
|
| | 25                  | 0 years            | 10 years             | 0-25%                       
| | 25                  | 0 years            | 10 years             | 25-48.99%                   
| | 20                  | 0 years            | 10 years             | 49-73.99%                   
| | 15                  | 0 years            | 10 years             | 74-89.99%                   
| | 10                  | 0 years            | 10 years             | 90-100%                     

| | Other
Region
| | ------------

| | Rate of
Reduced Tax | Reduced Tax
Period | Tax Exemption
Period | Percent of
Foreign Ownership
| | ------------------- | ------------------ | -------------------- | ----------------------------
|
| | 25                  | 5 years            | 2 years              | 0-25%                       
| | 25                  | 8 years            | 2 years              | 25-48.99%                   
| | 20                  | 8 years            | 2 years              | 49-73.99%                   
| | 15                  | 8 years            | 2 years              | 74-89.99%                   
| | 10                  | 8 years            | 2 years              | 90-100%                     

|v | The
twelve years limitation period for reduced tax rate of 15% on dividend from the approved
enterprise will not apply.
|- | -----------------------------------------------------------------------------------------------------------------------

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

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Currently
we have five approved enterprises programs under the capital investment law, which entitle
us to some tax benefits. Income derived from these alternative benefit programs is exempt
from tax for a period of ten years, starting in the first year in which we generate
taxable income from the approved enterprise, subject to certain conditions.As
mentioned above the years limitation does not apply to the exemption period.

Tax benefits under the
2005 Amendment

The
amendment includes revisions to the criteria for investments qualified to receive tax
benefits as an Approved Enterprise. The amendment applies to new investment programs and
investment programs commencing after 2004, and does not apply to investment programs
approved prior to December 31, 2004. However, a company that was granted benefits
according to section 51 of the Investment Law would not be allowed to commence production
for a period of 3 years from the companys previous year of commencement of benefits
under the investment law (prior the amendment).

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

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

The
amendment simplifies the approval process: according the amendment, only Approved
Enterprises receiving cash grants require the approval of the Investment Center. The
Investment Center will be entitled, to approve such programs only until 30.12.2007

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

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

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

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

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

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

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

The
Amendment will apply to approved enterprise programs in which the year of election under
the Investments Law is 2004 or later, unless such programs received approval from the
Investment Center on or prior to December 31, 2004, in which case the Amendment provides
that terms and benefits included in any certificate of approval already granted will
remain subject to the provisions of the law as they were on the date of such approval.

Special
Provisions Relating to Measurement of Taxable Income

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

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

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

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

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The
Minister of Finance may, with the approval of the Knesset Finance Committee, determine by
decree, during a certain fiscal year (or until February 28th of the following year) in
which the rate of increase of the Israeli consumer price index would not exceed or did not
exceed, as applicable, 3.0%, that some or all of the provisions of the Inflationary
Adjustments Law shall not apply with respect to such fiscal year, or that the rate of
increase of the Israeli consumer price index relating to such fiscal year shall be deemed
to be 0%, and to make the adjustments required to be made as a result of such
determination.

In
specified circumstances, gains on traded securities, which might otherwise be eligible for
reduced rates of tax, will be subject to regular corporate tax rate.

Tax
Benefits of Research and Development

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

Capital
Gains Tax on Sales of Our Ordinary Shares

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

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

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

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

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

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

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

Taxation of Non-Resident
Holders of Shares

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

Foreign Exchange
Regulations

We
are permitted to pay in Israeli and non-Israeli currency:

| | v | dividends
to holders of our ordinary shares; and
| | - | ------------------------------------------------

| | v | 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.

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# 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:

|v | broker-dealers,
|- | ---------------

|v | financial
institutions,
|- | -----------------------

|v | certain
insurance companies,
|- | ----------------------------

|v | investors
liable for alternative minimum tax,
|- | ---------------------------------------------

|v | tax-exempt
organizations,
|- | -------------------------

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

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

|v | investors
that actually or constructively own 10 percent or more of our voting shares, and
|- | ------------------------------------------------------------------------------------------

|v | 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:

|v | an
individual who is a citizen or,  a resident of the United States for U.S. federal income
tax purposes;
|- | ---------------------------------------------------------------------------------------------------------

|v | a
 partnership,  corporation  or other entity  created or organized in or under the laws of
the United  States or      any political subdivision thereof;
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------

|v | an
estate whose income is subject to U.S. federal income tax regardless of its source;
|- | --------------------------------------------------------------------------------------

|v | 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
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|v | 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 certain dividend income received
by individual U.S. Holders, with respect to taxable years beginning on or before December
31,2010 may be eligible for a reduced rate of taxation. Such dividend income will be taxed
at the applicable long-term capital gains rate (currently, a maximum rate of 15%) if the
dividend is received from a qualified foreign corporation, and the shareholder
of such foreign corporation holds such stock for at least 61 days during the 121-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 in the united states. Dividend income will not qualify
for the reduced rate of taxation if the corporation is a passive foreign investment
company, or PFIC (seebelow), for the year in which the dividend is distributed or
for the previous year.

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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 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 the first preceding taxable years and forward for the first ten taxable
years in order to reduce U.S. federal income taxes, subject to the credit limitation
applicable in each of such years. 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
31-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.

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.

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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) the average
percentage of the value of all of our assets for the taxable year which produce or are
held for the production of passive income is at least 50%. For this purpose, cash is
considered to be an asset which produces passive income. Passive income includes, among
others, dividends, interest, certain types of royalties and 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.

# 10F. Dividend and Paying
Agents

Not
applicable.

# 10G. Statement by Experts

Not
applicable.

- 73 -

---

---



# 10H. Documents on Display

Reports
and other information of Optibase filed electronically with SEC 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 Public Reference Room at 100 F
Street, NE, Washington, D.C. 20549. Copies of this material are also available by mail
from the Public Reference Room at 100 F Street, NE, Washington, D.C. 20549, at prescribed
rates.

# 10I. Subsidiary
Information

Not
applicable.

|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 is 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 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. To date, our marketable securities are comprised of
structured notes and corporate 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.

# Investments 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. As of
December 31, 2006, our available net cash was $42.9 million. We manage our available cash
on a discretionary basis, within the framework of an investment policy based upon an
established set of guidelines approved by our board of directors. For information
concerning our investment policy, see Item 5B. Liquidity and Capital Resources
above. The investment guidelines are to be reviewed periodically by our board of directors
with the President and Chief Financial Officer

As
of December 31, 2006, approximately 64% of our available cash invested in structured notes
acquired from several banks. Under the terms of the notes, for each day in which the
relevant 6-month LIBOR rate is below an agreed fixed rate, which ranges from 3% to 7%
(calculated on an annual basis), the notes bear interest at a rate of 10% to 10.5% per
annum. On all other days, the notes do not bear any interest. Under the terms of the
notes, the issuer of the notes has a call option that allows such issuer to prepay the
notes at PAR at any coupon date. Changes in the rate of the LIBOR may significantly affect
the market value of our investments. Our available cash (including the Notes) is generally
classified as available for sale and, consequently, is 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, interest rates and other factors may adversely affect the value of our
available cash. As a result, we may recognize in earnings the decline in fair value of our
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 investments as well as on our results of operations. We do not currently
hedge these interest rate exposures.

- 74 -

---

---



The
table set forth shows the construction of our available cash investments classified as
available for sale (in thousands):

|                              | December 31,
|----------------------------- | ------------
|
|
|
|
|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.

|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

We
maintain disclosure controls and procedures that are designed to ensure that information
required to be disclosed in our periodic filings with the SEC is recorded, processed,
summarized and reported within the time periods specified in the SECs rules and
forms, and that such information is accumulated and communicated to our management,
including our Chief Executive Officer and Chief Financial Officer to allow timely
decisions regarding required disclosure. In designing and evaluating the disclosure
controls and procedures, management recognized that any controls and procedures, no matter
how well designed and operated, can provide only reasonable assurance of achieving the
desired control objectives. Furthermore, management necessarily was required to use its
judgment in evaluating the cost to benefit relationship of possible disclosure controls
and procedures. Based on the evaluation by our Chief Executive Officer and Chief Financial
Officer of the effectiveness of our disclosure controls and procedures as of the end of
the period covered by this annual report on Form 20-F, our Chief Executive Officer and
Chief Financial Officer have concluded that our disclosure controls and procedures as
defined in Rules 13a-15(e) and 15d-15(e) as of the end of the period covered by this
annual report are effective at such reasonable assurance level.

- 75 -

---

---



# Internal controls

There
were no changes in our internal control over financial reporting that occurred during the
year ended December 31, 2006 that have materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting.

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

The
Board of Directors has determined that Gil Weiser and Chaim Labenski are audit
committee financial experts as defined in Item 16A. of Form 20-F.

|Item 16B. | Code
of 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
was attached as Exhibit 11 to the Companys annual report on Form 20-F for the fiscal
year ended December 31, 2003, filed with the Commission on May 17, 2004.

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

Kost,
Forer Gabbay & Kasierer, a member of Ernst & Young Global, or Ernst & Young
has served as our independent public accountants for each of the fiscal years in the
three-year period ended December 31, 2006, 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 2006 and 2005 (in thousands):

|                       | 2005 | 2006
|---------------------- | ---- | ----
|
|
|
|
|Audit fees (1)         |      |     
|Audit-related fees (2) |      |     
|Tax fees (3)           |      |     
|All other fees (4)     |      |     
|                       |      |     
|Total                  |      |     

---

|(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.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(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.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

- 76 -

---

---



|(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

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.

During
2006, none of audit-related fees, tax fees or other fees provided to us by Kost, Forer
Gabbay & Kasierer in Israel or by Ernst & Young in the United States were approved
by the Audit Committee pursuant to the de minimis exception to the pre-approval
requirement provided by paragraph (c)(7)(i)(C) of Rule 2-01 of Regulation S-X.

|Item 16D. | Exemption
From the Listing Standards for Audit Committee
|--------- | --------------------------------------------------------

Not
applicable.

|Item 16E. | Purchases
of Equity Securities by the Issuer and Affiliate Purchasers
|--------- | ---------------------------------------------------------------------

Not
applicable.

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

Not
Applicable.

# Part III

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

Our,
and our subsidiarys Consolidated Financial Statements beginning on pages F-1 through
F-40, as set forth in the following index, are hereby incorporated herein by reference.
These Consolidated Financial Statements are filed as part of this Annual Report.

| |                                                         |           
| | ------------------------------------------------------- | ----------
|
|
|
|
| | Report of Independent Registered Public Accounting Firm | F-2       
| | Consolidated Balance Sheets                             | F-3 - F-4 
| | Consolidated Statements of Operations                   | F-5       
| | Statements of Changes in Shareholders' Equity           | F-6       
| | Consolidated Statements of Cash Flows                   | F-7 - F-8 
| | Notes to Consolidated Financial Statements              | F-9 - F-40

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

See
Exhibit Index.

- 77 -

---

---



# OPTIBASE LTD. AND ITS
SUBSIDIARY

# CONSOLIDATED FINANCIAL
STATEMENTS

# AS OF DECEMBER 31, 2006

# U.S. DOLLARS IN
THOUSANDS

# INDEX

|                                                        | Page      
|------------------------------------------------------- | ----------
|
|
|
|
|Report of Independent Registered Public Accounting Firm | F-2       
|Consolidated Balance Sheets                             | F-3 - F-4 
|Consolidated Statements of Operations                   | F-5       
|Statements of Changes in Shareholders' Equity           | F-6       
|Consolidated Statements of Cash Flows                   | F-7 - F-8 
|Notes to Consolidated Financial Statements              | F-9 - F-40



---

---



# REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM

# To the Board of
Directors and Shareholders of

# OPTIBASE LTD.

We
have audited the accompanying consolidated balance sheets of Optibase Ltd. (the
Company) and its subsidiary as of December 31, 2005 and 2006, and the related
consolidated statements of operations, changes in shareholders equity and cash flows
for each of the three years in the period ended December 31, 2006. These financial
statements and are the responsibility of the Companys management. Our responsibility
is to express an opinion on these financial statements based on our audits.

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

In
our opinion, the consolidated financial statements referred to above, present fairly, in
all material respects, the consolidated financial position of the Company and its
subsidiary as of December 31, 2005 and 2006, and the consolidated results of their
operations and their cash flows for each of the three years in the period ended December
31, 2006, in conformity with accounting principles generally accepted in the United
States.

As
discussed in Note 2 to the consolidated financial statements, in 2006, the Company adopted
Financial Accounting Standard Board Statement No. 123(R), Share-Based Payment.

|Tel-Aviv, Israel
May 14, 2007 | KOST FORER GABBAY & KASIERER
A Member of Ernst & Young Global
|----------------------------- | -------------------------------------------------------------

F - 2

---

---



|OPTIBASE LTD. AND ITS SUBSIDIARY
|--------------------------------
|                                
|CONSOLIDATED BALANCE SHEETS     
|                                
|U.S. dollars in thousands       

|                                                                       | December 31,
|---------------------------------------------------------------------- | ------------
|
|
|
|
|ASSETS                                                                 |             
|                                                                       |             
|CURRENT ASSETS:                                                        |             
|Cash and cash equivalents                                              |             
|Cash held in favor of other consortium partners (Note 10c)             |             
|Marketable securities (Note 3)                                         |             
|Trade receivables (net of allowance for doubtful accounts of $ 307 and |             
|$ 313 at December 31, 2005 and 2006, respectively) (Note 16b)          |             
|Deferred costs                                                         |             
|Other accounts receivable and prepaid expenses (Note 4)                |             
|Inventories (Note 5)                                                   |             
|Assets related to discontinued operations                              |             
|                                                                       |             
|                                                                       |             
|Total current assets                                                   |             
|                                                                       |             
|                                                                       |             
|LONG-TERM INVESTMENTS:                                                 |             
|Long-term lease deposits (Note 10a)                                    |             
|Marketable securities (Note 3)                                         |             
|Severance pay fund                                                     |             
|Investments in companies (Note 6)                                      |             
|                                                                       |             
|                                                                       |             
|Total long-term investments                                            |             
|                                                                       |             
|                                                                       |             
|PROPERTY AND EQUIPMENT, NET (Note 7)                                   |             
|                                                                       |             
|                                                                       |             
|Total assets                                                           |             
|                                                                       |             

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

F - 3

---

---



|OPTIBASE LTD. AND ITS SUBSIDIARY                           
|-----------------------------------------------------------
|                                                           
|CONSOLIDATED BALANCE SHEETS                                
|                                                           
|U.S. dollars in thousands (except share and per share data)

|                                                                                | December 31,
|------------------------------------------------------------------------------- | ------------
|
|
|
|
|LIABILITIES AND SHAREHOLDERS' EQUITY                                            |             
|                                                                                |             
|CURRENT LIABILITIES:                                                            |             
|Short-term bank credit line and loans (Note 9)                                  |             
|Trade payables                                                                  |             
|Deferred revenues                                                               |             
|Other accounts payable and accrued expenses (Note 8)                            |             
|Liabilities related to discontinued operations                                  |             
|                                                                                |             
|                                                                                |             
|Total current liabilities                                                       |             
|                                                                                |             
|                                                                                |             
|ACCRUED SEVERANCE PAY                                                           |             
|                                                                                |             
|                                                                                |             
|COMMITMENTS AND CONTINGENT LIABILITIES (Note 10)                                |             
|                                                                                |             
|SHAREHOLDERS' EQUITY (Note 13):                                                 |             
|Share capital -                                                                 |             
|Ordinary Shares of NIS 0.13 par value -                                         |             
|Authorized: 19,230,800 shares at December 31, 2005 and 2006; Issued: 13,822,638 |             
|and 14,004,888 shares at December 31, 2005 and 2006, respectively; Outstanding: |             
|13,291,618 and 13,473,868 shares at December 31, 2005 and 2006, respectively    |             
|Additional paid-in capital                                                      |             
|Treasury shares (531,023 shares at December 31, 2005 and 2006)                  |             
|Accumulated other comprehensive loss                                            |             
|Accumulated deficit                                                             |             
|                                                                                |             
|                                                                                |             
|Total shareholders' equity                                                      |             
|                                                                                |             
|                                                                                |             
|Total liabilities and shareholders' equity                                      |             
|                                                                                |             

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

|May 14, 2007
Date of approval of thefinancial statements | 
Tom WylerPresident, Chief Executive Officer and Executive Chairman of the Board of Directors. | 
Chaim LabenskiDirector | 
Danny LustigerChief Financial Officer
|-------------------------------------------------------------------- | ---------------------------------------------------------------------------------------------------------- | ----------------------------------- | --------------------------------------------------

F - 4

---

---



|OPTIBASE LTD. AND ITS SUBSIDIARY                           
|-----------------------------------------------------------
|                                                           
|CONSOLIDATED STATEMENTS OF OPERATIONS                      
|                                                           
|U.S. dollars in thousands (except share and per share data)

|                                                                                                         | Year ended December 31,
|-------------------------------------------------------------------------------------------------------- | -----------------------
|
|
|
|
|Revenues (Notes 14 and 15b)                                                                              |                        
|Cost of revenues (Note 15d)                                                                              |                        
|                                                                                                         |                        
|                                                                                                         |                        
|Gross profit                                                                                             |                        
|                                                                                                         |                        
|                                                                                                         |                        
|Operating expenses:                                                                                      |                        
|Research and development, net (Note 16a)                                                                 |                        
|Selling and marketing                                                                                    |                        
|General and administrative                                                                               |                        
|                                                                                                         |                        
|                                                                                                         |                        
|Total operating expenses                                                                                 |                        
|                                                                                                         |                        
|                                                                                                         |                        
|Operating loss                                                                                           |                        
|Other income (expenses), net (Notes 11)                                                                  |                        
|Financial income, net (Note 16c)                                                                         |                        
|                                                                                                         |                        
|                                                                                                         |                        
|Net income (loss) from continuing operations                                                             |                        
|                                                                                                         |                        
|Income (loss) from discontinued operations                                                               |                        
|                                                                                                         |                        
|                                                                                                         |                        
|Net loss                                                                                                 |                        
|                                                                                                         |                        
|                                                                                                         |                        
|Basic earnings (loss) per share from continuing operations                                               |                        
|                                                                                                         |                        
|                                                                                                         |                        
|Diluted earnings (loss) per share from continuing operations                                             |                        
|                                                                                                         |                        
|                                                                                                         |                        
|Basic  earnings (loss) per share from discontinued operations                                            |                        
|                                                                                                         |                        
|                                                                                                         |                        
|Diluted earnings (loss) per share from discontinued operations                                           |                        
|                                                                                                         |                        
|                                                                                                         |                        
|Basic loss per share                                                                                     |                        
|                                                                                                         |                        
|                                                                                                         |                        
|Diluted loss per share                                                                                   |                        
|                                                                                                         |                        
|                                                                                                         |                        
|Weighted average number of shares used in computing
  basic net earnings (loss) per share (in thousands) |                        
|                                                                                                         |                        
|                                                                                                         |                        
|Weighted average number of shares used in computing                                                      |                        
|diluted net earnings (loss) per share (in thousands)                                                     |                        
|                                                                                                         |                        

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

F - 5

---

---



|OPTIBASE LTD. AND ITS SUBSIDIARY             
|---------------------------------------------
|                                             
|STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
|                                             
|U.S. dollars in thousands                    

|                                                                     | Ordinary
shares | Additional
paid-in
capital | Treasury
shares | Accumulated
other
comprehensive
income (loss) | Accumulated
deficit | Total
comprehensive
loss | Total
shareholders'
equity
|-------------------------------------------------------------------- | --------------- | -------------------------- | --------------- | --------------------------------------------- | ------------------- | ------------------------ | --------------------------
|
|
|
|
|Balance as of January 1, 2004                                        |                 |                            | $               | 524                                           |                     | $                        | 116,986                   
|                                                                     |                 |                           
|Exercise of employees stock options                                  |                 |                            |                 | 4                                             |                     |                          | 407                       
|Compensation related to warrants granted to   consultant             |                 |                            |                 | -                                             |                     |                          | 77                        
|Other comprehensive loss:                                            |                 |                           
|Unrealized loss on available-for-sale   marketable securities, net   |                 |                            |                 | -                                             |                     |                          | -                         
|Net loss                                                             |                 |                            |                 | -                                             |                     |                          | -                         
|                                                                     |                 |                            |                 |                                               |                     |                          |                           
|Total comprehensive loss                                             |                 |                            |                 |                                               |                     |                          |                           
|                                                                     |                 |                            |                 |                                               |                     |                          |                           
|                                                                     |                 |                           
|Balance as of December 31, 2004                                      |                 |                            |                 | 528                                           |                     |                          | 117,470                   
|                                                                     |                 |                           
|Exercise of employees stock options                                  |                 |                            |                 | 5                                             |                     |                          | 432                       
|Compensation related to warrants granted to   consultant             |                 |                            |                 | -                                             |                     |                          | 73                        
|Other comprehensive loss:                                            |                 |                           
|Unrealized loss on available-for-sale     marketable securities, net |                 |                            |                 | -                                             |                     |                          | -                         
|Net loss                                                             |                 |                            |                 | -                                             |                     |                          | -                         
|                                                                     |                 |                            |                 |                                               |                     |                          |                           
|Total comprehensive loss                                             |                 |                            |                 |                                               |                     |                          |                           
|                                                                     |                 |                            |                 |                                               |                     |                          |                           
|                                                                     |                 |                           
|Balance as of December 31, 2005                                      |                 |                            |                 | 533                                           |                     |                          | 117,975                   
|                                                                     |                 |                           
|Exercise of employees stock options                                  |                 |                            |                 | 6                                             |                     |                          | 492                       
|Stock based compensation related to options   granted to employees   |                 |                            |                 | -                                             |                     |                          | 714                       
|Other comprehensive loss:                                            |                 |                           
|Unrealized gain on available-for-sale     marketable securities, net |                 |                            |                 | -                                             |                     |                          | -                         
|Net loss                                                             |                 |                            |                 | -                                             |                     |                          | -                         
|                                                                     |                 |                            |                 |                                               |                     |                          |                           
|Total comprehensive loss                                             |                 |                            |                 |                                               |                     |                          |                           
|                                                                     |                 |                            |                 |                                               |                     |                          |                           
|                                                                     |                 |                           
|Balance as of December 31, 2006                                      |                 |                            | $               | 539                                           |                     | $                        | 119,181                   
|                                                                     |                 |                            |                 |                                               |                     |                          |                           

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

F - 6

---

---



|OPTIBASE LTD. AND ITS SUBSIDIARY     
|-------------------------------------
|                                     
|CONSOLIDATED STATEMENTS OF CASH FLOWS
|                                     
|U.S. dollars in thousands            

|                                                                                               | Year ended December 31,
|---------------------------------------------------------------------------------------------- | -----------------------
|
|
|
|
|Cash flows from operating activities:                                                          |                        
|                                                                                               |                        
|Net loss                                                                                       |                        
|Adjustments required to reconcile net loss to net cash used in operating activities:           |                        
|Depreciation and amortization                                                                  |                        
|Impairment of long-term investment                                                             |                        
|Accrued interest and amortization of premium and discount on available-for-sale                |                        
|marketable securities                                                                          |                        
|Realized gain (loss) on sale of available-for-sale marketable securities                       |                        
|Impairment of available-for-sale marketable securities                                         |                        
|Gain on sale of property and equipment                                                         |                        
|Accrued severance pay, net                                                                     |                        
|Compensation related to warrants granted to consultants                                        |                        
|Compensation related to options and restricted shares granted to employees       and directors |                        
|Decrease (increase) in trade receivables, net                                                  |                        
|Decrease in other accounts receivable and prepaid expenses                                     |                        
|Increase in inventories                                                                        |                        
|Increase (decrease) in trade payables                                                          |                        
|Increase in deferred costs                                                                     |                        
|Increase in deferred revenues                                                                  |                        
|Increase (decrease) in accrued expenses and other accounts payable                             |                        
|Net cash provided by (used in) discontinued operations operating activities                    |                        
|                                                                                               |                        
|                                                                                               |                        
|Net cash used in operating activities                                                          |                        
|                                                                                               |                        
|                                                                                               |                        
|Cash flows from investing activities:                                                          |                        
|                                                                                               |                        
|Proceeds from sale of property and equipment                                                   |                        
|Purchase of property and equipment                                                             |                        
|Investments in available-for-sale marketable securities                                        |                        
|Proceeds from sale of available-for-sale marketable securities                                 |                        
|Proceeds from redemption of available-for-sale marketable securities                           |                        
|Redemption of (investment in) long-term lease deposits                                         |                        
|Investment in companies                                                                        |                        
|Net cash  provided by (used in) discontinued operations investing activities                   |                        
|                                                                                               |                        
|                                                                                               |                        
|Net cash provided by (used in) investing activities                                            |                        
|                                                                                               |                        
|                                                                                               |                        
|Cash flows from financing activities:                                                          |                        
|                                                                                               |                        
|Short-term bank credit                                                                         |                        
|Proceeds from exercise of stock options                                                        |                        
|Payments of long-term capital lease obligations                                                |                        
|                                                                                               |                        
|                                                                                               |                        
|Net cash provided by (used in) financing activities                                            |                        
|                                                                                               |                        
|                                                                                               |                        
|Increase (decrease) in cash and cash equivalents                                               |                        
|Cash and cash equivalents at the beginning of the year                                         |                        
|                                                                                               |                        
|                                                                                               |                        
|Cash and cash equivalents at the end of the year                                               |                        
|                                                                                               |                        

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

F - 7

---

---



|OPTIBASE LTD. AND ITS SUBSIDIARY     
|-------------------------------------
|                                     
|CONSOLIDATED STATEMENTS OF CASH FLOWS
|                                     
|U.S. dollars in thousands            

|                                                            | Year ended December 31,
|----------------------------------------------------------- | -----------------------
|
|
|
|
|Supplemental disclosure of cash flow activities:            |                        
|                                                            |                        
|(a) Non-cash transactions:                                  |                        
|                                                            |                        
|Reclassification of inventories into property and equipment |                        
|                                                            |                        
|                                                            |                        
|(b) Cash paid during the year for:                          |                        
|                                                            |                        
|Interest                                                    |                        
|                                                            |                        

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

F - 8

---

---



|OPTIBASE LTD. AND ITS SUBSIDIARY          
|------------------------------------------
|                                          
|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.
| | -- | ------------------------------------------------------------------------------------------

| | The
 Company  has  one  wholly-owned  subsidiary:  Optibase  Inc.  in  the  United  States
 which  was                      incorporated in 1991.
| | -------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company and its subsidiary provide high quality equipment for a wide range of
professional video applications in the Broadband IPTV, Broadcast, Government, Enterprise
and Post-production markets, which performed through the operation of two product lines.
Video technologies and IPTV
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company and its subsidiary sell their products worldwide, directly and through
distributors, Value Added Resellers (VARs), system integrators and Original
Equipment Manufacturers (OEMs), all of which are considered end-customers
from the perspective of the Company and its subsidiary.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
majority of the Company and its subsidiary sales are made in North America, Europe and
the Far East (see Note 14a).
| | -----------------------------------------------------------------------------------------------------------------------

| | b. | On
March 18, 2004, the Company and Media 100 Inc. a U.S.-based provider of
               professional video editing and compositing systems (Media 100)
               entered into an Assets Purchase Agreement (the Agreement).
Under the                terms of the Agreement, the Company acquired certain assets and
liabilities                assumed of Media 100 in consideration of $ 2,500 in cash. In
addition, the                Company incurred costs totaling $ 401, in connection with
the transaction. The                closing date was June 1, 2004.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
acquisition was accounted for in accordance with Statement of Financial Accounting
Standard No. 141, Business Combination, using the purchase method of
accounting. Accordingly, the purchase price has been allocated to the assets acquired and
the liability assumed based on their fair value at the date of acquisition. The fair
values of the identified intangible assets were established based on an independent
valuation study performed by a third-party specialist. The excess of the purchase price
over the fair value of the net assets acquired has been recorded as goodwill.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | Impairment
of long-lived assets and goodwill in 2004 (see also Note 2h and 2i):
| | -- | -------------------------------------------------------------------------------

| | During
the fourth quarter of 2004, the Company decided to restructure the operations of its
digital non-linear editing product line. Consequently, the Company performed a
recoverability test on its long-lived assets associated with its digital non-linear
editing product line. As a result, the Company recorded a non-cash charge of $ 1,471 in
accordance with Statement of Financial Accounting Standard No. 144, Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of(SFAS
144), with respect with its digital non-liner editing product lines. This
impairment charge is included in the consolidated statements of operations. Management
considered current and anticipated industry conditions, recent changes in its business
strategies, and current and anticipated operating results.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 9

---

---



|OPTIBASE LTD. AND ITS SUBSIDIARY          
|------------------------------------------
|                                          
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

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

| | The
composition of the impairment as follows:
| | ---------------------------------------------

| |                            | 
| | -------------------------- | 
|
|
|
|
| | Technology (*)             | 
| | Customer relationship (*)  | 
| | Property and equipment (*) | 
| |                            | 
| |                            | 
| |                            | 
| |                            | 

| | (*) | Related
to the purchase of certain assets and liabilities of Media 100, at June           1,
2004.
| | --- | --------------------------------------------------------------------------------------------------

| | As
part of the goodwill annual impairment test and in connection with the evaluation, the
Company has recognized a goodwill impairment loss in the amount of $ 540 in accordance
with Accounting Standard No. 142, Goodwill and Other Intangible Assets(SFAS
142). The fair value of the reporting unit, the digital non-linear editing product
line, was estimated using the present value of expected future cash flows. The goodwill
impairment charge of $ 540 is included in the consolidated statements of operations.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | d. | Restructuring:
| | -- | --------------

| | In
connection with the restructuring made during the forth quarter of 2004, the Company
recorded a restructuring charge of approximately $ 84, during the first quarter of 2005,
related to employee termination expenses.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
June 22, 2005, the Company signed an agreement with Artel Software Corp. (Boris FX),
a developer of integrated effects technology for video and film production, according to
which, the Company sold certain software technology known as the Final Effect Complete,
in consideration of $ 75, net. In September 2005, the Company signed an agreement
with Acoustic Technologies LLC (the Purchaser), according to which the
Company transferred certain Patent Rights of Media 100 to the Purchaser in consideration
of $ 900, net. In respect of these two sale transactions, the Company has recorded other
income in the amount of $ 975.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
September 2005, the Company entered into an agreement with Boris FX for the sale of its
digital non-linear product line operations, including all services, warranty and
maintenance obligations, in consideration of $ 20, net. Under the terms of the agreement,
Boris FX is obligated to pay royalties from future sales of products and services up to $ 2,000,
the Company agreed to make its manufacturing facilities available to Boris FX for a
period of two years.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 10

---

---



|OPTIBASE LTD. AND ITS SUBSIDIARY          
|------------------------------------------
|                                          
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

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

| | In
respect with the sale of the digital non-linear product line, the Company recorded losses
in the amount of $ 60. In connection with the sale, the Company recorded additional
restructuring charges of approximately $ 125, in September 2005, related to future
rent obligations for the facilities, net of expected sublease income, in accordance with
Statement of Financial Accounting Standard No. 146, Accounting for Costs Associated
with Exit or Disposal Activities (SFAS No. 146). On November 1, 2005,
as part of the agreements signed with Boris FX, the Company entered into a sublease
agreement with Boris FX, according to which the Company will receive future sublease
payments in the amount of $ 453 through December 31, 2007. The Companys
future lease payment under the lease agreement amounted to $ 550 through December 31,
2007. The Company has recorded the sublease payment as a reduction of the restructuring
accrual.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
following table details the components of the restructuring charges and the remaining
reserve balances as of December 31, 2006:
| | -----------------------------------------------------------------------------------------------------------------------------------

| |                            | Original accrual | Utilized | Balance at
December 31, 2006
| | -------------------------- | ---------------- | -------- | ----------------------------
|
|
|
|
| | Facility lease termination |                  |          | $                           
| | Termination benefits       |                  |          |                             
| |                            |                  |          |                             
| |                            |                  |         
| |                            |                  |          | $                           
| |                            |                  |          |                             

| | e. | Discontinued
operations:
| | -- | ------------------------

| | During
the forth quarter of 2006, the Company determined that the level of activity and cash
flow generated from the disposed digital non-linear product line are no longer
significant and as such reassessed the classification of the Digital non-linear product
line, and decided that it is a discontinued operation, in accordance with SFAS 144 and
EITF 03-13, Applying the Condition in Paragraph 42 of FAS 144 in Determining
Whether to Report Discontinued Operations.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Accordingly,
the results of operations including revenues, operation expenses and other income and
expenses of the digital non-linear product line for 2004, 2005 and 2006 have been
reclassified in the accompanying statements of operations as discontinued operations. The
Companys balance sheets at December 31, 2005 and 2006 reflect the net liabilities
of the digital non-linear product line as liabilities and assets related to discontinued
operations.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 11

---

---



|OPTIBASE LTD. AND ITS SUBSIDIARY          
|------------------------------------------
|                                          
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

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

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

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

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

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

| | A
majority of the revenues of the Company and its subsidiary is generated in United States
dollars (dollars). In addition, a substantial portion of their costs is
incurred or determined in dollars. The Companys management believes that the dollar
is the currency of the primary economic environment in which the Company and its
subsidiary operate. Thus the dollar is their functional and reporting currency.
Accordingly, monetary accounts maintained in currencies other than the dollar are
remeasured into U.S. dollars, in accordance with Statement of Financial Accounting
Standard No. 52, Foreign Currency Translation (SFAS No. 52). All
transaction gains and losses of the remeasured monetary balance sheet items are reflected
in the statements of operations as financial income or expenses, as appropriate.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | Principles
of consolidation:
| | -- | ----------------------------

| | The
consolidated financial statements include the accounts of the Company and its subsidiary.
Intercompany transactions and balances, including profits from intercompany sales not yet
realized outside of the Group, have been eliminated upon consolidation.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | d. | Cash
equivalents:
| | -- | -----------------

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

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

| | The
Company and its subsidiary 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
securities at the time of purchase, and reevaluates such determinations at each balance
sheet date.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2005 and 2006, 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 16c).
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 12

---

---



|OPTIBASE LTD. AND ITS SUBSIDIARY          
|------------------------------------------
|                                          
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

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

| | 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 of December 31, 2005 and 2006, the Companys available-for-sale securities
declines in the amount of $ 430 and $ 0 were included in the statement of operations as
financial expenses, respectively.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Structured
notes were accounted for 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. Under the notes terms, for each day in which
the six-months LIBOR rate is below an agreed fixed rate, which ranges from 3% to 10%, the
notes 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, 2006, investments in
structured notes securities are less than their market value (see Note 3).
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | f. | Inventories:
| | -- | ------------

| | Inventories
are stated at the lower of cost or market value. Inventory reserves are provided to cover
risks arising from slow-moving items or technological obsolescence. In 2004, 2005 and
2006, the Company and its subsidiary recorded write-off charges in a total amount of $ 336,
$ 0 and $ 0, respectively, related to 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  cost of manufacturing with the addition of
allocable indirect manufacturing costs.
| | ------------------------------------------------------------------------------------------------------------------------

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

| | Property
and equipment are 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             | The shorter of the useful life or term of the lease

F - 13

---

---



|OPTIBASE LTD. AND ITS SUBSIDIARY          
|------------------------------------------
|                                          
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

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

| | h. | Goodwill
and intangible assets:
| | -- | -------------------------------

| | SFAS
No. 142 requires goodwill to be tested for impairment on adoption and at least annually
thereafter or between annual tests in certain circumstances, and written down when
impaired, rather than being amortized as previous accounting standards required. Goodwill
attributable to each of the reporting units is tested for impairment by comparing the
fair value of each reporting unit with its carrying value. Fair value is determined using
discounted cash flows. Significant estimates used in the methodologies include estimates
of future cash flows, future short-term and long-term growth rates, weighted average cost
of capital and estimates of market multiples for each of the reportable units. As of
December 31, 2006, no impairment losses have been identified.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Intangible
assets acquired in a business combination are amortized over their useful life using a
method of amortization that reflects the pattern in which the economic benefits of the
intangible assets are consumed or otherwise used up, in accordance with SFAS No. 142.
Acquired technology is amortized over a weighted average of four years, and customer
relationship is amortized over a weighted average of three years. Amortization expenses
for the year ended December 31, 2004, amounted to $ 247.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | i. | Long-lived
assets:
| | -- | ------------------

| | The
Company and its subsidiarys 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. 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 with 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. As of December 31, 2006, no
impairment losses have been identified.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | j. | Investments
in companies:
| | -- | -------------------------

| | Investments
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 holds
an equity stake of less than 20%, does not have the ability to exercise significant
influence over operating and financial policies of the investee, (ii) a privately held
company by a way of convertible notes.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 14

---

---



|OPTIBASE LTD. AND ITS SUBSIDIARY          
|------------------------------------------
|                                          
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

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

| | The
Companys investment in a 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); (ii)
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 SAB 59. As
for impairment charges recorded in 2004, 2005 and 2006 see Notes 6a and 6b.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | k. | Revenue
recognition:
| | -- | --------------------

| | The
Company and its subsidiary generate revenues mainly from the sale of hardware products (products)
and to a lesser extent from sales of software products. The Company and its subsidiary
sell their products worldwide directly and through system integrators, VARs, distributors
and OEMs who are considered end-customers.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Revenues
from product sales in which the software is incidental to the hardware 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 subsidiary past experience and are
accrued in the financial statements. The Company and its subsidiary do not grant a right
of return.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Revenues
from sale of products that include post customer support are recognized in accordance
with Emerging Issues Task Force (EITF) Issue No. 00-21, Revenue
Arrangements with Multiple Deliverables (EITF 00-21) a multiple-element
arrangement (an arrangement that involves the delivery or performance of multiple
products, services and/or rights to use assets) is separated into more than one unit of
accounting, if the functionality of the delivered element(s) is not dependent on the
undelivered element(s), there is vendor-specific objective evidence (VSOE) of fair value
of the undelivered element(s) and delivery of the delivered element(s) represents the
culmination of the earnings process for those element(s). If these criteria are not met,
the revenue is deferred until such criteria are met or until the period in which the last
undelivered element is delivered
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Revenues
from the sale of products that require significant customization, integration and
installation are recognized based on SOP 81-1, Accounting for Performance of
Construction-Type and Certain Production-Type Contracts, according to which
revenues are recognized on a percentage of completion basis. Percentage of completion is
determined based on the Output Method, upon completion of milestones, when
collectibility is probable. After delivery of a milestone, if uncertainty exists about
customer acceptance, revenue is not recognized until acceptance. Provisions for estimated
losses on uncompleted contracts are recognized in the period in which the likelihood of
the losses is identified. As of December 31, 2006, no such estimated losses were
identified.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 15

---

---



|OPTIBASE LTD. AND ITS SUBSIDIARY          
|------------------------------------------
|                                          
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

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

| | The
Company accounts for product sales in which the software is fundamental to the hardware
in accordance with Statement of Position 97-2, Software Revenue Recognition,
as amended (SOP 97-2). SOP 97-2 generally requires revenue earned on software
arrangements involving multiple elements to be allocated to each element based on the
relative fair value of the elements. Furthermore, the Company follows Statement of
Position 98-9, Modification of SOP 97-2, Software Revenue Recognition with Respect
to Certain Transactions (SOP 98-9). SOP 98-9 requires that revenue be
recognized under the residual method when VSOE of fair value exists for all
undelivered elements and VSOE does not exist for one or more of the delivered elements.
Under the residual method, any discount in the arrangement is allocated to the delivered
elements.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | Amounts
received from customers for whom revenue has not yet been recognized, are presented as
deferred revenues.
| | -----------------------------------------------------------------------------------------------------------------

| | l. | Research
and development costs:
| | -- | -------------------------------

| | 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.
| | ------------------------------------------------------------------------------------------------------------------------------

| | 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 of Israels Ministry of Industry, Trade and Labor, and
the European Union Research and Development Program (see also Note 10b and 10c).
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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. Total costs capitalized
amounted to $ 1,238 and are fully amortized as of December 31, 2006. Amortization
expenses amounted to $ 80, $ 60 and $ 0 for the years ended December 31,
2004, 2005 and 2006, respectively.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 16

---

---



|OPTIBASE LTD. AND ITS SUBSIDIARY          
|------------------------------------------
|                                          
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

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

| | m. | Income
taxes:
| | -- | -------------

| | The
Company and its subsidiary 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 subsidiary provide a valuation allowance, if
necessary, to reduce deferred tax assets to their estimated realizable value.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | n. | 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 (see also Note 10b).
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | o. | Non-royalty-bearing
grants:
| | -- | ---------------------------

| | The
Company receives non-royalty-bearing grants from the European Union Research and
Development Program, and from the MOST, STRIMM and NEGEV 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 in research and development costs.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | p. | Concentrations
of credit risk:
| | -- | ------------------------------

| | Financial
instruments that potentially subject the Company and its subsidiary 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, minimum credit risk exists with respect to these financial instruments.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Marketable
securities are invested in via major investment banks in the United States. These
investments include corporate bonds, Government and corporate structured notes.
Management believes that the financial institutions are financially sound, the
investments are well diversified and, accordingly, credit risk exists with respect to
these marketable securities, all in accordance with the Companys investment policy.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 17

---

---



|OPTIBASE LTD. AND ITS SUBSIDIARY          
|------------------------------------------
|                                          
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

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

| | The
trade receivables of the Company and its subsidiary are geographically diversified and
derived from sales to customers mainly in North America, Europe and the Far East. The
Company and its subsidiary generally do not require collateral; however, in certain
circumstances, the Company and its subsidiary may require letters of credit, advance
payments, insurance, other collateral or additional guarantees. An allowance for doubtful
accounts is determined with respect to those amounts that the Company and its subsidiary
have determined to be doubtful of collection in addition to a general allowance for the
remaining accounts. The Company and its subsidiary perform ongoing credit evaluations of
their customers.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | q. | 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).
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | On
January 1, 2006, the Company adopted SFAS No. 123 (revised 2004), Share-Based
Payment (SFAS No. 123(R)) which requires the measurement and
recognition of compensation expense based on estimated fair values for all share-based
payment awards made to employees and directors. SFAS No. 123(R) supersedes Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB
No. 25), for periods beginning in fiscal year 2006. In March 2005, the Securities
and Exchange Commission issued Staff Accounting Bulletin No. 107 (SAB 107)
relating to SFAS No. 123(R). The Company has applied the provisions of SAB 107 in its
adoption of SFAS No. 123(R). SFAS No. 123(R) requires companies to estimate the fair
value of equity-based payment awards on the date of grant using an option-pricing model.
The value of the portion of the award that is ultimately expected to vest is recognized
as an expense over the requisite service periods in the Companys consolidated
operations statements.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | At
December 31, 2006, the Company has four stock-based employee compensation plans, which
are described more fully in Note 13. Prior to January 1, 2006, the Company accounted for
those plans under the recognition and measurement provisions of APB No. 25, and related
interpretations, as permitted by FASB Statement No. 123, Accounting for Stock-Based
Compensation. No stock-based employee compensation cost was recognized in the
statement of operations for the years ended December 31, 2005 and 2004, as all
options granted under those plans had an exercise price equal to the market value of the
underlying common stock on the date of grant.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 18

---

---



|OPTIBASE LTD. AND ITS SUBSIDIARY          
|------------------------------------------
|                                          
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

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

| | Effective
January 1, 2006, the Company adopted the fair value recognition provisions of FASB
Statement No. 123(R), Share-Based Payment, using the
modified-prospective-transition method. Under that transition method, compensation cost
recognized during 2006 includes: (a) compensation cost for all share-based payments
granted prior to, but not yet vested as of January 1, 2006, based on the grant date
fair value estimated in accordance with the original provisions of Statement 123, and (b)
compensation cost for all share-based payments granted subsequent to January 1,
2006, based on the grant-date fair value estimated in accordance with the provisions of
Statement 123(R). Results for prior periods have not been restated.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
a result of adopting Statement 123(R) on January 1, 2006, the Companys net loss
from continuing operations for the year ended December 31, 2006, were $ 519 higher than
if it had continued to account for share-based compensation under APB No. 25. Basic and
diluted loss per share for the year ended December 31, 2006, $ 0.04 higher than if the
Company had continued to account for share-based compensation under Opinion 25. The
adoption of Statement 123(R) did not affect the Companys discontinued operation.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company estimates the fair value of stock options granted using the Black-Scholes- option
pricing model. The option-pricing model requires a number of assumptions, of which the
most significant are the expected stock price volatility and the expected option term.
Expected volatility was calculated based upon actual historical stock price movements.
The expected term of options granted is based upon historical experience and represents
the period of time that options granted are expected to be outstanding. The risk-free
interest rate is based on the yield from U.S. treasury bonds with an equivalent term. The
Company has historically not paid dividends and has no foreseeable plans to pay
dividends. The Company recognizes the related expenses over the vesting period using the
straight line method.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
fair value for options granted in 2004, 2005 and 2006 is estimated at the date of grant
using a Black-Scholes options pricing model with the following weighted average
assumptions:
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                         | Year ended December 31,
| | ----------------------- | -----------------------
|
|
|
|
| | Volatility              |                        
| | Risk-free interest rate |                        
| | Dividend yield          |                        
| | Expected life (years)   |                        

F - 19

---

---



|OPTIBASE LTD. AND ITS SUBSIDIARY                           
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except share and per share data)

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

| | The
following table illustrates the effect on 2004 and 2005 net loss and loss per share if
the Company had applied the fair value recognition provisions of Statement 123 to options
granted under the Companys stock option plans in all periods presented. For
purposes of this pro forma disclosure, the value of the options is estimated using a
Black-Scholes option-pricing formula and amortized to expense over the options vesting
periods.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                                                          | Year ended December 31,
| | ------------------------------------------------------------------------ | -----------------------
|
|
|
|
| | Net income (loss) from continuing operations, as reported                |                        
| | Add: Stock-based employee compensation expense included in reported net  |                        
| | income, net of related tax effects                                       |                        
| | Deduct: Total stock-based employee compensation expense determined       |                        
| | under fair value based method for all awards, net of related tax effects |                        
| |                                                                          |                        
| |                                                                          |                        
| | Pro forma net income (loss), from continuing operations                  |                        
| |                                                                          |                        
| |                                                                          |                        
| | Net loss, from discontinuing operations as reported                      |                        
| | Add: Stock-based employee compensation expense included in reported net  |                        
| | income, net of related tax effects                                       |                        
| | Deduct: Total stock-based employee compensation expense determined       |                        
| | under fair value based method for all awards, net of related tax effects |                        
| |                                                                          |                        
| |                                                                          |                        
| | Pro forma net loss, from discontinuing operations                        |                        
| |                                                                          |                        
| |                                                                          |                        
| | Net loss, as reported                                                    |                        
| |                                                                          |                        
| |                                                                          |                        
| | Pro forma net loss                                                       |                        
| |                                                                          |                        
| |                                                                          |                        
| | Basic and diluted earnings (loss) per share as reported:                 |                        
| | Basic from continuing - as reported                                      |                        
| |                                                                          |                        
| | Diluted from continuing - as reported                                    |                        
| |                                                                          |                        
| | Basic  from discontinuing - as reported                                  |                        
| |                                                                          |                        
| | Diluted from discontinuing - as reported                                 |                        
| |                                                                          |                        
| | Basic - as reported                                                      |                        
| |                                                                          |                        
| | Diluted - as reported                                                    |                        
| |                                                                          |                        
| |                                                                          |                        
| | Basic from continuing - pro forma                                        |                        
| |                                                                          |                        
| | Diluted from continuing - pro forma                                      |                        
| |                                                                          |                        
| | Basic from discontinuing - pro forma                                     |                        
| |                                                                          |                        
| | Diluted from discontinuing - pro forma                                   |                        
| |                                                                          |                        
| | Basic - pro forma                                                        |                        
| |                                                                          |                        
| | Diluted - pro forma                                                      |                        
| |                                                                          |                        

F - 20

---

---



|OPTIBASE LTD. AND ITS SUBSIDIARY          
|------------------------------------------
|                                          
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

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

| | s. | Severance
pay:
| | -- | --------------

| | The
Companys liability for severance pay is calculated pursuant to Israels
Severance Pay Law, based on the most recent salary of the employees, multiplied by the
number of years of employment as of the balance sheet date. 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 a decrease in an employees 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 for all of its employees is fully provided by monthly deposits
with insurance policies and by an accrual. The value of these policies is recorded as an
asset in the Companys balance sheet.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | Severance
pay expense amounted to $ 346, $379 and $ 355 for the years ended December 31,
2004, 2005 and 2006, respectively.
| | ---------------------------------------------------------------------------------------------------------------------------

| | t. | Employee
benefit plan:
| | -- | ----------------------

| | The
Company has a 401(K) defined contribution plan covering certain employees in the U.S. All
eligible employees may elect to contribute up to 100%, but no more than $ 13 per
year, of their annual compensation to the plan through salary deferrals, subject to IRS
limits. The Company makes a matching contribution up to 25% over a vesting period of 4
years.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

| | The
carrying amounts of cash and cash equivalents, trade receivables, other accounts
receivable, trade payables, other accounts payable and derivative instruments approximate
their fair value due to the short-term maturity of such instruments.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
fair value of marketable securities is based on quoted market prices (see Note 3).
| | --------------------------------------------------------------------------------------

| | The
carrying amount of long-term lease deposits and long-term capital lease obligations is
estimated by discounting the future cash flows using the current interest rate for
deposits and obligations of similar terms and maturities. The carrying amount of the
long-term lease deposits and the long-term capital lease obligations approximates their
fair value.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 21

---

---



|OPTIBASE LTD. AND ITS SUBSIDIARY          
|------------------------------------------
|                                          
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

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

| | v. | Impact
of recently issued accounting standards:
| | -- | -----------------------------------------------

| | In
July 2006, the FASB issued FASB Interpretation No. 48 Accounting for Uncertainty in
Income Taxes an Interpretation of FASB Statement No. 109 (FIN 48). FIN
48 clarifies the accounting for income taxes by prescribing the minimum recognition
threshold a tax position is required to meet before being recognized in the financial
statements. FIN 48 utilizes a two-step approach for evaluating tax positions. Recognition
(step one) occurs when an enterprise concludes that a tax position, based solely on its
technical merits, is more-likely-than-not to be sustained upon examination.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Measurement
(step two) is only addressed if step one has been satisfied (i.e., the position is
more-likely-than-not to be sustained). Under step two, the tax benefit is measured as the
largest amount of benefit, determined on a cumulative probability basis that is
more-likely-than-not to be realized upon ultimate settlement.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | FIN
48 applies to all tax positions related to income taxes subject to the Financial
Accounting Standard Board Statement No. 109, Accounting for Income Taxes(FAS
109). This includes tax positions considered to be routine as well as
those with a high degree of uncertainty.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | FIN
48 has expanded disclosure requirements, which include a tabular roll forward of the
beginning and ending aggregate unrecognized tax benefits as well as specific detail
related to tax uncertainties for which it is reasonably possible the amount of
unrecognized tax benefit will significantly increase or decrease within twelve months.
These disclosures are required at each annual reporting period unless a significant
change occurs in an interim period.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | FIN
48 is effective for fiscal years beginning after December 15, 2006. The cumulative effect
of applying FIN 48 will be reported as an adjustment to the opening balance of retained
earnings. The Company does not expect the adoption of FIN 48 will have any material
effect on its consolidated financial statements.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
September 2006, the FASB issued SFAS No. 157, Fair Value Measurements(SFAS
No. 157). This statement provides a single definition of fair value, a framework
for measuring fair value, and expanded disclosures concerning fair value. Previously,
different definitions of fair value were contained in various accounting pronouncements
creating inconsistencies in measurement and disclosures. SFAS No. 157 applies under those
previously issued pronouncements that prescribe fair value as the relevant measure of
value, except SFAS No. 123(R) and related interpretations. The statements does not apply
to accounting standards that require or permit measurement similar to fair value but are
not intended to measure fair value. This pronouncement is effective for fiscal years
beginning after November 15, 2007. The Company is currently evaluating the impact of
adopting SFAS 157.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 22

---

---



|OPTIBASE LTD. AND ITS SUBSIDIARY                           
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except share and per share data)

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

| | In
February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities (SFAS No. 159). This statement
provides companies with an option to report selected financial assets and liabilities at
fair value. Generally accepted accounting principles have required different measurement
attributes for different assets and liabilities that can create artificial volatility in
earnings. The Standards objective is to reduce both complexity in accounting for
financial instruments and the volatility in earnings caused by measuring related assets
and liabilities differently. This Statement is effective as of the beginning of an entitys
first fiscal year beginning after November 15, 2007. The Company is currently evaluating
the impact of adopting SFAS 159.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| |                               | December 31,
| | ----------------------------- | ------------
|
|
|
|
| | 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.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Realized
gains on sales of available-for-sale securities totaled $ 1,003, $ 36 and $ 10
in 2004, 2005 and 2006, respectively (Note 16c). Realized losses on sales of
available-for-sale securities totaled $ 0, $ 0 and $ 42 in 2004, 2005 and 2006,
respectively (Note 16c). 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 $ (459), $ (3,056)
and $ 1,566 in 2004, 2005 and 2006, respectively. As of December 31, 2005 and 2006,
the amount of other comprehensive losses is composed of unrealized losses, net.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Included
in the Companys investments are structured notes with an estimated fair value of
approximately $ 26,742 and $ 27,663 as of December 31, 2005 and 2006, respectively.
Such investments are used by management to enhance yields, diversify the investments, and
manage the Companys exposure to interest rate fluctuations. The notes were acquired
from several banks and were categorized as available-for-sale. The notes bear interest
based upon the rate of the 6 months LIBOR.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2006, the Company reclassified its structured notes having fair value
lower than the amortized cost as short-term and long-term investment, according to the
anticipated recovery date, since it believes that the decline in fair market value is not
other-than- temporary and it has the intent and ability to hold the structured notes till
recovery in accordance with SAB 59. As of December 31, 2006 the Companys investment
in marketable securities included continuous unrealized losses of $ 1,248 for a period
greater than 12 months.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 23

---

---



|OPTIBASE LTD. AND ITS SUBSIDIARY                           
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except share and per share data)

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

| |                                | December 31, 2005 | December 31, 2006
| | ------------------------------ | ----------------- | -----------------
|
|
|
|
| | Available-for-sale securities: |                   |                  
| | Matures in one year            |                   |                  
| | Matures from 1 to 5 years      |                   |                  
| | Matures from 6 to 10 years     |                   |                  
| |                                |                   |                  
| |                                |                   |                  
| | Total                          |                   |                  
| |                                |                   |                  

|NOTE 4: |  | OTHER
ACCOUNTS RECEIVABLE AND PREPAID EXPENSES
|------- | - | ----------------------------------------------

| |                        | December 31,
| | ---------------------- | ------------
|
|
|
|
| | Employees              |             
| | Government authorities |             
| | Prepaid expenses       |             
| | Interest receivable    |             
| |                        |             
| |                        |             
| |                        |             
| |                        |             

|NOTE 5: |  | INVENTORIES
|------- | - | -----------

| |                              |  | 
| | ---------------------------- |  | 
|
|
|
|
| | Raw materials and components |  | 
| | Work in progress             |  | 
| | Finished goods               |  | 
| |                              |  | 
| |                              |  | 
| |                              |  | 
| |                              |  | 

F - 24

---

---



|OPTIBASE LTD. AND ITS SUBSIDIARY          
|------------------------------------------
|                                          
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

|NOTE 6: |  | INVESTMENTS
IN COMPANIES
|------- | - | ------------------------

| | a. | In
November 2000, the Company signed an agreement with a privately held company,
               Mobixell Network, Inc. (Mobixell), according to which the
Company                has licensed Mobixell to use certain of its MPEG-4 technologies.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2006, the outstanding balance of $ 700 represents the investment in
Mobixell. As of December 31, 2006, the Company holds approximately 7.08% of Mobixells
equity. The investment is treated on the basis of the cost method.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | In
July 2001, the Company, invested $ 250 in a privately held company, V.Box
               Communication Ltd. (V. Box). The investment was made by way of
a                loan against a note that can be converted into Ordinary shares of V.
Box, at any                time, by a five-day prior written notice. The principal amount
of the loan                should be payable upon the earlier of: (i) July 1, 2010; (ii)
actual liquidation                of V. Box; or (iii) mutual consent of the Company and
the other investor of V.                Box. The loan does not bear interest. Through
December 31, 2006, the Company                invested an additional $ 2,322 in V.
Box in respect of additional                convertible notes, as described above. In
case of conversion, the Company will                hold approximately 34% of V. Box
Ordinary shares.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company recorded impairment losses in the amount of $ 574, $ 622 and $ 173 in
the years ended December 31, 2004, 2005 and 2006, respectively, which are included in the
statement of operations under other expenses (income), net. Please refer also to Note 17b.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|NOTE 7: |  | PROPERTY
AND EQUIPMENT
|------- | - | ----------------------

| |                                    | December 31,
| | ---------------------------------- | ------------
|
|
|
|
| | Cost:                              |             
| | Computers and peripheral equipment |             
| | Office furniture and equipment     |             
| | Motor vehicles                     |             
| | Leasehold improvements             |             
| |                                    |             
| |                                    |             
| |                                    |             
| | Accumulated depreciation           |             
| |                                    |             
| |                                    |             
| | Depreciated cost                   |             
| |                                    |             

| | As
for charges, see Note 10e.
| | -----------------------------

| | Depreciation
expenses amounted to $ 778, $ 1,049 and $ 1,106 for the years ended December 31,
2004, 2005 and 2006, respectively.
| | --------------------------------------------------------------------------------------------------------------------------------

| | As
for impairment charges in 2004, see Note 1c.
| | -----------------------------------------------

F - 25

---

---



|OPTIBASE LTD. AND ITS SUBSIDIARY          
|------------------------------------------
|                                          
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

|NOTE 8: |  | OTHER
ACCOUNTS PAYABLE AND ACCRUED EXPENSES
|------- | - | -------------------------------------------

| |                                                           | December 31,
| | --------------------------------------------------------- | ------------
|
|
|
|
| | Employees and payroll accruals                            |             
| | Royalties (see Note 10b)                                  |             
| | Accrued expenses                                          |             
| | Commitments related to European grant plan (see Note 10c) |             
| | Others                                                    |             
| |                                                           |             
| |                                                           |             
| |                                                           |             
| |                                                           |             

|NOTE 9: |  | SHORT-TERM
BANK CREDIT LINE
|------- | - | ---------------------------

| | As
of December 31, 2005 and 2006, the Company and its subsidiary had authorized lines of
credit in the amount of $ 10,434 and $ 13,228, respectively, out of which $ 434
and $ 828, respectively, are linked to the NIS and bear an annual bank interest rate of
Prime plus 1%-1.25%, and $ 10,000 and $ 12,400, respectively, bear an annual
interest rate of LIBOR plus 0.5%-0.65%. An amount of approximately $ 32,000 is
secured by marketable securities of the Company and its subsidiary.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company and its subsidiary had an utilized line of credit in the amount of $ 1,222
and $ 3,636 as of December 31, 2005 and 2006, respectively (there is no material fee
for the unused portion of the line of credit).
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|NOTE 10: |  | COMMITMENTS
AND CONTINGENT LIABILITIES
|-------- | - | --------------------------------------

| | a. | Lease
commitments:
| | -- | ------------------

| | The
Company and its subsidiarys facilities and motor vehicles are leased under several
operating lease agreements for periods ending in 2009.
| | ----------------------------------------------------------------------------------------------------------------------------------------------

| | Future
minimum lease commitments under non-cancelable operating leases are as follows:
| | --------------------------------------------------------------------------------------

| | Year ended December 31, | 
| | ----------------------- | 
|
|
|
|
| | 2007                    | 
| | 2008                    | 
| | 2009                    | 
| |                         | 
| |                         | 
| |                         | 
| |                         | 

| | As
of December 31, 2006, the Company and its subsidiary provided long-term deposits
amounting to $ 313 as collateral, in accordance with the lease agreements.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Rent
expenses amounted to $ 858, $ 804 and $ 607 for the years ended December 31,
2004, 2005 and 2006, respectively. Motor vehicle leasing expenses for the years ended
December 31, 2004, 2005 and 2006, were $ 682, $ 438 and $ 505, respectively.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 26

---

---



|OPTIBASE LTD. AND ITS SUBSIDIARY          
|------------------------------------------
|                                          
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

|NOTE 10: |  | COMMITMENTS
AND CONTINGENT LIABILITIES (Cont.)
|-------- | - | ----------------------------------------------

| | b. | Royalty
commitments:
| | -- | --------------------

| | The
Company participated in programs sponsored by the Israeli Government for the support of
research and development activities. The Company is obligated to pay royalties to the
Office of the Chief Scientist (OCS), amounting to 3%-5% of the sales of the
products and other related revenues generated from such projects, up to 100% of the
grants received, linked to the U.S. dollar and for grants received after January 1, 1999
also bearing interest at the rate of LIBOR. The obligation to pay these royalties is
contingent on actual sales of the products and in the absence of such sales, no payment
is required.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Through
December 31, 2006, the Company has paid or accrued royalties to the OCS in the amount of $ 3,620,
which was recorded under cost of revenues. As of December 31, 2006, the Company had an
outstanding contingent obligation to pay royalties in the amount of approximately $ 2,996
plus interest.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | The
Company is coordinating a consortium, TIRAMISU, in a two year collaborative
               project, which commenced on November 1, 2003, funded by the European 6th
               framework. The grants the Company receives from this project do not bear
any                repayment royalties. As a coordinator of this project, the Company
receives the                consortium funds from the European Commission and distributes
those funds to the                consortium members based on an agreement between the
consortium members. As of                December 31, 2005 and 2006, the Company holds a
pre-payment from the European                Commission amounting to $ 141 and $ 0,
respectively that is distributed to the                consortium members, according to
the payment schedule detailed in the consortium                agreement. The Company
presents this amount as Cash held in favor of other                consortium
partners.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | d. | Guarantees:
| | -- | -----------

| | As
of December 31, 2005 the Company has obtained a letter of credit in favor of a customer
and bank guarantees in favor of a lessor totaling $ 1,030. As of December 31, 2006 the
Company has obtained bank guarantees in favor of a lessor and the Israeli Chambers of
Commerce totaling $ 207.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | e. | Assets
pledged as collateral:
| | -- | -----------------------------

| | As
collateral for the Companys lines of credit, a fixed charge has been placed on the
Companys property and equipment, shareholders equity and a floating charge
(security interest in assets of the Company as they exist from time to time) has been
placed on all the other assets of the Company. Part of the Company and its subsidiarys
marketable securities are used as collateral for a line of credit (see Note 9).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | f. | Legal
claim andcontingent liabilities:
| | -- | --------------------------------------

| | On
September 13, 2005 the Company received a lawsuit filed by Vsoft Ltd. (Vsoft),
a company that is undergoing liquidation proceedings. Vsoft argues that Optibase failed
to act in good faith during 2002 negotiations regarding a potential purchase of a
controlling interest in Vsoft, which led to Vsofts entering into liquidation
proceedings. Vsoft has demanded damages in the amount of $ 2,129 as well as the
reimbursement of expenses, legal fees and applicable VAT. Based on facts known to the
Companys management, it believes that such claim is without merit.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 27

---

---



|OPTIBASE LTD. AND ITS SUBSIDIARY          
|------------------------------------------
|                                          
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

|NOTE 10: |  | COMMITMENTS
AND CONTINGENT LIABILITIES (Cont.)
|-------- | - | ----------------------------------------------

| | From
time to time, the Company is a party to claims arising in the ordinary course of its
business operations. In the opinion of management, it is not anticipated that the
settlement or resolution of any such matters, if any, will have a material adverse impact
on the Companys financial condition, results of operations or cash flows.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|NOTE 11: |  | OTHER
INCOME (EXPENSES), NET
|-------- | - | ----------------------------

| |                            | Year ended December 31,
| | -------------------------- | -----------------------
|
|
|
|
| | Impairment losses of V.Box |                        
| | Other income               |                        
| |                            |                        
| |                            |                        
| |                            |                        
| |                            |                        

| | (*) | On
February 5, 2002, the Company filed a claim with the New York stock
               exchange against Merrill Lynch & Co., for damages incurred as a result
of                Merrill Lynchs sale to the Company of unsuitable securities. On
               December 24, 2003, the panel awarded the Company $ 1,790 in
damages.                In February 2004, the Company received payments with regard to
this arbitration                and recorded other income in the amount of approximately $ 1,382,
net of                legal expenses.
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|NOTE 12: |  | TAXES
ON INCOME
|-------- | - | ---------------

| | a. | Measurement
of taxable income under the Income Tax (Inflationary Adjustments)           Law, 1985:
| | -- | --------------------------------------------------------------------------------------------------

| | Results
for tax purposes are measured in terms of earnings in NIS after certain adjustments for
increases in the Israeli Consumer Price Index (CPI). As explained in Note 2b,
the financial statements are measured in U.S. dollars. The difference between the annual
change in the Israeli CPI and in the NIS/dollar exchange rate causes a further difference
between taxable income and the income before taxes shown in the financial statements. In
accordance with paragraph 9(f) of SFAS No. 109, the Company has not provided deferred
income taxes on the difference between the functional currency and the tax bases of
assets and liabilities.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | Tax
rates:
| | -- | ----------

| | Until
December 31, 2003, the regular tax rate applicable to income of companies (which are not
entitled to benefits due to approved enterprise, as described below) was 36%.
In June 2004, an amendment to the Income Tax Ordinance (No. 140 and Temporary Provision),
2004 was passed by the Knesset (Israeli parliament) and on July 25, 2005,
another law was passed, the amendment to the Income Tax Ordinance (No. 147) 2005,
according to which the corporate tax rate is to be progressively reduced to the following
tax rates: 2004  35%, 2005  34%, 2006  31%, 2007  29%, 2008 27%,
2009  26%, 2010 and thereafter  25%.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 28

---

---



|OPTIBASE LTD. AND ITS SUBSIDIARY          
|------------------------------------------
|                                          
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

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

| | c. | Tax
benefits under the Law for the Encouragement of Capital Investments, 1959           (the
law):
| | -- | ----------------------------------------------------------------------------------------------------

| | The
Companys production facilities have been granted the status of an Approved
Enterprise under the law, for five separate investment programs, which were
approved in February 1991, January 1994, April 1998, May 2000 and January 2005. The
Company completed its investments according to its first, second, third and forth
programs on November 30, 1994, July 1, 1995, December 31, 1999 and October 2004,
respectively. The Company is in the process of implementing the fifth investment program.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | According
to the provisions of the law, the Company has elected the Alternative Benefitstrack
 waiver of grants in return for tax benefits. As of December 31, 2004 and 2005,
there were no outstanding loans and the right to receive such loans was terminated.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | According
to the provisions of the law, income derived from the Approved Enterpriseprograms,
under the Alternative Benefits track, will be tax-exempt for a period of two
years, commencing with the year in which the Company first earns taxable income and
subject to corporate taxes at the reduced tax rate of 10%-25%, for an additional period
of five to eight years (depending on the percentage of foreign investor ownership in the
Company).
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
law also grants entitlement to claim accelerated depreciation on equipment used by the
Approved Enterprise during first five tax years.
| | ---------------------------------------------------------------------------------------------------------------------------------------------

| | 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 years limitation
does not apply to the exemption period).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | If
the retained tax-exempt income is distributed in a manner other than upon the complete
liquidation of the Company, it would be taxed at the reduced corporate tax rate
applicable to such profits (between 10%-25%). The Company has decided not to declare
dividends out of such tax-exempt income.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
entitlement to the above benefits is conditional upon the Companys fulfilling the
conditions stipulated by the above law, regulations published hereunder and the
certificates of approval for the specific investments in Approved Enterprises.
In the event of failure to comply with these conditions, the benefits may be canceled and
the Company may be required to refund the amount of the benefits, in whole or in part,
including interest. As of December 31, 2006, management believes that the Company is
meeting all of the aforementioned conditions.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
April 1, 2005, an amendment to the Investment Law came into effect (the Amendment)
and has significantly changed certain provisions of the Investment Law. The Amendment
limits the scope of enterprises which may be approved by the Investment Center by setting
criteria for the approval of a facility as a Privileged Enterprise, such as
provisions generally requiring that at least 25% of the Privileged Enterprise income
will be derived from export. Additionally, the Amendment enacted major changes in the
manner in which tax benefits are awarded under the Investment Law so that companies, that
elect tax benefits under the Alternative Benefits track, no longer require
Investment Center approval in order to qualify for tax benefits.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 29

---

---



|OPTIBASE LTD. AND ITS SUBSIDIARY          
|------------------------------------------
|                                          
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

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

| | However,
the Investment Law provides that terms and benefits included in any certificate of
approval already granted will remain subject to the provisions of the law as they were on
the date of such approval. Therefore the Companys existing Approved Enterprise will
generally not be subject to the provisions of the Amendment.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Should
the Company derive income from sources other than the Approved Enterpriseduring
the relevant period of benefits, such income will be taxable at the regular Israeli
corporate tax rate.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Since
the Company is operating more than one Approved Enterprise and since part of
its taxable income is not entitled to tax benefits under the abovementioned law and is
taxed at the regular corporate tax rate, its effective tax rate is the result of a
weighted combination of the various applicable rate and tax exemptions, and the
computation is made for income derived from each program on the basis of formulas
specified in the law and in the approvals.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | d. | Tax
assessments:
| | -- | ----------------

| | The
Company has final tax assessments through the 2001 tax year.
| | ----------------------------------------------------------------

| | e. | Tax
benefits under the Law for the Encouragement of Industry (Taxation), 1969:
| | -- | ------------------------------------------------------------------------------

| | The
Company may currently qualify as an industrial company within the definition
of the Law for the Encouragement of Industry (Taxation), as such, it may be eligible for
certain tax benefits, including, inter alia, special depreciation rates for machinery,
equipment and buildings, amortization of patents, certain other intangible property
rights and deduction of share issuance expenses.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | An
industrial company owning an Approved Enterprise may choose between these
special depreciation rates and the depreciation rates available to the Approved
Enterprise.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Eligibility
for benefits under this law is not subject to receipt of prior approval from any
Government authority.
| | ------------------------------------------------------------------------------------------------------------------

| | f. | 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.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 30

---

---



|OPTIBASE LTD. AND ITS SUBSIDIARY          
|------------------------------------------
|                                          
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

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

| | g. | Deferred
income taxes:
| | -- | ----------------------

| | Deferred
income taxes reflect the net tax effects of temporary differences between the carrying
amounts of assets and liabilities for financial reporting purposes and the amounts used
for income tax purposes. Significant components of the Company and its subsidiarys
deferred tax assets are as follows:
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                                   | December 31,
| | ------------------------------------------------- | ------------
|
|
|
|
| | Operating loss carryforward                       |             
| | Reserves and allowances                           |             
| |                                                   |             
| |                                                   |             
| | Net deferred tax asset before valuation allowance |             
| | Valuation allowance                               |             
| |                                                   |             
| |                                                   |             
| | Net deferred tax asset                            |             
| |                                                   |             

| | The
Company and its subsidiary have provided valuation allowances in respect of deferred tax
assets resulting from tax loss carryforward and other temporary differences. Management
currently believes that, since the Company and its subsidiary 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 2006,
the Company and its subsidiary increased the valuation allowance by approximately $ 1,108.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | h. | Net
operating losses carryforward:
| | -- | ----------------------------------

| | Through
December 31, 2006, Optibase Ltd. had a net operating losses carryforward for tax purposes
in Israel of approximately $ 32,894 which may be carried forward and offset against
taxable income in the future, for an indefinite period.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2006, Optibase Inc. had U.S. federal net operating loss carryforward of
approximately $ 18,375 that can be carried forward and offset against taxable income
for 20 years, no later than 2007 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 - 31

---

---



|OPTIBASE LTD. AND ITS SUBSIDIARY          
|------------------------------------------
|                                          
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

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

| | i. | Reconciliation
of the theoretical tax expenses to the actual tax expenses:
| | -- | --------------------------------------------------------------------------

| | A
reconciliation between the theoretical tax expense, assuming all income is taxed at the
statutory tax rate applicable to the income of the Company and the actual tax expense as
reported in the statements of operations is as follows:
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                                                                     | Year ended December 31,
| | ----------------------------------------------------------------------------------- | -----------------------
|
|
|
|
| | Loss before taxes as reported                                                       |                        
| |                                                                                     |                        
| |                                                                                     |                        
| | Theoretical tax benefit computed at the statutory rate (35%, 34% and                |                        
| | 31% for the years 2004, 2005 and 2006, respectively)                                |                        
| | Tax adjustments in respect of currency translation                                  |                        
| | Income and other items for which a valuation allowance was provided                 |                        
| | Non-deductible write-off of in-process technology and amortization of  other assets |                        
| | Other non-deductible expenses                                                       |                        
| |                                                                                     |                        
| |                                                                                     |                        
| | Income tax expense                                                                  |                        
| |                                                                                     |                        

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

| |          | Year ended December 31,
| | -------- | -----------------------
|
|
|
|
| | Domestic |                        
| | Foreign  |                        
| |          |                        
| |          |                        
| |          |                        
| |          |                        

F - 32

---

---



|OPTIBASE LTD. AND ITS SUBSIDIARY                           
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except share and per share data)

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

| | a. | General:
| | -- | --------

| | 1. | The
Ordinary shares of the Company are traded on the NASDAQ Global Market since
          April 1999.
| | -- | -----------------------------------------------------------------------------------------------------

| | Ordinary
shares confer on their holders the right to receive notice to participate and vote in
general meetings of the Company, the right to a share in excess assets upon liquidation
of the Company, and the right to receive dividends, if declared.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | The
Companys share capital consist of 13,144,605, 13,291,618 and           13,473,865
issued and outstanding Ordinary shares, as of December 31, 2004, 2005           and 2006,
respectively.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | Stock
options:
| | -- | --------------

| | Since
1990, the Company has granted options to employees and directors to purchase Ordinary
shares.
| | ---------------------------------------------------------------------------------------------------

| | In
1999, the Company adopted an Israeli Option Plan (1999 Israeli option plan),
a U.S. Option Plan (1999 U.S. option plan) (collectively the 1999 plans).
Under the terms of the above option plans, options may be granted to employees, officers,
directors and various service providers of the Company and its subsidiary. Also, the
options generally become exercisable monthly over a four-year period, commencing one year
after date of the grant, subject to the continued employment of the employee. The options
generally expire no later than seven years from the date of the grant.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
April 2001, the Board of Directors of the Company approved the adoption of the 2001
Non-Statutory Share Option Plan. Under the terms of this plan, options may be granted to
available personnel, employees, directors and consultants. The options to be granted
under the plan are limited to non-statutory options. The plan has terms similar to those
contained under the 1999 U.S. Option Plan.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
May 1, 2003, the Board of Directors of the Company approved three years extension to the
options granted under the 1994 share option agreement. At the same date, the Company
adopted the Share Option Agreement 2003 in accordance with the amended
Section 102 of Israels Income Tax Ordinance.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
exercise price of the options granted under the plans may not be less than the nominal
value of the shares into which such options are exercised. Any options, which are
forfeited or cancelled before expiration, become available for future grants.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
total amount of options available for future grants as of December 31, 2006 was
1,303,137.
| | ----------------------------------------------------------------------------------------------

F - 33

---

---



|OPTIBASE LTD. AND ITS SUBSIDIARY                           
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except share and per share data)

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

| | A
summary of the Companys stock option activity, and related information, is as
follows:
| | -----------------------------------------------------------------------------------------

| |                                                                   | Year ended December 31
| | ----------------------------------------------------------------- | ----------------------
|
|
|
|
| | Outstanding at the beginning of the                               |                       
| | year                                                              |                       
| | Granted                                                           |                       
| | Exercised                                                         |                       
| | Forfeited                                                         |                       
| |                                                                   |                       
| |                                                                   |                       
| | Outstanding at the end of the year                                |                       
| |                                                                   |                       
| |                                                                   |                       
| | Exercisable options at the end of
   the year                     |                       
| |                                                                   |                       
| |                                                                   |                       
| | Options vested and expected to vest                               |                       
| | at end of year                                                    |                       
| |                                                                   |                       
| |                                                                   |                       
| | Weighted average fair value of
   options granted during the year |                       
| |                                                                   |                       

| | The
aggregate intrinsic value in the table above represents the total intrinsic value (the
difference between the Companys closing stock price on the last trading day of the
fiscal year 2006 and the exercise price, multiplied by the number of in-the-money
options) that would have been received by the option holders had all option holders
exercised their options on December 31, 2006. This amount changes based on the fair
market value of the Companys stock. The total intrinsic value of options
outstanding at December 31, 2006 was $ 997. The total intrinsic value of exercisable
options at the end of the year was approximately $ 911. The total intrinsic value of
options vested and expected to vest at December 31, 2006 was approximately $ 993. The
total intrinsic value of options exercised during the year ended December 31, 2006 was
approximately $ 260.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2006, there was $ 975 of total unrecognized compensation cost
related to non-vested share-based compensation arrangements granted under the Companys
stock option plans. That cost is expected to be recognized over a weighted-average period
of 3 years.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 34

---

---



|OPTIBASE LTD. AND ITS SUBSIDIARY                           
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except share and per share data)

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

| | The
options outstanding as of December 31, 2006, have been separated into ranges of exercise
price as follows:
| | --------------------------------------------------------------------------------------------------------------

| | Range of
exercise
price | Options
outstanding
as of
December 31, 2006 | Weighted average
number of years
remaining
contractual life | Weighted average
exercise
price | Options
exercisable
as of
December 31,
2006 | Weighted
average
exercise
price
| | ----------------------- | ------------------------------------------- | ----------------------------------------------------------- | ------------------------------- | ------------------------------------------- | -------------------------------
|
|
|
|
| | $            0.17       |                                             |                                                             |                                 | 1,590                                       |                                
| | $ 1.52 - $ 2.09         |                                             |                                                             |                                 | 8,000                                       |                                
| | $ 2.38 - $ 3.27         |                                             |                                                             |                                 | 822,615                                     |                                
| | $ 4.12 - $ 4.9          |                                             |                                                             |                                 | 29,500                                      |                                
| | $ 5.04 - $ 5.93         |                                             |                                                             |                                 | 932,695                                     |                                
| | $ 6 - $ 6.64            |                                             |                                                             |                                 | 198,500                                     |                                
| | $ 12.03 - $ 16.88       |                                             |                                                             |                                 | 128,022                                     |                                
| | $ 17.5 - $ 19.63        |                                             |                                                             |                                 | 32,000                                      |                                
| | $           23.75       |                                             |                                                             |                                 | 48,000                                      |                                
| | $           28.38       |                                             |                                                             |                                 | 4,000                                       |                                
| | $              32       |                                             |                                                             |                                 | 5,000                                       |                                
| |                         |                                             |                                                             |                                 |                                             |                                
| |                         |                                             |                                                            
| |                         |                                             |                                                             |                                 | 2,209,922                                   |                                
| |                         |                                             |                                                             |                                 |                                             |                                

| | c. | Nonvested
shares:
| | -- | -----------------

| | In
May 2006, the Board of Directors approved the adoption of the 2006 Israeli Incentive
Compensation Plan (the 2006 Plan). The 2006 Plan provides for the grant of
options, restricted shares and restricted share units in accordance with various Israeli
tax tracks. The Company currently uses the 2006 Plan for the grant of restricted shares
only. The restricted shares are granted at no consideration and with a vesting schedule
of two years (50% each year). The restricted shares are granted in accordance with the
Israeli capital gains tax track.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | A
summary of the status of the entitys nonvested shares as of December 31, 2006, and
changes during the year ended December 31, 2006, is presented below:
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------

| | Nonvested shares                | Shares | Weighted average
grant date fair value
| | ------------------------------- | ------ | --------------------------------------
|
|
|
|
| | Non-vested at January 1, 2006   |        |                                       
| |                                 |        |                                       
| | Granted                         |        |                                       
| | Vested                          |        |                                       
| | Forfeited                       |        |                                       
| |                                 |        |                                       
| |                                 |        |                                       
| | Non-vested at December 31, 2006 |        |                                       
| |                                 |        |                                       

F - 35

---

---



|OPTIBASE LTD. AND ITS SUBSIDIARY                           
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except share and per share data)

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

| | As
of December 31, 2006, there was $ 324 of total unrecognized compensation cost
related to nonvested share-based compensation arrangements granted to employees under the
Plan. That cost is expected to be recognized over a weighted average period of 2 years.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
total equity-based compensation expense related to all of the Companys equity-based
awards, recognized for the year ended December 31, 2006, was comprised as follows:
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                                            | Year ended
December 31,
| | ---------------------------------------------------------- | -----------------------
|
|
|
|
| | Cost of goods sold                                         |                        
| | Research and development                                   |                        
| | Selling and marketing                                      |                        
| | General and administrative                                 |                        
| |                                                            |                        
| |                                                            |                        
| | Total equity-based compensation expense before taxes       |                        
| |                                                            |                        
| |                                                            |                        
| | Net equity-based compensation expense, per Ordinary share: |                        
| | Basic and diluted                                          |                        
| |                                                            |                        

| | d. | Warrants
to consultants:
| | -- | ------------------------

| | In
June 2004, the Company has committed to grant warrants, in four equal installments, to
consultants to purchase 85,000 Ordinary shares of the Company at an exercise price of $
4.97 per share. The warrants expired after 20 months. During 2004 and 2005, the Company
issued 42,500 and 42,500 warrants under the 1999 Plans and recorded compensation expenses
in the amount of $ 77 and $ 73, respectively.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 36

---

---



|OPTIBASE LTD. AND ITS SUBSIDIARY                           
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except share and per share data)

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

| | a. | Summary
information about geographic areas:
| | -- | -------------------------------------------

| | The
Company and its subsidiary operate in one reportable segment: solutions that enable
preparation and delivery of digital video-based on MPEG and Windows Media TM over ATM,
DVB, the Internet Protocol (IP) and other packet-based networks (see brief
description in Note 1), and follow the requirements of Statement of Financial Accounting
Standard No. 131, Disclosures about Segments of an Enterprise and Related
Information (SFAS 131).
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
following presents total revenues for the years ended December 31, 2004, 2005 and 2006
and long-lived assets as of December 31, 2004, 2005 and 2006.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------

| |                            | Year ended December 31,
| | -------------------------- | -----------------------
|
|
|
|
| | Israel                     |                        
| | North America              |                        
| | Europe                     |                        
| | Far East (excluding Japan) |                        
| | Japan                      |                        
| | Other                      |                        
| |                            |                        
| |                            |                        
| |                            |                        
| |                            |                        

| | *) | Net
revenues are attributed to countries based on end-customer location.
| | -- | ------------------------------------------------------------------------

| | b. | Total
revenues from external customers per product line are divided as follows:
| | -- | -------------------------------------------------------------------------------

| |                    | Year ended December 31,
| | ------------------ | -----------------------
|
|
|
|
| | Video technologies |                        
| | IPTV               |                        
| |                    |                        
| |                    |                        
| |                    |                        
| |                    |                        

F - 37

---

---



|OPTIBASE LTD. AND ITS SUBSIDIARY                           
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except share and per share data)

|NOTE 15: |  | RELATED
PARTY TRANSACTIONS
|-------- | - | --------------------------

| | The
Company has signed sublease and distribution agreements with V. Box through December 31,
2005.
| | --------------------------------------------------------------------------------------------------

| | The
balances with and the revenues derived from related party were as follows:
| | ------------------------------------------------------------------------------

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

| |    |                                            | Year ended December 31,
| | -- | ------------------------------------------ | -----------------------
|
|
|
|
| | 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.
| | ----------------

F - 38

---

---



|OPTIBASE LTD. AND ITS SUBSIDIARY          
|------------------------------------------
|                                          
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                          
|U.S. dollars in thousands                 

|NOTE 16: |  | SELECTED
STATEMENT OF OPERATIONS DATA
|-------- | - | -------------------------------------

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

| |    |                                                                     | Year ended December 31,
| | -- | ------------------------------------------------------------------- | -----------------------
|
|
|
|
|
| |    | Total research and development costs                                |                        
| |    | Less - grants and participation                                     |                        
| |    |                                                                     |                        
| |    |                                                                     |                        
| |    |                                                                     |                        
| |    |                                                                     |                        
| |    |                                                                     |                        
| | b. | Allowance for doubtful accounts:                                    |                        
| |    |                                                                     |                        
| |    | Balance at beginning of year                                        |                        
| |    | Increase during the year                                            |                        
| |    | Write-off of bad debts                                              |                        
| |    |                                                                     |                        
| |    |                                                                     |                        
| |    | Balance at the end of year                                          |                        
| |    |                                                                     |                        
| |    |                                                                     |                        
| | c. | Financial income:                                                   |                        
| |    |                                                                     |                        
| |    | Financial income:                                                   |                        
| |    | Interest                                                            |                        
| |    | Foreign currency translation adjustments                            |                        
| |    | Realized gains on sale of available-for-sale marketable securities  |                        
| |    |                                                                     |                        
| |    |                                                                     |                        
| |    |                                                                     |                        
| |    |                                                                     |                        
| |    | Financial expenses:                                                 |                        
| |    | Interest                                                            |                        
| |    | Foreign currency translation adjustments                            |                        
| |    | Realized losses on sale of available-for-sale marketable securities |                        
| |    | Impairment of marketable securities                                 |                        
| |    |                                                                     |                        
| |    |                                                                     |                        
| |    |                                                                     |                        
| |    |                                                                     |                        
| |    |                                                                     |                        
| |    |                                                                     |                        
| |    |                                                                     |                        

F - 39

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|OPTIBASE LTD. AND ITS SUBSIDIARY                           
|-----------------------------------------------------------
|                                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                 
|                                                           
|U.S. dollars in thousands (except share and per share data)

|NOTE 16: |  | SELECTED
STATEMENT OF OPERATIONS DATA (Cont.)
|-------- | - | ---------------------------------------------

| | d. | Net
earnings (loss) per share:
| | -- | ------------------------------

| | The
following table sets forth the computation of basic and diluted net earnings (loss) per
share from continuing operations:
| | -----------------------------------------------------------------------------------------------------------------------------

| |                                                                                                                                 | Year ended December 31,
| | ------------------------------------------------------------------------------------------------------------------------------- | -----------------------
|
|
|
|
| | Numerator:                                                                                                                      |                        
| | Numerator for basic and diluted net earnings (loss) per share -                                                                 |                        
| | income (loss) available to shareholders of Ordinary shares                                                                      |                        
| |                                                                                                                                 |                        
| |                                                                                                                                 |                        
| | Numerator for basic and diluted net earnings (loss) per share -
     income (loss) available to shareholders of Ordinary shares |                        
| |                                                                                                                                 |                        
| |                                                                                                                                 |                        
| | Numerator for basic and diluted net earnings (loss) per share - loss                                                            |                        
| | available to shareholders of Ordinary shares                                                                                    |                        
| |                                                                                                                                 |                        
| |                                                                                                                                 |                        
| | Denominator:                                                                                                                    |                        
| | Denominator for basic net earnings (loss) per share- weighted
     average number of Ordinary shares (in thousands)             |                        
| |                                                                                                                                 |                        
| | Effect of dilutive securities:                                                                                                  |                        
| | Employee stock options (in thousands)                                                                                           |                        
| |                                                                                                                                 |                        
| |                                                                                                                                 |                        
| | Denominator for diluted net earnings (loss) per share - adjusted
       weighted average number of shares (in thousands)        |                        
| |                                                                                                                                 |                        

| | *) | Antidilutive.
| | -- | -------------

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

| | a. | In
January 2007, the Company purchased 3,035,223 Ordinary shares of Scopus Video
               Networks Ltd (Scopus), representing approximately 23% of
Scopus                issued share capital, from Koor Corporate Venture Capital and Koor
Industries                Ltd. at an aggregate purchase price of approximately $ 16,000.
The Company is                currently evaluating the accounting treatment of its
investment in Scopus under                the guidance of APB 18.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | During
the first quarter of 2007, the Company invested an additional $ 154 in V.
               Box in respect of additional convertible notes.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------

F - 40

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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.

|Date: May 14, 2007 |  | OPTIBASE LTD.By:   /s/ Tom Wyler
Tom WylerPresident and Chief Executive Officer
|------------------ |  | ---------------------------------------------------------------------------------------------

- 78 -

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# Exhibit Index

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

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

|1.2 |  | Amended
Articles of Association of the Company (incorporated by reference to Exhibit 3.2 to the
Company's registration statement on                              From S-8 (File no.
333-137644), filed with the Commission on September 28, 2006).
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.1 |  | Patent
Purchase Agreement between Optibase, Inc. and Acoustic Technology LLC dated June 16, 2005
(incorporated by reference to Exhibit 4.(a)(1) to the Companys annual report on
Form 20-F for the fiscal year ended December 31, 2005, filed with the Commission on April
12, 2006).
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.2 |  | Agreement
between Optibase, Inc. and Artel Software Corp. dated September 28, 2005 (incorporated by
reference to Exhibit 4.(a)(2) to the Companys annual report on Form 20-F for the
fiscal year ended December 31, 2005, filed with the Commission on April 12, 2006).
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.3 |  | Agreement,
dated as of January 9, 2007, between the Company and Koor Corporate Venture Capital and
Koor Industries Ltd.
|--- |  | -----------------------------------------------------------------------------------------------------------------------

|4.4 |  | Form
of Letter of Indemnity between Optibase Ltd. and its directors and officers (incorporated
by reference to Exhibit 99.3 to                              Company's Report on Form
6-K, filed with the Commission on October 5, 2005).
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.5 |  | Form
of Letter of Indemnity between Optibase, Inc. and its directors and officers
(incorporated by reference to Exhibit 4.9 to the Companys annual report on Form
20-F for the fiscal year ended December 31, 2002, filed with the Commission on June 30,
2006).
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.6 |  | 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).
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.7 |  | 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).
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.8 |  | 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).
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------

|4.9 |  | 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).
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.10 |  | 2001
Non-statutory Share Option Plan as amended and Form Option Agreement (incorporated by
reference to Exhibit 10.5 to the Companys annual report on Form 20-F for the fiscal
year ended December 31, 2000, and with respect to an amendment, by reference to Exhibit
99.7 to the Companys Report on Form 6-K, filed with the Commission on February 15,
2002).
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.11 |  | 2003
Amendment to the 1999 Israel Share Option Plan (incorporated by reference to Exhibit
4.(c). 9 to the Companys annual report on Form 20-F for the fiscal year ended
December 31, 2003, filed with the Commission on May 17, 2004).
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.12 |  | 2006
Israeli Incentive Compensation Plan (incorporated by reference to Exhibit 4.1 to the
Company's registration statement on From                              S-8 (File no.
333-137644), filed with the Commission on September 28, 2006).
|---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|8.1 |  | List
of the subsidiaries of the Company (incorporated by reference to Exhibit 8.1 to the
Companys annual report on Form 20-F for the fiscal year ended December 31, 2003,
filed with the Commission on May 17, 2004).
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|11.1 |  | Code
of Business Conduct and Ethics (incorporated by reference to Exhibit 11 to the Companys
annual report on Form 20-F for the fiscal year ended December 31, 2003, filed with the
Commission on May 17, 2004).
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|12.1 |  | 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.
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

- 79 -

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

|12.2 |  | 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.
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|13.1 |  | Certification
by Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|---- |  | ---------------------------------------------------------------------------------------------------

|13.2 |  | Certification
by Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|---- |  | -------------------------------------------------------------------------------------------------------

|15.1 |  | Consent
of Kost, Forer Gabbay & Kasierer, a member of Ernst & Young Global.
|---- |  | ---------------------------------------------------------------------------

- 80 -

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